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Category: Investment

Visit: Mercer

February 14, 2013 ( newswire) Many Canadian pension plan sponsors have entered 2013 facing significant increases in their pension deficits which could impact both financial statement reporting and cashflow management for many organizations, according to Mercer.

"Further declines in interest rates in 2012 coupled with modest equity returns domestically over the last two years continue to put pressure on Canadian plan sponsors' contribution levels. In addition, pensioners are living longer, and this will ultimately have to be recognized in pension costs as new mortality tables that better reflect this increasing longevity are coming down the pipe in Canada .", said Heather Cooke, leader of Mercer's Financial Strategy Group in Canada.

"As we head into 2013, interest rates are rising but we may remain in a market environment in which interest rates remain relatively low for some time, and where volatile equity market conditions can whipsaw plan asset levels," said Ms. Cooke. "Plan sponsors, who are concerned with the effect pension volatility has on their key financials, either need to de-risk their plans now, which could be painful given current market conditions, or need to put in place a robust risk management plan that will allow them to quickly react to market changes and take advantage of opportunities to de-risk their plans."

The first step on this path is to understand the true economic costs, and risks, of the promises made to plan members, she noted.

"It is important to focus both on investment strategy and execution, as well as the overall governance framework to ensure that internal obstacles do not get in the way when the time is right to reduce pension funding risk," said Yvan Breton, the Canadian Fiduciary Management leader in Mercer's Investments business.

In this environment, Mercer has identified eight top pension risk management priorities for Canadian plans in 2013.

1. Understand the true economic cost of the promise made to plan members.

Commonly used liability measures give only a partial picture of the true economic cost of the pension promise made to members. In order to make an informed decision regarding pension plan costs and risks, plan sponsors need to fully understand the true economic cost of the promise as more commonly used measures for accounting and actuarial purposes on give a partial picture.

2. Develop a comprehensive plan on how best to manage and pay these benefits.

Consider a broad toolkit of strategies on several fronts: asset, liability, benefit design, funding and risk transfer. Examples include revisiting the asset mix to explore alternatives, dynamic interest rate hedging approaches or more optimal growth portfolio structures to capture higher growth opportunities such as emerging markets and global small cap. Or explore funding relief options that are being rolled out in various jurisdictions.

3. Evaluate emerging plan designs

Private sector plan sponsors looking to reduce pension risk have often transitioned from a defined benefit (DB) to a defined contribution (DC) plan. This involves a complete transfer of risks to employees, and the elimination of the pooling of risks. Concerns are growing that many DC plan members don't understand the risks they face and are not well equipped to bear those risks.

Recently, plan design solutions in the middle of the spectrum have been gaining increasing attention. One such approach is the Shared Risk Plan introduced in New Brunswick. Both DB and DC plan sponsors should pay close attention to these developments, and start thinking about whether approaches such as target benefit plans or plans where certain benefits are contingent on the financial position of the plan would make sense in their environment.

4. Review your plan's funded status frequently as the foundation for establishing outcome-oriented goals.

Funded status monitoring should include an analysis of all the factors that affect the ratio of assets to liabilities, including interest rate and credit spread movements, equity performance, as well as cashflows in and out of the plan. This is a first step in understanding the underlying health of a plan's funding position and identifying the factors that could impact the plan in 2013 and beyond.

5. Understand how the range of possible market conditions and changes in funding status could affect the corporation's cash flow, balance sheet, and reported earnings.

Now is the time to conduct "what if" scenario analysis for 2013 and beyond. Stress testing such scenarios as "lower interest rates for longer" - given continued quantitative easing, weaker global growth due to US debt ceiling limit uncertainty, and ongoing challenges in Europe - can provide insights that inform financial planning and risk management.

6. Develop a formal de-risking plan.

For those, wanting to de-risk, there have been several opportunities since 2000 to take risk off the table as funded status improved. Yet most sponsors did not take advantage of these market windows, as they did not have a plan in place to know when to reduce overall plan risk, nor did they have the time, resources or specialized investment expertise. Sponsors should develop a roadmap to de-risk the plan that can be executed quickly, as and when opportunities arise. This roadmap might include plan design changes, funding strategies, investment allocation movements, fixed income portfolio construction, and risk transfer components.

There is no "one size fits all" de-risking plan for plan sponsors, so careful thought needs to go into developing and executing these plans.

7. Consider liability transfer options.

In the US, General Motors and Verizon both entered into landmark annuity purchases in 2012 that introduced game changes to the risk transfer landscape. Mercer expects that this trend will accelerate in 2013 and beyond. We also expect to start seeing some large Canadian plan sponsors taking steps to transfer some or all of their pension risk to others. Advantages of risk transfer strategies include reduction of funded status volatility, administration and investment costs. Sponsors planning to implement these strategies in 2013 should begin up-front feasibility and execution planning now to maximize the effectiveness of the program.

8. Review your governance structure and decision-making process.

Developing a plan creates the framework, but executing and implementing investment decisions can be challenging and resource intensive. Since market volatility can create opportunities that last for only a brief time, adopting an appropriate governance model is critical. This should include an assessment of current resources, as well as any additional tools and resources that may be required within a de-risking framework. With increased focus on funded status and timely asset allocation shifts based on triggers, this may include delegation of investment monitoring and execution to a third party who can measure asset and liability values daily and then act quickly to take advantage of these opportunities.

About Mercer

Mercer is a global consulting leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset - their people. Mercer's 20,000 employees are based in more than 40 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital. With 52,000 employees worldwide and annual revenue exceeding $10 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a global leader in management consulting. For more information, visit Follow Mercer on Twitter @MercerInsights.

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