Aon plc (AON), released new analysis of the Canadian findings of its 2013 Global Pension Risk Survey, which confirms that many pension plan sponsors are taking a wide range of actions to manage the risk of their defined benefit (DB) plans.
Just a reminder that a defined benefit plan is a type of pension plan in which an employer/sponsor promises a specified monthly benefit on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns.
The other type of pension plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. Individual accounts are set up for participants and benefits are based on the amounts credited to these accounts (through employer contributions and, if applicable, employee contributions) plus any investment earnings on the money in the account. Only employer contributions to the account are guaranteed, not the future benefits.
The survey found that a majority of Canadian plan sponsors:
- Are managing risk in their DB plans with strategies increasingly grounded in long-term planning;
- Are establishing clear long-term goals that are monitored and measured as standard practice;
- Are paying closer attention to plan funding and viewing performance as critical; and,
- Are actively managing investment strategies with a focus on liabilities and are paying increased attention to diversification and alternative investments such as real estate.
Plans in different sectors are using varying approaches when they see a need to make changes to DB plan benefits.
The private sector plans are more likely to make fundamental changes to member benefits. Like corporate plans in other parts of the world, many Canadian sponsors have already closed or intend to close plans to new members, freeze accruals for existing members, and/or switch to a pension structure where more of the risks are borne by plan members.
On the other hand, there is a strong commitment to DB plans in the public sector. Sponsors are more likely to look for adjustments to benefits or cost structures that maintain the form of the benefit but at a level that is more manageable for plan sponsors. Many sponsors are looking at ways to make the underlying benefit less costly, and the vast majority are contemplating further cost sharing with members.
There is considerable interest in finding out more about the "target benefit plan" concept, although it is a relatively new way to manage many of the risks inherent in traditional DB plans and defined contribution plans and legislation is still outstanding in most jurisdictions.
(Target benefit plans are similar to defined benefit plans in that the annual contribution is determined by a formula to calculate the amount needed each year to accumulate (at an assumed interest rate) a fund sufficient to pay a projected retirement benefit, the target benefit, to each participant upon reaching retirement. It is similar to a defined contribution plan in that the plan does not guarantee any benefit will be paid. The plan's only obligation is to pay whatever benefit can be provided by the amount in the contributor’s account)
Most DB plan sponsors are employing a cautious combination of passive and active measures to meet funding obligations. There is an encouraging trend toward investment diversification and de-risking practice, though many continue to rely on passive measures such as interest rate increases to boost their funding position. Letters of credit continue to be underutilized, despite being useful in some cases for managing short-term contribution volatility. Letters of credit can be used to satisfy solvency funding requirements by securing funding obligations rather than making cash contributions.
As well as having choices in managing benefits, plan sponsors also have an increasing array of tools that can be used to manage plan liabilities. Annuity options are increasingly marketed by insurance providers and are popular in other parts of the world. The popularity of annuities in Canada can be expected to grow given the private sector trend toward plan closures and freezes. Annuity purchases can reduce pension liability by transferring some or all of a plan's benefit obligations to an insurance carrier. They can be used by plan sponsors wanting to exit the DB business, and also by those wanting to de-leverage an ongoing plan.
The growing focus on risk may well be the catalyst for the dramatic growth in monitoring practices as years of discussion are finally transformed into actionable strategy. Recognition of the need for pension plan sustainability, supported by long-term goals and strategic planning to support robust, reduced-risk plans, is gaining momentum. It is apparent that sponsors are not only mindful of the need for long-term planning, but that plans are also focused on achieving established and measurable goals.
Copies of the report on the Pension Risk Survey are available at http://www.aon.com/canada/attachments/thought-leadership/report_Global_Pension_Risk_Survey_2013_EN_highlights.pdf
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