Companies may have to double DB pension contributions in 2012

Aon Hewitt said the median pension solvency funded ratio — the ratio of the market value of plan assets to liabilities — is approximately 15% lower this year than at the start of 2011.

“With the solvency position of these plans only in the 68% range — down from around 83% a year ago — plan sponsors that will file an actuarial valuation this year will need to add extra funds to comply with minimum funding rules that assure DB plans can meet their pension promises,” its said.

“As a result, employers may be pressing pension regulators for further funding relief, if such relief has not already been granted.”

However, not all plan sponsors are in the same boat, Aon Hewitt says, noting those that have taken defensive positions by increasing the ratio of bonds to equities have experienced a lower drop in their solvency position.

“Increasing investment in bonds from 40% to 60% would have meant a drop to only a 71% solvency ratio, rather than 68%,” said Andre Choquet, an investment consultant with Aon Hewitt in Toronto.

“Three per cent may not sound like much, but it means a $3 million smaller shortfall to fund on a $100-million pension plan.”

Choquet also recommends a better match between bond and liability duration, noting that pension plans typically invest in universe bonds, with terms of mainly between five and 10 years.

“Switching to long bonds, with maturity between 10 and 30 years more closely match the plan’s liabilities cash flows and helps assets and liabilities behave in tandem when interest rates fluctuate,” he said.

Tom Ault, a vice-president with Aon Hewitt in Vancouver, said that given the likelihood of more economic uncertainty in the coming year, all DB plan sponsors should reconsider their approach to risk management.

Among other things, he recommends organizations take another look at pension plan design, funding policy and contribution strategy.

Dynamic investment policies are also becoming more prevalent.

“These policies, in particular dynamic de-risking policies that reduce risk as a plan’s funded ratio improves, reduce risk and long-term costs, while taking the emotional element out of asset mix decisions,” said Ault.

“Such policies can be tailored to a low-interest rate environment, allowing for some downside protection, while leaving room for some improvement if interest rates rise.”

In Canada, only about four in 10 workers have defined benefit plans, which seek to guarantee a set amount of income on retirement.

As a result, many such employers are switching to defined contribution plans in which the eventual payout is determined by the long-term investment performance of the plan fund.

Attempts to overcome low interest rates with equity investments have met limited success.

For example, the Mercer Pension Health Index released Thursday showed that despite a rebound in stock markets in October, the solvency of most Canadian pension plans failed to improve in the fourth quarter due to a further drop in federal bond yields.

The Mercer index has fallen 13% to 60 in the past year, measured against a model reading of 100 for pension solvency.

And on Wednesday, pension consulting firm Towers Watson said the deteriorating health of Canadian pensions in 2011 is likely to convince more employers to shift burdens to employees this year and force an increase in retirement ages.