More pension plans move into surplus as market returns improve
More than a third of defined benefit plans surveyed recently are more than fully funded
The huge Ontario Teachers’ Pension Plan (OTPP) is the latest defined benefit pension plan in Canada to report a much-improved financial position, thanks to healthy stock markets and higher long-term interest rates.
The OTPP today reported a surplus of $5.1 billion – its first surplus in 10 years – with the plan 103 per cent funded.
"A preliminary surplus is good news, however our plan continues to face demographic challenges as well as market uncertainty," said OTPP chief executive Ron Mock. "That's why representatives of the [Ontario Teachers Federation], the government and Teachers' management are working together to ensure the plan's sustainability."
In recent years, for instance, the plan’s sponsors made inflation protection dependent on the financial health of the plan.
The OTPP isn’t the only defined benefit pension plan to see its fortunes improve.
A survey released this week by Aon Hewitt of more than 275 such plans from the public and private sectors in Canada found that the median solvency ratio – the market value to plan assets over plan liabilities – stood at 95.4 per cent on March 27. That’s a 21 percentage point increase over the same quarter a year ago.
The main driver of the improvement was strong equity markets. Canadian equities returned almost five per cent in the first quarter of this year, while U.S equities returned 4.6 per cent. That added to the double-digit gains that North American markets scored in 2013. The declining value of the Canadian dollar also helped as it boosted the domestic market value of U.S. assets.
36% of plans fully funded
More than a third of the plans Aon Hewitt surveyed — 36 per cent — were more than fully funded. Just three per cent could say the same thing a year ago.
“Strong equity market returns have been positive for [defined benefit] plans, but that’s not the only story,” said Ian Struthers, a partner at Aon Hewitt. “Last year, we saw improvements across the board from strong market returns, increased contributions and higher interest rates.”
But Struthers noted that while the most recent quarter this year was positive, benchmark yields and emerging markets suffered losses. “Today, we’re seeing a more dynamic world, which creates volatility.”
By the Numbers:
38.4%: Percentage of employees covered by a workplace pension plan
4.48 million: Number of Canadians with a defined benefit pension plan
1 million: Number of Canadians with a defined contribution pension plan
Source: Statistics Canada, Dec. 31, 2011
With a defined benefit pension, the plan is obliged to pay a promised amount to retirees, regardless of how well its investments have performed.
These plans, which are common in the public sector but much less so in the private, guarantee a preset lifetime pension. The better plans include partial or full inflation indexing. Both the employee and the employer contribute. But it’s the employer’s responsibility to make sure that the plan is properly funded to pay the promised benefits. Any shortfalls in the plan’s funding must be made up entirely by the employer.
In the case of public sector employers, that means the taxpayer is responsible for solving the pension deficit problem.
In the private sector, many employers have dealt with the pension deficit problem by closing their defined benefit plans to new enrolment and require new hires to enrol in the other kind of plan – the defined contribution, or DC, pension plan. Under a defined contribution plan, a member receives a set amount that they then invest to pay for their retirement.
In past years, the health of defined benefit pension plans has been a major issue for many of Canada's largest corporate names as record low interest rates and poor market returns drove up the liabilities of those plans and forced the companies to make large contributions to return the plans to solvency.
The drive is on now to "de-risk" defined benefit pension plans. Having some benefits, like indexing, depend on investment returns is a solution that is being adopted by more plan sponsors, including several public and private sector plans in New Brunswick.