Why pension plans can't afford to be complacent

Industry insider tells WP equity returns have bailed out many and different investment strategies are needed

Why pension plans can't afford to be complacent

Equity returns this year have bailed out many defined benefit pension plans, who should be proactively preparing for lower returns going forward.

The warning came from Andrew Whale, principal in Mercer Canada’s Financial Strategy Group, which last week issued data concluding that DB pension plans would have to increase their current service funding contributions by close to 20% based on lower-return expectations on the asset mix underlying the Mercer Pension Health Index.

It detailed how positive equity performance in 2019 and the September rebound in long-term rates prevented a potential 14% decline in the index driven by the lowest yields on long-term bonds in more than 60 years.

Whale told WP that given the downbeat news stories of the past year, the survival of the DB pension plans should not be taken for granted and the emphasis should now be on looking forward. Of course, if the investment returns are expected to be lower, then the contributions going in have to be higher. Complacency over this is a real danger, he said.

“We hear that there is a lot of volatility, a lot going on from a global political risk perspective but ‘we’re still okay, we withstood the storm’.

“We want to get the message across that plans shouldn't be complacent and to some extent, equity returns this year bailed them out of the very low interest-rate environment.”

Whale said he is encouraging clients to start considering different strategies. Smaller DB plans can learn from their bigger peers and re-examine asset strategies and mixes that may not have been available to them in the past.

For those with a longer-term time horizon, this could include looking at the private market via private fixed income, real estate and other alternatives, including interest-rate hedging strategies.

“In only the very recent past, these were unavailable to some of the smaller plans in Canada. But we believe that they can now certainly expand the menu from which they can pick from.”

 A fresh look is vital given the “storms on the horizon”, with inverted yield curves, negative yield curves in some parts of Europe, trade tensions and political uncertainty in the US and the UK top of mind.

Whale said that if plans think they can rely on consistent growth and ignore these recessionary indicators, they are in trouble.

He said: “That’s why we are advising them to look at different types of risk – areas like private asset classes, which allow plans to pick up yield on illiquidity. For example, if you're a longer-term plan, you don't necessarily need tremendous amounts of cash in the short term. You can lock up your investments and pick up illiquidity premium.

“There are strategies that a lot of the big plans and insurers have played in for a long time and I think there is an opportunity now for the smaller plans to take advantage.”