Do you have an employer sponsored pension plan? Consider yourself lucky. Today fewer than three in 10 Canadians have a company pension plan – and those who do face an uphill battle with their savings. While low interest rates are welcomed if you’re paying off debt like a mortgage or credit card, they pose a challenge for retirees and company pension plans who depend on interest rates for decent returns.
Despite the low rate environment, though, new developments are in store for pensions in 2013. The Mercer Pensions Health Index reached 91 per cent for May, up from 86 per cent in April and 82 per cent at the beginner of 2013.
Behind the Numbers
So why is the solvency of pension plans all of a sudden improving? “Pension plans are getting a boost from three key sources: buoyant equity markets, rising long-term interest rates and plan sponsors making contributions to fund the deficits,” says Manuel Monteiro, a partner in Mercer’s financial strategy group. “For many plan sponsors, getting back to a fully funded status is now clearly in sight.”
In layman’s terms, similar to when the Loonie appreciates in value, this is a good news, bad news story depending on which side of the fence you sit. Rising Government of Canada bond yields have already led lendersTD and RBC to increase their fixed mortgage rates. Meanwhile, the balance sheets of company pension plans have benefited from these higher yields. Increasing long-term Government of Canada bond yields means lower pension liabilities, as they are used to measure pension plan solvency. Long-term bond yields are already up 20 basis points in May, since the start of 2013, according to Mercer. Pension plans have also reaped the rewards of the robust performance of foreign stocks markets like the S&P 500, which is up a stellar 15.4 per cent so far this year.
Understanding Pension Valuation
Company pension plans invest millions of dollars for their hard-working employees. Not only does the pension fund have to be well managed to meet the needs of current retirees, there has to be enough money left over when active employees eventually retire. That’s where actuarial valuations come into play. Pension plans are typically given a “checkup” in the form of a valuation at least once every three years. The valuation looks at the plan assets versus its liabilities to see if it’s in good shape. Pensions are valued in two ways: going concern and solvency basis. Going concern assumes the pension plan will continue indefinitely, while solvency basis assumes the pension plan will end at the valuation date (usually December 31st).
What Pension Members Should Know
If you’re a member in your company’s pension plan, it’s important to monitor your plan’s solvency. Last year’s annual pension statement usually goes out in the mail by the end of June. You can find out the health of your pension plan under the “plan funding” section. While you shouldn’t be too concerned if your pension plan is less than 100 per cent funded, there could be measures put in place, like holding back a portion of your pension when you leave your employer, if your pension plan becomes too underfunded.
Investment Economies of Scale
One of the major benefits of pension plans is investment economies of scale. Canadians pay on average an MER (management expenses ratio) of 2.5 per cent on Canadian stock mutual funds. That’s 2.5 off the top before you’ve even made a penny. Sure, you can buy low-cost investments like ETFs or Index Funds, but you’ll still pay some sort of MER.
Size really does matter when it comes to investing. Large pension funds manage their investments at a fraction of the cost individual investors can only dream of. The top 10 largest pension funds in Canada manage their investments at a cost of only 0.3 per cent, according to The Boston Consulting Group. Not only are their expenses a lot lower, they have access to large investments individual investors are shut out from.