(August 17, 2012) – Defined benefit (DB) pension funds are sliding into the “danger zone” of underfunding, according to a comprehensive study of 451 large Canadian and American plans by ratings agency and research firm DBRS.
More than two-thirds of plans did not meet the researchers’ “reasonable funding” threshold of 80%. (And that’s lowballing, according to a major actuarial group.) In total, 69% of plans’ funded status fell in 2011, making it the second-worst year behind 2008 in the study’s 10-year analysis.
“In order for companies to address this funding gap, employers will have to maintain high levels of contributions, as many plans have now entered the danger zone of funded status,” said James Jung, a senior vice president at DBRS, in a statement.
At 81.7%, the aggregate funded status of all 451 plans is not as low as one might expect. However, that’s down from 85.1% in 2010, and exactly on par with the 2002 level. The aggregate funded status “has not recovered since the 2008 economic downturn as the low interest rate environment has more than offset the benefits from asset performance and sponsor contributions,” according to the report. Over the last two years, “persistent weakness in the global economy, despite stimulus efforts and considerable liquidity injections, decreased returns on assets and drove down interest rates. As a result, pension deficits skyrocketed.”
In last year’s study, DBRS concluded fully funded status was possible by 2012. They have since revised their optimistic outlook, and consider full funding not achievable until at least 2014. Nevertheless, the researchers concluded that four factors will likely lead to the health of DB pension funds to improving over time:
1. Interest rates will eventually rise, which will reduce the obligation side of the balance sheet through higher discount rates
2. Companies have maintained strong balance sheets, which should allow for greater contributions.
3. The evolution of regulatory changes requires companies to eliminate plan deficits over the long term.
4. The relative size of a company’s obligation should gradually fall as fewer employees are added to the plans because of a shift to defined contributions, outsourcing and/or reduced labour requirements.
North American DB plans may improve in health, but are not likely to grow in number. “We’re seeing fewer companies offering defined benefits to new employees,” said Jung. “These plans are difficult to manage and they are overly burdensome.” Somewhere, a few CIOs are nodding vigorously.