Pensions Plans on the rebound

[Kip Powick]

Pension plans have rallied to the relief of retirees, shareholders and taxpayers, yet most plans are still in the emergency room.

A typical plan is about a third of the way back to the health status of mid-2007, thanks to three short months of rising stock prices and interest rates.

Pension consultants say the swift and sharp improvement has reduced the state of panic around all but those companies at risk of a bankruptcy that would lead to the slashing of pension payments.

Yet further improvements in health remain uncertain and, even when things get better, ever fewer young employees may enjoy the sort of company-guaranteed pension benefits their elders enjoyed.

"The level of concern, rightly or wrongly, is much better than in March, when people were horrified," says Mercer consulting actuary Malcolm Hamilton.

His company's pension health index tracks the percentage of pension benefits a hypothetical company would be able to pay if it were to cease operations and pay benefits earned to date from the interest on government bonds.

Mercer's index bounced up to 71 per cent by the end of June, up from 59 per cent at the start of the year, thanks to a combination of a 5.6 per cent investment gain and a rise in interest rates that reduced the estimated cost of paying future benefits. Yet the typical plan was still funded at well below the level charted in early 2002.

Meanwhile, a similar index of funding levels produced by Watson Wyatt Worldwide has jumped to 75 per cent from a low of 61 per cent. Watson assumes employers would have started making extra contributions when their plans fell short of funds. The index also incorporates a recent relaxation of actuarial standards.

Watson actuary Ian Markham and Mercer's Hamilton predict that the upset of a second stock market crash in a decade could drive more employers to cut off new entrants to their pension plans, and to invest more heavily in government bonds to reduce risk.

"We may get to the point where pension sponsors say the risk is too high," Hamilton says. "When you put money in the stock market, you expect to earn a higher return (than on bonds), but stocks do badly at inopportune times."

While stock prices may recover over the next three to five years, Mercer consultant Paul Forestell says many employers will still want to take 10 years instead of the usual five to restore their plans to withstand an insolvency.

He said some employers are faced with paying 30 per cent of payroll to maintain and restore their pension plans over five years, and 20 per cent over 10 years.

Ontario, other provinces and the federal government have offered companies the extra time, provided no more than a third of employees and/or pensioners object.

Forestell said pension-funding levels would improve markedly if interest rates on long-term government bonds were to rise by a percentage point.

The cost of paying earned benefits with bonds would fall by 10 to 15 per cent if rates rose a single point. Plans with more retirees than active workers would save the least.

Few economists foresee such a big change within a year or so, however. So members of poorly funded plans have to hope their companies will stay in business.

Carlos Leitao of Laurentian Bank Securities predicts a decline in interest rates, which would make things worse for pension plans and weak employers.

Leitao says the decline in rates will occur as investors realize how slowly economies are going to grow and how little chance there is of price inflation over the next two or three years.