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pension troubles seen
By ELIZABETH CHURCH, The Globe and Mail
July 15, 2003
top companies are being overly optimistic in the assumptions they use for
their troubled corporate pension plans, spelling further funding troubles
down the road, a new study by UBS argues.
funding shortfall at Canada's largest companies with defined benefit
pension plans on the S&P/TSX 60-stock index ballooned to $16.6-billion
last year from $3.5-billion in 2001, the study notes. While these growing
pension deficits have captured headlines, it says the assumptions behind
these numbers are still too rosy. That means there is even more pension
pain to come in the form of rising deficits and growing contributions in
our view, more disturbing than the sheer size of these pension obligations
and funding deficits is the yawning gap between assumptions and
reality," says the UBS report, which was released yesterday.
most companies have reduced their assumptions on the two key figures that
affect the size of pension obligations and expenses -- the discount rate
and the expected return on pension assets -- the study's authors say it
has generally been a case of too little, too late.
realities have changed at a pretty rapid rate, but the assumptions are
lagging behind," said George Vasic, chief economist and strategist
with UBS in Canada.
the end of last year, for example, the average return on assets assumption
at the 49 companies in the sample was 7.66 per cent -- a drop of 31 basis
points over two years.
basis point is 1/100th of a percentage point.)
find that quite a startling figure," Mr. Vasic said.
study argues 6 per cent is a realistic target for a portfolio comprising
55-per-cent stocks, 40-per-cent bonds and 5-per-cent cash.
study also takes issue with the average discount rate -- a key calculation
used by plans to determine the money needed now to meet future pension
obligations. The discount rate is linked to the yield on corporate bonds.
Falling bond yields in the first half of this year mean that rate needs to
be lowered too, the study says, to 6 per cent from the average 6.52 per
cent for its sample at the end of last year.
Bonnar, a pension specialist with consultants Towers Perrin in Toronto,
agrees that conditions have deteriorated for most pension plans in the
first half of this year, but takes issue with the argument that companies'
past assumptions were misguided.
return on equity assumptions, he said, have been moving lower and are
likely to continue to drop, but he does not agree that 6 per cent is a
fair long-term rate of return.
absolutely low in my mind," he said.
Bonnar also said there is "no question" discount rates need to
come down, given the drop in bond yields this year.
he said it would be wrong to infer that the rates used by companies at the
end of last year were incorrect. Conditions have merely changed since
then, he said.
way, the end result will be more bad news for Canadian plans, he said.
figures from Towers Perrin show that the funding deficit at a benchmark
pension plan grew by a further 5 per cent in the first six months of the
plans likely made more on their assets because of a rise in equities,
falling bond yields meant that they also needed even more assets to cover
their pension obligations, he explained.
net result is that we are in worse shape than we were at the end of last
year," Mr. Bonnar said, unless firms have made major contributions to
pension results continue to decline, the UBS study highlights that not all
companies will share this pain in equal measure.
handful of companies, it notes, account for the lion's share of the
funding shortfall. Just eight companies in its sample account for 70 per
cent of the total pension shortfall -- $11.6-billion out of the
pension deficit at these eight companies also is greater than 10 per cent
of their market capitalization as of July 7 of this year.
this, the study finds it "most alarming" that pension
contributions at these eight companies account for just 38.9 per cent of
contributions in the sample.
a small number of companies, this is a significant issue," Mr. Vasic
said. "Among all the other things, this is something investors have
to consider . . . it's like an extra debt."
Vasic said contributions have only just begun to respond to what have
become huge funding deficits in some cases. But he said they likely will
have to continue and increase.
a strong sustained market rally, combined with rising interest rates will
erase some of the current shortfalls, he said. And that is not "a
highly likely prospect."
The eight largest pension deficits relative to market
capitalization represent 70 per cent of the S&P/TSX 60's total.
obligation 2002 funding deficit
S&P/TSX 60 as a % C$, As a % of
companies market cap millions market cap
Bombardier 66.8% -$2,653.50 30.5%
Inco 65.5 -1,270.00 24.3
Abitibi-Consolidated 83.1 -791.00 20.0
Quebecor World 38.9 -639.60 19.5
Cdn. Pacific Railway 122.4 -863.50 17.6
Alcan 84.9 -2,241.80 16.8
Nortel Networks 55.9 -2,817.60 16.2