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How solid are private-sector pension plans?

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VICTORIA — My most recent column focused on the enormous, unfunded public pension liabilities that represent a ticking financial time bomb for our country’s governments and taxpayers. But even where the pensions of public and private sector workers are backed up by invested assets, how solid is that funding base compared to retiree obligations?

A documentary co-produced by the Cormana Group and Ontario Teachers’ Pension Plan entitled Pension Plan Evolution delves into that question. The $117 billion Teachers’ Pension Plan is considered one of Canada’s best run, with an average annual return of 10 per cent since 1990. Despite that performance, the plan’s actuarial liability is growing faster than its assets, resulting in an unfunded liability of some $10 billion.

In a covering letter sent with the documentary video to business leaders across Canada, then Teachers’ CEO Jim Leech stated: "Pension plans across the globe are facing the same set of challenges . . . changing demographics, low interest rates and slow growth economies all serve to complicate the already ponderous issues of pension fund financial sustainability and intergenerational equity".

The documentary hi-lights some of those "ponderous issues". Fund growth has been seriously hampered as returns on low risk investments such as government bonds have fallen from 4 per cent to 1 per cent. On the cost side, the addition of progressively more generous benefits such as early retirement options and inflation indexing have coincided with a two-year per decade increase in retiree life expectancy. While the documentary doesn’t purport to have the solution, one commentator states that we need to "lengthen the work dimension and shorten the post-work dimension".

The issues raised in the documentary are reinforced by a Dominion Bond Rating Service (DBRS) report released last year that investigated 461 defined benefit pension plans in Canada, the United States, Japan and Europe. The conclusion: "For the first time since DBRS began evaluating the health of pensions, the aggregate pension deficit has fallen into the "danger zone", with just 41 per cent of the funds remaining "in good shape".

The evidence is clear. Traditional "defined benefit" plans that guarantee pensioners a fixed retirement payout based on a combination of years worked and earnings during the final (and usually highest) working years are almost completely unfunded in the public sector and financially unsustainable in the private sector.

This begs the huge question: Are defined benefit pension plans doomed?

In the private sector, that question is already being answered in the affirmative. Many of our country’s biggest companies have shifted to "defined contribution" (DC) plans wherein the employer and the employee contribute a percentage of earnings, with the employee’s pension payout dependent upon the accumulated value of invested funds at retirement.

One upside for employees is that invested assets are completely portable should they change jobs. The huge advantage for employers is that, since there is no guaranteed pension payout, no funding deficits can occur. This is driving a strong trend to DC plans across the corporate world. As of June 30, 2012, just 11 American Fortune 100 companies offered a traditional defined benefit plan to new employees. There is also a strong trend towards DC plans in Canada and Europe.

So far, few governments have followed the corporate world’s lead. But mushrooming unfunded public pension liabilities, together with increasing taxpayer pressure, make the status quo impossible to sustain. The Netherlands is leading the way with a "shared risk" public pension structure wherein factors such as economic growth (or lack of it) impact pension payouts.

New Brunswick, facing a billion dollar pension funding shortfall, has introduced a shared-risk plan based on the Dutch model. The collaboratively designed plan, which attempts to combine the most important features of DB and DC plans, has been widely embraced by public sector unions worried that existing plans are doomed to failure. Changes include moving the pension to a percentage of career-average earnings rather than final salary and raising the minimum age for retiring without a reduction to 65 from 60. New Brunswick’s announcement stated that the changes "Addresses demographic challenges that make the current system unsustainable, including fewer people working and a larger number of retirees who are living longer".

Those words describe the challenge facing both private and public pensions around the globe.

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