Cdn companies slower to react to market volatility than in U.K./U.S.

The past year's financial market turbulence has many Canadian organizations contemplating – but not yet implementing – actions to better manage the risks associated with their defined benefit (DB) pension plans, according to a new survey conducted by Hewitt Associates, a global human resources consulting and outsourcing company. More than 400 organizations from around the world responded to Hewitt's 2009 Global Pension Risk survey, including 80 from Canada.

From mid-June to early November of 2008 the aggregate funded ratio of S&P/TSX company-sponsored defined benefit plans dropped from 112 per cent to 86 per cent. By the end of November 2009, their funded ratio had improved to 97 per cent. Against this backdrop of extreme volatility, this year's responses, gathered in September 2009, indicate some change in attitude toward pension risks on the part of plan sponsors since the 2008 survey conducted before the financial crisis. However, unlike their counterparts in the U.K. and U.S., employers in Canada are not rushing to make changes, preferring to take a more cautious approach to pension risk management.

One explanation for this lag is provided by responses to questions regarding the business impact of higher company contributions to pension plans. Of the 84 per cent of respondents expecting to have to make higher contributions as a result of the credit crisis, only four per cent felt that the additional contributions would have a significant impact on their business.

"Funding relief measures provided by pension regulators clearly softened the blow of the events of the past 18 months," says Rob Vandersanden, a senior pension consultant in Hewitt's Calgary office. "However, 55 per cent of Canadian employers indicated they would not be taking advantage of the relief measures, primarily because they were not cash constrained. Perhaps, like Canadian banks, plan sponsors in Canada did not suffer from the effects of the credit crisis to the same extent that organizations in other countries did."

Increasing financial risks
Despite their commitment to DB plans – Canada continues to have the lowest global incidence of plan closures – Canadian employers are at least a year behind American and British organizations in implementing pension risk measures. "In the 2008 global survey, it was clear that U.S. and U.K. companies recognized the importance of pension risk, but weren't taking active steps to manage it," says Andrew Hamilton, a Toronto-based senior retirement consultant with Hewitt. "Now there has been a surge of activity in those two countries."

"What was particularly surprising is the fact that 44 per cent of Canadian DB plan sponsors have not yet developed a long-term strategy for managing pension risk, despite the fact that the recent credit crunch made it clear the world over that doing so is vital," says Hamilton. "This is especially alarming given the fast-approaching transition date to international accounting standards in 2011. The new standards will result in even greater financial statement volatility associated with pension costs than under the current Canadian standards. For private sector plan sponsors subject to the new rules, a lack of planning for the increased financial risks could mean lower returns to shareholders in the future."

Strategies to manage risks
Canadian employers are taking some action, however. "What is encouraging is that 45 per cent of organizations with DB plans are at least measuring their pension risk more often," says Vandersanden.

In addition, in terms of investment changes, there are two dominant strategies: a greater diversification of return-seeking portfolios (out of Canadian equities and into alternative asset classes and foreign equities), as well as a net movement towards more liability-driven investment strategies (liability-matching assets, liability driven investment (LDI) strategies and dynamic asset allocation).

While employers in the U.S. and U.K. are showing significant interest in delegated investment services that allow them to delegate all or part of the investment process, this is still a new concept in Canada. "Other than monitoring investment managers, there has not been a significant movement towards delegating more of the investment process to outside professionals," states Vandersanden. "This is a strategy more employers will want to consider as they move to managing their pension risk more proactively."

In addition to the investment strategies that are already being considered, Vandersanden highlighted other key initiatives Canadian employers with DB plans should think about to better manage pension risks:

  • Review the objectives for the pension plan and make sure they are consistent with the direction the company's business is taking and the "new normal" economy post-2008. If things have changed, it may be time to consider plan design changes.

  • Consider benefit changes as a middle road between continuing with the current plan, which may have become too costly, and closing the plan altogether. It may be possible to prospectively increase pensionable age, increase member contributions or reduce accrual rates. Other possibilities that are more common in other countries are to introduce caps on pensionable earnings and convert any post-retirement pension increases to lump sums.

  • Look at the plan's pension risks in detail to ensure the options are clear for slicing and dicing risks-equity, interest rate, inflation and longevity. Which risks are acceptable to retain and what price is the company willing to pay to remove the others?

"While Canadian organizations trail those in the U.S. and U.K. in terms of taking action to manage pension risk, we expect that to change significantly over the next year in the face of increased volatility and expected regulatory and accounting changes," says Vandersanden. "Employers with DB plans will want to measure their risk exposures and then take action to ensure they are manageable. The events of the last year have underlined the importance of having a long-term strategy and monitoring process in place."

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