Building a more efficient machine

Countries around the world are trying to tweak their pensions regulations to keep funding requirements from weighing down companies already under pressure from a weak economy.

In Canada, the US and the Netherlands, governments have in some way instituted or proposed measures that can ease the burdens of mounting liabilities. The short-term proposals, though, don't wipe out companies' need to keep their pension funds solvent in the long-run.

"I don't think (the solvency relief regulations) will resolve these issues in the long-term," said Association of Canadian Pension Managers' president Scott Perkin. "What I think these temporary solvency measures will do is help during this time when (companies) are struggling to remain as a going concern."

Canadian fund relief
In Canada, the Ontario government and federal government have proposed a number of measures to provide temporary funding relief.

"The rationale is the same everywhere," said Hewitt Associates senior retirement consultant Jerry Lotterman. He explained that Canadian provinces, all of which dictate their own pension rules, are generally working to keep companies from crumbling in an attempt to stave off rising pension liabilities.

Almost across the board, provinces are allowing pension schemes to amortise their pension deficits for a longer period of time or are permitting funds to roll previous deficits, already in repayment, into new deficits and re-set the payback schedule.

In June, Ontario approved regulations allowing companies 10 years to become solvent, instead of five, or a year long deferral of catch up payments to provide some cashflow relief. In order to extend the payments to ten years, the company needs member and retiree consent, a move that could make it difficult for plan sponsors to take advantage of this provision, observers say.

Active employees concerned about their job security - and by extension, the welfare of the overall company - will be more likely to approve the extension than retirees, who have nothing to lose by opposing, said Lotterman.

Ontario Ministry of finance spokesman Scott Blodgett said: "The consent requirement ensures that these measures are taken in partnership with workers, their unions, and retired members. Where a pension plan's governance structure currently provides a strong voice for its members, as is the case for jointly-governed plans, the consent requirement is waived."

The extension can make a significant dent in a company's cash flow.

For example, a company that was making no solvency payments before the crisis, but now has to pay US$5m per year over the next five years can decrease its yearly payments by 40% by doubling the pay-back period, said Lotterman.

Ontario will also allow plans to smooth assets using market values above the current 110% limit, which will stabilise short-term fluctations.

More than a third of all pension funds in Canada - 4,100 of 11,000 - are domiciled in Ontario so changes in Ontario will have an impact on more schemes than in any other province. The new pension regulations were introduced as part of Ontario's spring 2009 budget.

Restricting American assets
Just south of the border in the US, former president George Bush enacted the Worker, Retiree and Employer Recovery Act (WRER). The WRER was passed in December and allowed plans to phase-in strict funding targets put in place with the Pension Protection Act of 2006 (PPA) which went into effect last year.

The WRER also allowed 24 month asset smoothing and eases the requirements that restrict the accrual of benefits.

But pension experts in the US say it was a finer and more recent change made by the Internal Revenue Service (IRS) that will have the greatest impact on corporate plan sponsors.

In March, the IRS announced that pension funds could use the interest rates at the end of January 2009 or any of the four preceding months to calculate yield curves. The PPA allows various ways to calculate liabilities and one of those had been to choose January rates - this has now been widened.
Mercer financial strategy group principal Adrian Hartshorn said the ability to use the higher interest rates available in October to calculate yield curves could result in fewer plan freezes and lower contributions.

Companies using higher interest rates to calculate their liabilities will report lower liabilities.
"Some companies would have fallen below the 60% target that forces them to seize benefit accruals. This alleviates those trigger points," said Hartshorn adding the resulting lower liabilities will also ease the need for an immediate cash call.

Using the October rates could result in companies reporting up to 20% lower liabilities, he and others have said.

"The use of the October rate was a windfall," said Hewitt principal Joe McDonald. "If you translate this into pension costs, what (a company) needs to contribute could go down by more than that."
To his knowledge, not many companies have taken advantage of this option because the IRS has yet to outline some key questions, like how long pension funds would be locked into this method of valuation. The IRS did not return requests for comment.

Still, McDonald said legislators in the US are generally reluctant to issue out-and-out funding relief, and even changes like the rate calculation allowed by the IRS could be touted as a clarification more than a lifeline.

In the wake of bailout after bailout, "lawmakers have yet to come out with bold relief action".
McDonald said the Savings Recovery Act proposed by House Republican leader John Boehner offers one of the clearest forms of funding relief.

Among other changes, Boehner is proposing to double the amount of losses a company can smooth when funding its obligations through 2010. It would also extend the amortisation period of 2008 losses by two years to nine years.

The bill was introduced into the House on April 22.

Separately, in late June, the House Education and Labor Committee approved the 401(k) Fair Disclosure and Pension Security Act which included funding relief for multi-employer defined benefit plans.

The proposed bill allows certain plans to stretch their amortisation period to 25 to 30 years, up from 15 years. The bill has been passed on to the Ways and Means Committee, and if approved there, will go on to the full House of Representatives for vote. It then needs to be approved by the Senate.

The bills parallel the changes instituted in the Netherlands this year to help companies and industry pension funds with under-funded schemes.

The 105% solution
In February, the Dutch Ministry for Social Affairs announced it would allow schemes with a funded ratio below 105% an additional two years to return to the minimum level required by Dutch law.
The decision extended the recovery period for pension plans to five years from three years. Dutch pension funds were required to submit recovery plans to the De Nederlandsche Bank (DNB), the pensions regulator, before April 1.

According to the Ministry of Social Affairs, the decision was taken to prevent pension funds taking severe measures - such as cutting benefit payments - in order to be able to meet the three year recovery period.

Industry experts say that, in most cases, the temporary extension is enough for schemes to return to 105% funding without having to cut benefits.

Mercer Netherlands principal Paul Duijsens said: "That was enough for most of the pension funds to reach their 105% level."

On March 31, the Stichting Shell Pensioenfonds, the pension fund for Royal Dutch Shell, filed a recovery plan that allows the scheme to return to minimum solvency of 105% by October 2011 and full solvency of 127% by 2024. At the time, the funding level was hovering around 80%.

The recovery plan includes an increase in employer contribution. Chief financial officer at Royal Dutch Shell Peter Voser has said the firm expects to pay US$5bn in contributions in 2009, up from $1.6bn the previous year.

The plan also includes axing indexation, the increase of pension payments to match an increase in wages or cost of living.

Shell also changed its investment line-up to reduce risk in its investments. The scheme plans to reduce its equity weighting to 45% from 55%, boost fixed income to 35% from 30% and increase its allocation to alternative investments to 20% from 15%.

Other schemes have also de-risked on its road to recovery.

Risk reduction
One of the most significant changes the Stichting Pensioenfonds ABP, the pension fund for government employees and those in the educational sector, made to shore up funding was to make a slight reduction in investment risk, said ABP spokesman Jos van Dijk.

ABP's van Dijk said the pension fund increased its strategic allocation by one percentage point each to hedge funds (now 6%), convertible bonds (3%) and infrastructure (3%). ABP reduced its allocation to equities by three percentage points to 29%. The pension fund has also extended the durations of its fixed income assets.

"Most of the changes have taken place in the past few months and will serve as a starting point for the strategic investment plan 2010 to 2012," he said.

ABP also temporarily increased the premium for old-age and surviving dependants' pensions by one percentage point as of July 1, 2009, with an extra increase of two percentage points as of January 1, 2010, said van Dijk.

ABP's van Dijk also said the changes could have been more extreme had the recovery period not been extended.

"In that case the board of governors of ABP would have had to take additional measures. Possible measures that could be considered include a further increase in the temporary increase in the premium and a reduction in the pension rights," he said.

Dutch Association of Industry-Wide Pension Funds (VB) spokesman Gert Kloosterboer welcomed the extension. He said: "some of the funds would not have recovered in three to five years".

He said that while the two year extension helped, VB was hoping the regulator would provide a more customised approach.

In late-June, the DNB said it estimated members of around 20 pension funds might see their benefits reduced if the funds' recovery plans fail to bolster their financial position.

Despite the rough two years, pension plans around the world are seeing glimmers of hope in regards to their pension funding levels as the markets rebound and interest rates begin to rise again.