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DBRS: Defined-benefit pension plans are DOOMED

Funding gap for employers in Canada and U.S. keeps widening, the rating agency found


 

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TORONTO – A review of 451 defined-benefit pension plans in Canada and the United States by debt rating agency DBRS has found the gap between plan assets and obligations widened significantly last year.

DBRS says several factors have contributed to the revised outlook, including continuing low interest rates.

The review found the combined funding deficit at the 451 defined-benefit plans ballooned to an unprecedented $389 billion in 2011.

DBRS said that more than two-thirds of the defined benefit plans it reviewed this past year were underfunded by “a significant margin.”

Under defined benefit plans, employees generally make set contributions and are guaranteed a specific monthly retirement income. Any shortfall in the ability of the plan to make those payments is usually the employer’s responsibility, although there have been cases where the cost threatens the business.

DBRS says the funding gap has forced employers and their employees to increase contributions and the rating agency warned that this can put companies with defined benefit plans at a competitive disadvantage.

“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,” DBRS senior vice-president James Jung said in the report

Although there is no set number for adequate funding, DBRS has identified 80 per cent as “a reasonable funding threshold.”

Based on this threshold, more than two-thirds of plans reviewed this past year were underfunded by a significant margin, it said.

Moreover, DBRS said it believes that defined-benefit plans will be slowly unwound and removed over the next 40 years.

“These plans are difficult to manage and they are overly burdensome,” Jung said. “We’re seeing fewer companies offering defined benefits to new employees.”

The study notes a growing trend of employers offering workers defined-contribution plans rather than defined-benefit plans in the United States, which is reflective of the trend in Canada and abroad as well.

Defined-contribution plans effectively shift the risk of investment performance to the employee since both employer and employee make set contributions and the eventual payout is subject to vagaries of the market.


 
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DBRS: Defined-benefit pension plans are DOOMED

  1. Defined benefit pension plans are pretty much the original fatally flawed financial derivative product foisted upon the world.

    Defined contribution plans are not more risky than defined benefit plans. They are just more volatile, because one can “see the sausage being made” instead of hiding the volatility behind financial derivatives and actuarial manipulation, which leads one to be too complacent and not save enough.

    Retirement is ultimately funded out of invested savings, whether they be through DC or DB. i.e. In the long run, both are dependent on the growth of the economy, and on how much you save.

    Defined contribution is just more mark-to-market. You know exactly where you are closer to real time and have a better sense of whether you are saving and investing enough.

    Defined benefit is mark-to-model. As with all structured finance products (like CDO’s), one is relying on mathematical models that tell you things will always work out in the end. The trouble with this mathematical models is that they underestimate tail risk. Financial markets blow up more frequently than the models assume, which make the derivative models unreliable, and the DB pension plans end up underfunded.
    (i.e. since 1990, Mexican credit crisis, Asian financial panic, Y2K, tech bubble, 9/11, real estate and mortgage bubble, structured finance implosion).

  2. In other words employers are failing to live up to the commitment they made to their workforces which agreed to reduced compensation in order to have secure pensions. With all the fake institutes prognosticating about “expensive pension plans” and profitable companies pretending that they have been painted into a corner when they are the ones who have been managing the pension funds, it’s starting to look like the next phase in class warfare by the 1 per cent.

  3. I think it’s worth noting that one of the big problems with most DB Pension plans is that while employees ALWAYS contribute, when times are good employers are allowed to STOP contributing.

    A lot of these deficits exist because the employer took “contribution holidays” during the “fat” years, and now suddenly there’s not enough money in the “lean” times, despite the fact that the employees have been contributing to their pensions all along whether times were good or bad.

    • Moving to DC plans solves that problem.

      • In that it allows the employer to avoid taking any responsibility for mismanaging the DB pension in the first place, and transfers a fair share of the risks from the employer to the employees, yes. Yes it does.

  4. Through much of the 90’s I was a trustee of the largest public employee DB plan
    in the Maritimes… initially as an employer appointee and later as an employee (union)
    rep. Those were the days of the tech bubble when plans of all kinds were in surplus and
    every money manager was a genius. They were also the days when there was an endless
    stream of plan managers and employers coming through town to persuade trustee boards
    (primarily employer appointees) that now was the time to convert from DB to DC because
    the pension streets were going to be paved with gold forever. No space here to go into
    the Powerpoint peregrinations designed to limit or eliminate employer contributions to plans
    which those employers sponsored and operated… but when employers want out of plans
    that were overfunded and when they want out of plans that are underfunded it seems to
    be the logical conclusion that they just want out of plans.
    And no matter that a fair number of whining employers are sitting on a lot of cash waiting
    for whatever gummint to respond to their many needs.

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