Wednesday, August 7, 2013

New Worries For Corporate Plans?

Tara Perkins of the Globe and Mail reports, Growing lifespans the latest worry for pension plans:
Canadian companies are facing higher pension costs after an influential group published new research that suggests workers are living longer than previously thought.

For the first time, the Canadian Institute of Actuaries (CIA) commissioned studies based on Canadian lifespans, rather than relying on data from the United States. The studies found that life expectancies are on the rise: A 60-year-old man, for instance, is now projected to live another 27.3 years, up from 24.4 years.

The numbers matter to business because most corporate pension plans use the institute’s mortality tables as a starting point when calculating the future cost of pensions. Towers Watson, a consulting firm, says that while the impact will vary from one pension plan to another, acceptance of the new mortality tables could “immediately increase pension accounting liabilities by 5 to 10 per cent for many plans, potentially impacting corporate income statements and balance sheets.”

The firm noted that the change comes just as corporate treasurers began to hope that rising stock markets and interest rates would improve the fortunes of their pension plans, many of which are badly underfunded.

“We are edging closer to a crisis,” said Jim Leech, chief executive officer of the Ontario Teachers’ Pension Plan. “Pension plans and sponsors need to come to grips with the volatility in the marketplace and the fact that people are living longer, and therefore have to save more.”

The new mortality tables will not have a direct impact on Teachers, one of Canada’s largest pension funds, because it has its own records dating back to 1917 and so crafts mortality tables based solely on the lifespans of teachers. But Mr. Leech knows the added burdens that assumptions about longer lifespans can cause. Like the general population, teachers are living longer, and that finding has already been worked into Teachers’ assumptions of future costs.

“Since I’ve been CEO, we’ve adjusted the mortality table three times – in 2007, 2010 and again in 2012,” Mr. Leech said. “Cumulatively, those three changes amounted to just under $10-billion of increase in liabilities.”

Teachers had $129.5-billion of assets at the end of last year.

The Canadian Institute of Actuaries’ new numbers are based in large part on a study of pensioners in the Canada Pension Plan and Quebec Pension Plan, which looked at the mortality of people who were collecting from those plans between 2005 and 2007.

The draft tables suggest that the life expectancy of a 60-year-old man is 2.9 years longer than under the current tables, while the life expectancy of a 60-year-old female is 2.7 years longer (rising to 29.4 years from 26.7 years), Towers Watson points out.

Jacques Lafrance, president of the Canadian Institute of Actuaries, said that most corporate pension plans rely on these mortality tables, although they might make their own adjustments based on their employee base. For instance, companies with white-collar employees might expect longer lifespans than average, while companies in the mining sector might expect shorter lifespans, he said.

He added that plans with more active workers and fewer retirees will generally face a larger impact than those with the reverse situation. The new mortality table will have an impact on the cash contributions that must be made into plans, as well as the way corporations account for their plans on their books.

“What the new table is showing is that we were somewhat wrong with our prediction, that it was not conservative enough, and that in fact people are living even longer than we expected,” Mr. Lafrance said.

Mr. Leech said pension plans and sponsors need to address longer lifespans by changing the rules around pensions.

“The retirement age needs to go up,” he said. “Guaranteed benefit levels shouldn’t necessarily have all the bells and whistles. Things like early retirement provisions, the ability to retire when you’re 55, it’s nice but somebody has to pay for it. … These things need to be made contingent, so they’re not guaranteed; they’re there if there is enough money for them.“

The CIA’s draft mortality tables are open for comment until the end of September.
You can view the draft report and mortality tables on CIA's website here. Jim Leech, CEO of the Ontario Teachers' Pension Plan, is right, we are edging closer to a pension crisis and plan sponsors need to address longer lifespans by changing the rules around pensions. The retirement age needs to increase and early retirement programs should be abolished or significantly curtailed.

It's worth noting the two main determinants of pension liabilities are interest rates and lifespans. The drop in interest rates and longer lifespans are why pension deficits ballooned all over the world. The strong performance of equity markets have helped cushion the blow but investment gains alone aren't enough to address ever widening deficits.

In the UK, Sarah Mortimer of Reuters reports, Pension deficits still widening at top UK companies:
The pension funding gap of Britain's top companies has widened in the past year despite billions of pounds of corporate cash being injected into retirement schemes, a report said on Tuesday.

Pension consultants LCP said pension scheme deficits for companies in the UK's FTSE 100 blue chip stock index grew to 43 billion pounds at June 30 compared with 42 billion a year before, as fund assets didn't generate enough cash to cover obligations.

The finding is an illustration of the impact of repeated rounds of "quantitative easing", under which the Bank of England has been buying back bonds to boost economic growth, contributing to a sharp drop in the yield on British government gilts - a staple investment for pension funds.

Pension funds have been left searching for higher-yielding investments such as real estate while they wait for gilt yields to turn higher.

The problem is not small, given FTSE 100 member companies remain responsible for pension liabilities worth nearly 0.5 trillion pounds, according to LCP.

"The (pension fund) deficit remains stubbornly high in spite of 21.9 billion pounds in company contributions," LCP said in its 20th annual survey of FTSE 100 company pension schemes.

The consultancy - whose deficit estimate is based on the companies' own actuarial forecasts for their pension obligations - also noted Britain has seen many governmental and regulatory changes, including the "auto-enrolment" initiative.

"Pension planning continues to be blighted by seemingly constant regulatory and legislative change," said LCP partner and report author Bob Scott.
While UK corporations are struggling with their pension deficits, the situation in the United States has dramatically improved over the last year. An analysis by Milliman shows the funded status of the 100 largest corporations improved by $23 billion in July and by a stunning $388 billion over the last 12 months, resulting in the lowest pension deficit since June of 2011:
Milliman, Inc., a premier global consulting and actuarial firm, today released the results of its latest Pension Funding Index, which consists of 100 of the nation's largest defined benefit pension plans. In July, these plans experienced a $26 billion increase in asset value and a $2 billion increase in pension liabilities. The pension funding deficit dropped from $182 billion at the end of June to $158 billion at the end of July.

"The last 12 months were the best 12-month period for corporate pension funded status in the history of our study," said John Ehrhardt, co-author of the Milliman Pension Funding Index. "We've seen gains in nine out of the last 12 months for a total improvement of $388 billion. Just to put that improvement in its proper perspective, consider that the total projected benefit obligation for these 100 pensions stood at $762 billion when we started analyzing these 100 plans 13 years ago. This has been a historic rally for pensions—hopefully it will continue."

Year-to-date, assets have improved by $60 billion and the projected benefit obligation has been reduced by $172 billion, resulting in a $233 billion improvement in funded status and increasing the funded ratio to 89.7%.

Looking forward, if the Milliman 100 pension plans were to achieve the expected 7.5% median asset return for their pension plan portfolios, and if the current discount rate of 4.73% were maintained, funded status would improve, with the funded status deficit narrowing to $128 billion (91.7% funded ratio) by the end of 2013 and $44 billion (97.2% funded ratio) by the end of 2014.
The complete Milliman study can be viewed here. The improvement in the funded status of the largest  U.S. corporate pension plans over the last 12 months is good news and suggests that the situation isn't as dire as other studies suggest.

Below, Bob Scott, partner at LCP, tells CNBC that UK pension funds "aren't about to run out of money." Mr. Scott is right, it's important to look at pension funds for the long-term and realize that over time, higher rates and investment gains will help bolster the funded status of corporate plans.