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Pension Plans May Produce Next Wave of Trouble

By Peter Hadekel, The Montreal Gazette 

November 14, 2008

So far, this vicious economic crisis has rocked the banking sector, the stock market and a host of corporations ranging from auto makers to retailers.

If you're worrying when the next shoe is going to drop, you're not alone.

Many experts have warned the next wave of trouble could come from pension plans, especially defined-benefit plans in the private sector that "guarantee" payouts to retirees.

The stock market crash has decimated stock portfolios in many pension plans and left corporations facing large unfunded obligations.

Without a market recovery, the fear is that companies could be dragged down by pension-plan liabilities. They might not be able to raise enough cash to meet their funding obligations and run their businesses at the same time.

Or they could be forced to raise contribution rates, cut benefits and restrict enrolments.

A research report on pension shortfalls, released this week by Desjardins Securities, estimates the average Canadian plan faces a 15- to 20-per-cent shortfall, if you include all benefits such as medical and dental care.

That estimate is based on data released before the stock market rout this fall. Taking into account the decline in equity prices over the last couple of months, the funding shortfall ranges between 25 and 30 per cent, the report says.

Assuming the typical plan has a mix of 60-per-cent stocks and 40-per-cent bonds, assets in the average plan probably would fall to just 72 per cent of liabilities if they were immediately recognized on financial statements.

Several Quebec companies are singled out as facing the biggest pension deficits, relative to their earnings and book value.

These include BCE, Bombardier, ACE Aviation, Cascades and Quebecor.

The analysts calculate that based on current profitability, ACE Aviation would require 9.5 years of earnings to pay off its shortfall and Bombardier would need 3.4 years.

Both firms carry pension liabilities in excess of $2.5 billion.

Current rules require companies to calculate pension shortfalls every three years, while deficits must be covered every five years.

The crisis has alarmed governments and regulators and led to calls that funding rules should be relaxed to give firms more time to catch up.

But despite the significant shortfalls, the Desjardins report suggests that if there is a pension plan crisis, it's not a systemic one. It's more of a case-by-case one, depending on the company.

Only current post-retirement obligations - not the total liability to current and future retirees - needs to be immediately funded, the report notes. That reduces the strain on corporate earnings.

While the numbers look big, they're not unmanageable, said the report's author, Jeff Evans, in an interview.

So far this year, operating earnings at Canadian companies have been growing at a 10- to 12-per-cent rate, leaving many in a strong enough position to deal with funding requirements as they arise, he said.

The report notes that "most plan sponsors could easily (perhaps surprisingly) fund pension shortfalls with only a few months of earnings (or free cash flow).

"It's really a selective issue" for companies with specific pension difficulties, Evans said.

Besides the Quebec companies mentioned, others in pension trouble include Loblaw, Nortel, Canadian Pacific, NOVA Chemicals and Imperial Oil.

Options for these companies could include cutting medical or dental benefits or closing their plans to new employees. Cutting pension benefits, however, would be more difficult.

The report notes that companies have had little incentive to run up pension surpluses because courts have ruled that they can't claim ownership of the surplus funds.

Academic research has also suggested that pension under-funding aligns employee behavior with the firm, giving employees the incentive to be more productive.

The U.S. government has a pension-guarantee agency that is supposed to ride to the rescue of any plan that fails. But it is severely under-funded itself and could face unprecedented demands if automakers go under.

Canada has no comparable agency at the federal level. Let's hope we won't need one.

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