{"id":17620,"date":"2019-11-22T09:05:54","date_gmt":"2019-11-22T14:05:54","guid":{"rendered":"https:\/\/www.benefitscanada.com\/news\/what-could-negative-yields-mean-for-canadian-pension-plans-funding-statuses-138924"},"modified":"2019-11-22T09:05:54","modified_gmt":"2019-11-22T14:05:54","slug":"what-could-negative-yields-mean-for-canadian-pension-plans-funding-statuses","status":"publish","type":"post","link":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/2019\/11\/22\/what-could-negative-yields-mean-for-canadian-pension-plans-funding-statuses\/","title":{"rendered":"What could negative yields mean for Canadian pension plans\u2019 funding statuses?"},"content":{"rendered":"
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Yaelle Gang<\/span> | November 22, 2019<\/p>\n

Globally, negative yielding bonds are alarming investors. And while Canadian government bonds haven\u2019t gone negative, movement in other countries is demonstrating to institutional investors that anything is possible. So if bond yields do go negative, what could this mean for Canadian pension plans\u2019 funding statuses?<\/p>\n

Canadian defined benefit plans can be valued in three different ways, all of which rely on different interest rate assumptions: solvency, going concern and accounting.<\/p>\n

Read: A refresher on the purposes of pension plan funding<\/a><\/strong><\/p>\n

\u201cIn general, when you\u2019re calculating the liabilities for a pension plan, basically, what you\u2019re doing is you\u2019re projecting the expected future benefit payments from the pension plan . . . and then you\u2019re discounting back those cash flows using an interest rate to the valuation date,\u201d says Gavin Benjamin, senior director of retirement at Willis Towers Watson. \u201cAnd the way the math works is, the higher the discount rate, the lower the liability; the lower the discount rate, the higher the liability.\u201d<\/p>\n

Solvency funding<\/strong><\/p>\n

A solvency funding calculation assumes some plan members will elect to take a commuted-value lump sum, while other members will elect to collect an ongoing pension benefit secured by an annuity paid by an insurance company. Generally, at a high level, these liabilities are calculated using a Government of Canada bond yield plus a spread.<\/p>\n

Even if government yields do go negative, it doesn\u2019t necessarily mean the interest rates used to value pension liabilities would be negative because of this spread, says Benjamin. \u201cIt wouldn\u2019t necessarily mean that you\u2019re using a negative interest rate to value a pension plan from a funding perspective, but what it would do is put downward pressure on the interest rate that the actuary is using. And if that were to occur, it wouldn\u2019t be good news for pension plan sponsors because it would result in increased liabilities and an accompanying increase in funding requirements.\u201d<\/p>\n

Going-concern funding<\/strong><\/p>\n

With that said, solvency measures are becoming less important in Canada, particularly in Ontario and Quebec<\/a>, which have both passed solvency reform, and in B.C. and other provinces, where they\u2019re under review, says Dean Newell, vice-president at Actuarial Solutions Inc. \u201cTo a certain extent . . . it makes solvency funding no longer the key driver in the contribution requirements it once was. So now there\u2019s more of a focus on the going-concern valuation results as driving the contribution requirements, at least in Ontario with the new funding framework that came into effect in 2018<\/a>.\u201d<\/p>\n

When a plan is valued on a going-concern basis, actuaries use a discount rate, which is based on the long-term expected investment return for the plan assets.<\/p>\n

Read: Could solvency reform in Canada lead to a DB pension revival?<\/a><\/strong><\/p>\n

\u201cEven for going-concern valuations \u2014 although I think it would be unlikely that the interest rates to value going-concern liabilities would go negative \u2014 there would be downward pressure on the interest rate used for the going-concern valuation because, for example, for a going-concern valuation the interest rate is based on the actuaries\u2019 long-term expectation with respect to the [investment return on the] pension plan fund,\u201d says Benjamin. \u201cAnd so, for example, if interest rates were to go negative, that would put downward pressure on the actuaries\u2019 expectation with respect to the expected long-term return on the bonds within the pension plan\u2019s portfolio.\u201d<\/p>\n

Although it isn\u2019t likely the effect would be as dramatic in going-concern situations as in solvency, this would still cause a decrease in the interest rate used, potentially driving up funding costs, he adds.<\/p>\n

In Ontario, the enhanced rules around going-concern solvencies also introduced the requirement for a pension plan to keep a funding cushion, otherwise known as a provision for adverse deviation.<\/p>\n

While the discount rate in going concern is generally long term in nature, Ontario\u2019s PfAD requirement uses a benchmark discount rate, based on Government of Canada long-bond yields, which forces a plan to take a more mark-to-market approach for the going-concern liability measurement. \u201cLower interest rates will inevitably be factored into the going-concern liabilities, at the very least by that benchmark discount rate component of the provision for adverse deviations for Ontario-registered plans,\u201d says Newell.<\/p>\n

Read: A look at the landscape for pension solvency funding reform across Canada<\/a><\/strong><\/p>\n

If a Government of Canada bond yield becomes negative on a plan\u2019s valuation date, it would potentially increase the PfAD in Ontario, notes Benjamin. \u201cIt would potentially mean that the cushion would be higher because the way it works . . . is you have this benchmark discount rate that\u2019s calculated . . . [and] one of the key inputs is the Government of Canada long-bond yield, and then you compare that to the actuaries\u2019 discount rate assumption. And to the extent that the benchmark rate is lower than the actuaries\u2019 assumption then you increase the PfAD.\u201d<\/p>\n

Accounting purposes<\/strong><\/p>\n

Pension plans are also valued for accounting purposes. Under most accounting standards, pension plan liabilities are valued using the yields on high-quality corporate bonds.<\/p>\n

\u201cFor accounting purposes, lower interest rates will result in higher liabilities and higher obligations and, therefore, bigger accounting deficits on a corporate entity\u2019s financial statement and higher expenses for their plans going forward,\u201d says Newell.<\/p>\n

As well, if interest rates go negative, this would put additional financial pressure on defined benefit plan sponsors, which could increase the desire to close DB plans and, for those that are closed and not yet frozen, freeze pension accruals going forward, says Benjamin.<\/p>\n

If interest rates do go negative, pension plans may also reach for positive returns by moving into more risky assets, he notes. \u201cAnd so, that\u2019s something that might not be desirable with respect to the level of risk within Canadian pension plans.\u201d<\/p>\n

Read: What options are available for de-risking DB pension plans?<\/a> <\/strong><\/p>\n

Overall, lower interest rates will ultimately lead to higher liabilities and higher costs for ongoing DB plans, says Newell. \u201cThe one caveat to all of that is for plan sponsors who have adopted a de-risked investment strategy. To the extent that they\u2019re currently investing in bonds, they might not see their funded status change all that much because, as interest rates decrease, the value of the bonds that they\u2019re holding will increase and, ideally, they\u2019ll be fully hedged, so that the increase in their obligations and liabilities would be offset by an increase in their plan assets.\u201d<\/p>\n

In general, plan sponsors should be considering the range of risks associated with their pension plans, says Benjamin, noting negative rates is one risk to consider. \u201cFor example, some have held the view for 10 years or more that interest rates can\u2019t go down any further. There\u2019s very little risk on the downside with respect to the level of interest rates and it\u2019s more likely that interest rates will go up.<\/p>\n

\u201cBut the fact that negative interest rates have emerged in other countries, and the fact that it\u2019s being discussed in Canada, is a reminder that it\u2019s not safe to assume that interest rates will necessarily go up and couldn\u2019t go down any further.\u201d<\/p>\n

This article was originally published on<\/em> Benefits Canada\u2018s companion site, the<\/em> Canadian Investment Review<\/a>.<\/em><\/p>\n

Read the full article at BenefitsCanada.com<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Yaelle Gang | November 22, 2019 Globally, negative yielding bonds are alarming investors. And while Canadian government bonds haven\u2019t gone negative, movement in other countries is demonstrating to institutional investors that anything is possible. So if bond yields...<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[],"tags":[],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/posts\/17620"}],"collection":[{"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/comments?post=17620"}],"version-history":[{"count":0,"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/posts\/17620\/revisions"}],"wp:attachment":[{"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/media?parent=17620"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/categories?post=17620"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/wp-json\/wp\/v2\/tags?post=17620"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}