Pensions at Risk?

I was in Toronto on Tuesday for a conference by Global Insights where I listened to a few interesting presentations, including one from a senior economist at the IMF. I also visited my favorite senior pension fund manager who took some time to share his thoughts with me.

I will come back to this Toronto trip a little later this week. First, more pension news. Paul Delean of the Montreal Gazette writes pensions at risk:

Carl Sinclair recently got a letter no pensioner wants to see. It informed him a 31-per-cent reduction in his monthly cheque was probably just months away.

"My first reaction was 'Good Lord, what are we going to do?,' " said Sinclair, 73, a Montreal native who lives in a home he built himself with his wife, Muriel, his partner of 55 years, near the U.S. border in the Quebec village of Piopolis.

Sinclair worked 35 years in a variety of jobs for what was once considered one of the premier Canadian companies, Nortel, which now is in the throes of a major restructuring.

He retired in 1994 with an indexed pension that currently pays him about $22,000 a year.

"I thought," he said, "that pensions were protected, that it was 100 per cent guaranteed."

Not under existing rules, they're not, although federal and provincial governments are pledging action to provide more safeguards.

Rollbacks of defined-benefit pensions (which are supposed to provide steady payments for life based on years of service and salary) still are rare in Canada, but the number is expected to grow as plan managers grapple with the combined effects of stock-market turbulence, record-low interest rates, a troubled global economy, downsizing, corporate "contribution holidays" and longer life expectancy for beneficiaries.

The federal Office of the Superintendent of Financial Institutions, which regulates 400 defined-benefit pension plans, reported that, as of June 30, the average plan was 88 per cent funded, meaning the total value of assets was 12 per cent lower than liabilities.

"Even if your employer is in good shape, it may seek permission to change the plan so you won't get as much pension for future service as you've earned in the past," notes financial commentator Bruce Cohen, co-author of The Pension Puzzle guidebook.

Cohen said members of many plans now pay higher contributions than before, and many employers have switched to defined-contribution plans, under which they pay a specified amount annually toward employee retirement plans but transfer responsibility for managing the funds to the beneficiary.

That leaves the investment risk squarely on employees, who may or may not make informed choices and, with few exceptions, underperform professional managers, resulting in a smaller retirement nest egg.

Government employees aren't as vulnerable on the pension front - their employers won't be going out of business anytime soon - but they could face concessions as well, particularly in the area of indexation, if the disparity between the retirement incomes of private and public-sector workers becomes a source of social discord.

"As we speak today, the future of Canadians in retirement is one of two solitudes," Cohen said. "There'll be a group of well-off retirees, mainly public employees and people who were fortunate enough to be good savers in their lives with good RRSPs, and everyone else. A majority of the population will be squeezed. The average baby boomer will not be able to realize the retirement vision he or she had a few years ago."

Pension concerns aren't limited to the 40 per cent of Canadians who belong to corporate or government plans.

There is mounting financial pressure as well on Old Age Security, available to virtually all Canadians age 65 and older, and the Canada and Quebec Pension plans, which start paying benefits as early as age 60.

A large cohort of new retirees, living longer because of improved healthcare, nutrition and exercise, risks skewing projections and sapping financial reserves much earlier than forecast.

Disastrous results like the 2008 loss of $39.8 billion by the Caisse de dépôt et placement du Québec, which manages the QPP and other pension monies, only add to the strain.

QPP dues from active workers and their employers have risen steadily over the years from 3.6 per cent of insurable earnings (roughly the average national wage) to a combined 9.9 per cent now, and may be headed for double digits. An actuarial study that predated by a year the stock-market meltdown of 2008 said the QPP contribution rate needed to be increased again, to 10.5 per cent, or the program won't be sustainable beyond 2050 at current rates. The number of QPP recipients is expected to double by 2030 to more than 2.4 million.

While today's employees are contributing more, to support those who came before, there's no guarantee they'll get as much down the line. Where there are three contributors today for every QPP recipient, there'll be fewer than two by 2020.

Actuaries also have floated the idea of pushing back the start of OAS payments to age 67 or even 70, though Ottawa has given no indication it's leaning that way.

If need be, Cohen said it's more likely to implement a benefit-reduction strategy such as basing OAS clawback calculations on family rather than individual income.

"OAS is affordable as long as the government keeps its books in order," Cohen said. "The future of OAS as it exists today will depend on the success of the federal government in doing that."

Employment trends, including anticipated shortages in many fields, also suggest most Canadians will continue working to some degree for the first 10 or 15 years of their retirement.

Unfortunately, that's not an option for Sinclair, who's been out of the workforce for 15 years and last year had a kidney transplant after five years on dialysis.

A pension rollback of almost $7,000 a year inevitably will cause some lifestyle disruption, said Sinclair, who took out a mortgage for an $85,000 home renovation last year and also has lease payments on a new van.

Other than the Nortel pension, his only income sources are the Canada Pension Plan, OAS and $115 a month from U.S. Social Security.

Already, his life has begun to change. The cranberry juice recommended by doctors to help his kidneys is out: too expensive. So are the $15 haircuts. Now he gets a brushcut at home every month.

"It was a lovely life," he said, "until this last shock."

Bertrand Marotte of the Globe and Mail reports that The Caisse's disastrous results in 2008 have prompted them to go back to basics:

The Caisse de dépôt et placement du Québec has gone back to basics in its investment strategy but will continue to play a leadership role in advancing the province's economic development, says chief executive officer Michael Sabia.

“We have regrouped around the basic functions of the Caisse and we have accelerated a plan of action to better manage risk,” Mr. Sabia said Tuesday.

“We have simplified our structures and investment strategies. We have moved away from complex derivative products,” he said at a Caisse-sponsored conference on entrepreneurship in the changing global economic order.

He added that the Caisse – which posted huge losses last year in the financial meltdown, and was heavily exposed to the toxic non-bank asset-backed commercial paper market as well as high-risk derivatives, real estate and private equity sector – does not intend to retrench as a key player in helping boost the fortunes of Quebec companies at home and abroad.

“In Quebec, we have a very important competitive advantage, which we have to use: we know Quebec and its economy deeply.

That translates into the ability to produce solid returns for its depositors and thus does not present the dilemma of having to make a choice between promoting Quebec's economic development and seeking out the best returns, he said.

The Caisse has a dual mandate of both helping Quebec companies and producing the best investment returns for its 25 depositors, such as the Quebec Pension Plan.

“The two go together,” Mr.Sabia said.

Mr. Sabia – who took over as president and CEO of the Caisse in March – also said today that the $120-billion public pension fund has several “projects on the table” that it will announce over the next few months.

Finally, Reuters reports that European companies underestimating their pension obligations:

Top European firms are underestimating their pension obligations by 300 billion euros (270 billion pounds), led by Royal Bank of Scotland and Lloyds Banking Group, according to a study.

Lloyds has underestimated its obligations by 14.2 billion euros, more than any other European company, followed by RBS, which has unrecognised liabilities of 13.3 billion euros, according to calculations by equity research firm AlphaValue.

Lloyds and RBS are, respectively, 43 percent- and 70 percent-owned by the state after receiving taxpayer-funded bailouts during last year's banking crisis.

The third-biggest underestimation is at British Airways, currently in the process of merging with Spanish rival Iberia, AlphaValue said.

The size of BA's pension deficit, currently being reviewed by the airline and its retirement fund trustees, could yet derail the tie-up between the two carriers, with Iberia reserving the right to back out if the shortfall is bigger than expected.

According to AlphaValue, the British carrier's true pensions obligation is 10.5 billion euros higher than the company's own estimate.

AlphaValue said many companies had underestimated their true pension obligations by assuming a low level of wage inflation, and by adopting a high discount rate in calculating the present value of future payouts.

The combined pensions deficit of 430 major listed European firms rose 22 percent to 280 billion euros last year, according to the companies' own calculations, AlphaValue said.

That left an additional unacknowledged pension obligation of 300 billion euros, equivalent to 9 percent of the shareholders' equity in the companies, it added.

The global affront on pensions continues. The rebound in stocks will offer a temporary reprieve, but the underlying structural problems remain and unless governments take this issue seriously, there will be many more pensions at risk.