Pensions Posting Dramatic Rebound?
Canadian pension plans posted a major turnaround last year as strong returns made all their “dreams come true,” and are looking forward to another positive year in 2014 that could push many into unaccustomed surplus status.And Benefits Canada reports, Largest U.S. pension plans could be fully funded by end of year:
Pension plans saw their funded status in 2013 hit the highest level in 12 years as stock market returns soared and bond yields climbed. The picture could brighten even further this year as most investment categories are expected to post gains, according to a new forecast from pension consulting firm Mercer.
The average plan in Canada was 99.9 per cent funded at the end of 2013, Mercer said, meaning it had nearly all the assets needed to provide pensions to plan members if it were wrapped up immediately. Only 6 per cent of plans were below 80 per cent funded. Those figures are based on data from 607 public and private sector funds that are Mercer clients.
Calculations of funding levels are volatile because they depend on long-term interest rates, which are used to calculate the size of a fund’s liabilities. But the numbers do indicate a dramatic turnaround.
A year ago, 60 per cent of pension plans were less than 80 per cent funded and companies were facing huge cash hits to improve their plan funding.
The big swing in pension plans’ fortunes over the past year could reduce the need over the long term for companies to add extra cash to their plans to make up funding shortfalls, removing a major risk from their balance sheets.
“2013 is the year that our pension investment dreams came true,” said Hari Pushparaj, a senior associate in Mercer’s investment division.
Paul Forestell, Mercer’s retirement practice leader, said pension plans would see their funded status improve by a further 3 per cent this year if forecasts prove accurate. That would push the funding of an average plan in Canada into a surplus by the end of 2014.
According to Mercer’s annual pension “Fearless Forecast,” which is based on a survey of 47 institutional money managers, Canadian stocks are expected to post 8-per-cent returns this year after climbing 13 per cent last year and international equities are expected to grow by 9.1 per cent compared to 32 per cent last year. Bonds are expected to post returns of 1.5 per cent after losing 1.2 per cent last year.
“If all this came true, pension plans would have a good year,” Mr. Forestell said in an interview.
Some Canadian companies with large pension plans have already begun signalling improvements due to better market conditions.
Air Canada, which had a pension deficit of $3.7-billion at the start of 2013, said its pension deficit fell by over $900-million to $2.8-billion as of May 31 because of high interest rates and better-than-expected investment returns, and would fall by another $1.1-billion once negotiated changes to the pension benefits received regulatory approval.
In November, Air Canada chief financial officer Mike Rousseau said the pension deficit has continued to improve since June. The airline will give out more information when it releases its year-end financial statements in February, spokesman Peter Fitzpatrick said Thursday.
Other manufacturers and industrial companies with huge pension liabilities have also reported benefiting from better market conditions. Bombardier Inc. spokeswoman Isabelle Rondeau said the company’s liability for retirement benefits fell by $663-million in the first nine months of the year due to increased interest rates and good returns on investments. Bombardier reported a $3-billion liability for retirement benefits at the end of 2012.
Mr. Forestell said with many plans nearing 100 per cent funded status, companies are starting to grow concerned about over-contributing and parking unnecessarily high levels of cash in the pension plan.
“If your plan is closed and you’re at 98 per cent funded, you’re not looking to get to 110, because there’s no reason for you to put any more money into that plan,” he said.
Instead, he anticipates many companies approaching full funding will seize the opportunity to “derisk” their pension plans by moving some investment assets out of stock markets – which can be highly volatile – and into other assets that may not have as much potential to grow quickly, but also are not likely to fall as sharply.
Mercer said even smaller pension plans are increasingly moving assets into alternative categories such as private equity, hedge funds or real estate. In 2010, 25 per cent of Mercer’s pension clients invested in alternative categories beyond stocks and bonds, but that proportion climbed to 38 per cent last year.
The largest corporate DB plans in the United States had a strong 2013, and it’s possible that they could reach fully funded status by the end of this year.The U.S. data is based on the largest corporate pension plans but rising rates and booming stock markets also helped bolster public plans.
The corporate pension plans of the Milliman 100 Pension Funding Index had a strong year as liabilities decreased by US$190 billion and assets increased by US$128 billion. It was the first time since its year-end 2007 report that liabilities decreased and assets increased in the same year.
The funded ratio was 95.2% as of Dec. 31, 2013, 18 percentage points higher than the 77.2% funded ratio at the beginning of 2013.
“Just to put this rally in perspective, these pensions saw a US$337-billion decrease in funded status in 2008, and, in the past year, we saw a $318-billion improvement,” says John Ehrhardt, a principal and consulting actuary at the firm. “These plans’ performance in 2013 nearly erased the losses of 2008. We are getting back on track.”
If the pension plans were to achieve the expected 7.5% median asset return for their portfolios and the current discount rate of 4.83% were maintained during 2014 and 2015, Milliman forecasts this would result in a projected pension surplus of US$14 billion (funded ratio of 100.9%) by the end of 2014 and a projected pension surplus of US$106 billion (funded ratio of 106.8%) by the end of 2015.
Under an optimistic forecast with rising interest rates (reaching 5.43% by the end of 2014 and 6.03% by the end of 2015) and asset gains (11.5% annual returns), the funded ratio would climb to 113% by the end of 2014 and 134% by the end of 2015.
In fact, 2013 was as good as it gets for pensions, which is why we see many have now achieved fully funded status. And as long as rates keep climbing and stocks keep soaring, we'll see even better figures next year.
What does a fully funded status imply? Unfortunately, it means the race to de-risk corporate pensions will gather steam in the United States and Canada. This is bad news for many employees but great news for insurers profiting from pension risk transfers.
You should all go back to read my recent comment on curing pension envy to understand what needs to be done to bolster defined benefit plans for everyone. As far as the shift into alternatives, I remain very skeptical and think most pensions will get clobbered when the next crisis hits.
Finally, please remember to contribute to this blog by clicking on the PayPal buttons on the top right-hand side. I thank all of you who have graciously contributed and understand the value of the information I provide.
Below, Pension Partners Chief Investment Strategist Michael Gayed discusses the state of retail with Trish Regan and Adam Johnson on Bloomberg Television’s “Street Smart.” Remeber to read my outlook 2014 for my market insights. Have a great weekend.