Canada’s defined-benefit (DB) pension plans, under pressure from low interest rates and uncertain equities markets, gained some ground in the third quarter (Q3) of calendar 2012 as actions taken by central banks spurred international markets.

This could be good news for your clients who have private-sector DB plans, but, analysts say, challenging times for these pensions are not over yet.

On the positive side, Canadian DB pension plans gained 3.2% in the quarter ended Sept. 30, compared with a loss of 1.1% in the quarter ended June 30, according to a survey in September by Toronto-based RBC Investor Services (RBCIS), a division of Royal Bank of Canada. RBCIS tracks the $410-billion RBCIS universe, a portion of Canada’s pension plans that serves as the benchmark for the pension sector.

Plan returns were lifted into positive territory as the financial services, energy and materials sectors rebounded from summer lows, according to the survey. Central bank pledges for continued monetary support have dispelled the gloom from Europe, China and the U.S.

For the nine months ended Sept. 30, the year-to-date return for Canadian DB plans was 6.6%.

That does not mean Canada’s pension plans, which are facing the first wave of baby boomer retirements, are out of the woods yet, says Scott MacDonald, head of pensions, insurance and sovereign wealth strategy with RBCIS.

“You can still see that solvency ratios are still a problem,” MacDonald says. “One good quarter is not going to reverse all of those issues.”

RBCIS reported recently that 48% of DB plan sponsors intend to move their asset allocation toward alternative investments such as real estate, infrastructure and private investments in an effort to boost returns and reduce their reliance on unpredictable public equities markets.

More worrisome, the RBCIS survey found that more than two-thirds of plan operators (70%) had funding levels below 90%. Low interest rates, MacDonald says, are “one of the contributing factors as to why so many plans are at less than 100% solvency.”

For pension-plan members and their financial advisors, there is some concern that plans may not be able to meet their obligations, which could mean your clients need to save more for retirement outside of the plan.

On the positive side, however, MacDonald argues that the survey of pension sponsors has found they are determined to continue to operate their DB plans. “Employers really do still want to do well by their employees,” he says. “Those who have DB plans are really still committed to them.”

The trend of DB plans giving way to less risky – for the plan sponsor – defined-contribution (DC) plans continues, however. The RBCIS survey found that although 61% of DB plan sponsors have no intention of ceasing to offer DB plans, the rest have either already closed off their DB plans to new members and opened DC plans (27%) or expect to do so within the next two to five years (12%).

Even so, Canada remains an international standout when it comes to DB plans, MacDonald says: “It is a $1.3 trillion pension market in Canada, and about 93% to 95% of those assets are still in DB plans. So, outside of Japan, Canada is fairly unique in still having such a high concentration of assets in DB plans.”

New York-based Mercer LLC‘s Toronto-based Canadian division, whose pension health index tracks the ratio of assets to liabilities for a model pension plan, also found that Canadian DB plans had improved their solvency position in Q3, but still have a long way to go. Mercer’s index stands at 80% at the end of the quarter, up from 77% three months earlier.

“About 95% of plans are in a deficit situation, on a solvency basis,” says Manuel Monteiro, partner in Mercer Canada’s financial strategy group, who adds that the average solvency rate is close to Mercer’s index rate of 80%.

That solvency rate is a cause for concern, not panic. “It is worrisome,” Monteiro says, “in the sense that if any of these companies were to go under and the plan is funded at 80% levels, members will lose benefits.”

Based on government data, Mercer Canada estimates that about only 12.5% of private-sector employees are participating in DB plans; 87% of public-sector workers are in a registered plan and, of those, 94% are in a DB plan.

The traditional support for DB plans, higher interest rates, appears unlikely to come to the rescue any time soon. The solution to the solvency gap lies in either generating higher returns or receiving larger contributions from plan sponsors.

“The reason why the [DB] plans are in deficit,” Monteiro says, “is that liabilities are measured based on long-term interest rates, and long-term rates are extremely low right now. If interest rates go up, and if equities returns remain strong, the problem becomes a lot smaller.” IE

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