Better investment performance helps improve funding ratios in third
TORONTO, Nov. 5 /CNW/ - Better investment returns in the third quarter of 2009 have improved funding ratios for defined benefit pension plans, according to Towers Perrin, but this should not lull companies into believing that their deficit troubles are behind them. In its 2009 Third Quarter Capital Market Update, the accounting funded ratio of Towers Perrin's benchmark plan at September 30, 2009 is still slightly below the ratio measured at December 31, 2008.
Impact on Corporate Financial Results
By the end of 2008, total defined benefit pension accounting deficits of Canadian public companies ballooned to $11 billion versus $5 billion one year earlier, while the total value of deferred pension costs grew to $20 billion in 2008 compared to $11 billion in 2007, according to Towers Perrin's annual report Trends & Directions in Pension Financial Impact. For this study, Towers Perrin reviewed key financial results from 2008 which were disclosed in the annual reports of 86 large companies traded on the Toronto Stock Exchange. According to the report, pension expense for 2008 totalled $3 billion or $16 million for the median company. This reduced aggregate operating income by 4.3% or 4.1% for the median company in 2008. "The impact of the downturn will start to be a drag on performance in 2009 as some of the deferred costs are captured in 2009 pension expense," says Karen Figueiredo, a Principal of Towers Perrin.
These deferred costs represent 9% to 10% of operating income for the median company in the sample, states the report.
The financial crisis led to a median fund return of -15% for the 86 companies included in the Towers Perrin report, but the impact on the financial position of the decline in asset values was cushioned by the dramatic increase in the average accounting discount rate from 5.50% at the end of 2007 to 6.56% at the end of 2008. According to Towers Perrin's Third Quarter 2009 analysis, the benchmark plan's 60% equity / 40% fixed income portfolio reported gains of 13.6% in 2009 year-to-date. However, discount rates used to measure defined benefit plan obligations have dropped in 2009, which could more than offset investment gains in financial results.
Impact on Cash Flow
The Pension Financial Impact report indicated that company contributions in 2008 and 2007 remained level in nominal terms for the median company (4.6% and 4.7% of the aggregate cash flow from operations, respectively) and represented a smaller draw on company cash flows than 2006 (5.7%). Still, plan sponsors could face significant demands for cash payments to repair new or larger pension deficits when funding valuation reports come due. Solvency funding measures will drive cash contribution requirements for many plan sponsors.
"Positive investment returns in 2009 may well be more than offset by increases in solvency liabilities caused by decreases in discount rates used for the solvency measure" says Figueiredo. "Smoothing techniques as well as the temporary funding relief measures introduced in many jurisdictions may provide some flexibility to sponsors. However, we conducted an informal survey of actions taken by sponsors of Ontario-registered plans this year, and few were taking advantage of the full extent of funding relief available, particularly those options which require some form of member consent."
Where to Next?
In the near term, plan sponsors should estimate the year-end balance sheet entry, 2010 income statement expense, and anticipated cash contribution requirements using today's assets and liabilities. As part of this planning process, sponsors should also develop illustrations of further changes in capital markets - for the better and for the worse.
At the same time, they should be thinking about how to manage their pension plan "subsidiary" in the long-term. "Plan sponsors remain largely commited to their defined benefit plans", says Jean-Remi Mayrand, Retirement practice leader for Towers Perrin in Montreal. In a survey released earlier this year by Towers Perrin and CFO Research Services, over 70% of finance executives in Canada indicated that they will focus on viability of their plans rather than seek alternatives to defined benefit and over 75% indicated that they intend to focus on risk reduction strategies over seeking additional returns.
"The need to rebalance the level of pension cost and risk is coming at a challenging time for some companies, which need to convert to IFRS (International Financial Reporting Standards). These accounting standards may have a major impact on how pensions affect corporate financial results since the volatility of pension plan funded status will become more visible on public companies' balance sheets," said Mayrand .
"To deal with their pension deficit issues, sponsor companies may need to consider all of the available levers -- funding, design, accounting and investment strategies -- to adjust levels of pension costs and risk exposure within their overall enterprise," Mayrand concludes.
About Towers Perrin
Towers Perrin is a global professional services firm that helps organizations improve performance through effective people, risk and financial management. The firm provides innovative solutions in the areas of human capital strategy, program design and management, and in the areas of risk and capital management, insurance and reinsurance intermediary services, and actuarial consulting. Towers Perrin has offices and alliance partners in the United States, Canada, Europe, Asia, Latin America, South Africa, Australia, New Zealand and the Middle East. More information about Towers Perrin is available at www.towersperrin.com.
SOURCE TOWERS PERRIN
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