Employers’ pension risk a balancing act

As employers look to limit risks by moving away from defined-benefit pension plans they face another potential danger: an unhappy workforce.

A shaky global economic outlook makes life difficult for many defined-benefit plan sponsors, consultancy Mercer told a forecast forum this week in a new survey that predicts interest rates will likely remain stagnant in 2013.

Among the tools to manage risk is the option to change pension plan design, namely switching to defined-contribution plans, which require more active involvement from employees.

Earlier this month, Mercer said the solvency of Canadian defined-benefit pension plans got a small boost last year, but that was largely due to bigger employer contributions to finance deficits, which can be a massive hit to a company's bottom line.

"The financial markets and the pressures that DB plan sponsors are under because yields have come down and because asset performance hasn't kept up has just been another knife in the coffin for DB plan sponsors," said Sofia Assaf, principal with Mercer's investment group .

"There really aren't many organizations unless you're going to the public sector that will offer you a rich DB plan these days. A lot of organizations in the private sector have DC plans set up for new employees. It's where the trend is going."

Herein lies the challenge: employers want to offload risks to employees, but that change could potentially give rise to generally low employee morale and loss of star performers.

Defined-benefit plans are designed to provide a predictable income for retirement, but they expose companies to risk if the fund assets are unable to pay for the benefits guaranteed to retirees due to choppy markets.

In contrast, defined-contribution plans are designed so a company's contribution is capped and payouts are dependent on the performance of underlying assets with investment choices made by workers.

In Canada, Assaf noted that some 60 per cent of registered pension plans are defined-benefit, while 35 per cent of registered pension plans are defined-contribution. The remainder is a hybrid.

"Over time we're going to see that most companies are going to have DC plans. Whether you're unhappy at company A or company B that's the reality," she said.

Meantime, 38 per cent of chief financial officers don't think employees can make appropriate investment decisions, while 37 per cent didn't know, according to the survey. Twenty-five per cent believed employees could make investment decisions.

"There's a need from plan sponsors to provide as much support as possible to members to ensure they have all the investment education and retirement tools available to them to be able to make those investment decisions themselves," said Assaf.

Even as companies are squirmy with the level of risk they are bearing, many are reluctant to reduce their exposure immediately by shifting from equities into bonds when interest rates are so low and their plan is poorly funded.

Pension funds are affected by low interest rates because they result in rising liability levels.

Manager expectations regarding bond yields were mixed, according to the outlook. Two-thirds expect short rates to remain stable, while a small majority of managers expect longer bond yields to increase modestly from current levels over the year.

Given low return expectations from bonds and uncertainty in equities, many sponsors and DC plan members are looking to alternative investments such as real estate, infrastructure, private equity and hedge funds to better diversify their investment portfolio, Mercer says.