“It’s not about volatility of returns; it’s about volatility of funded status,” said William da Silva, Senior Partner at AON Hewitt, a multinational company specializing in risk management and human resources. He was referring to financial risk management in the face of the developing pension crisis. He was the second of two speakers on the evening of January 30, 2014 at the GARP Toronto Chapter meeting held at First Canadian Place at King & Bay, Toronto.

“It’s been a decade of pain,” da Silva said, noting that the median solvency ratio of pension plans had gone from a healthy 110 percent funded in the year 2000 to 69 percent in 2012. However, the corner has been turned; for example, Air Canada announced recently they are back to 100 percent funded pension status (see Reuters news item 22 Jan 2014.)

“The problem is that the discount rate, pegged to bond yields, stayed low, and this had a huge impact on the solvency ratio,” said da Silva. Pension plans face strategic, operating, financial, and regulatory risk. The financial risk may be further subdivided into other risks: investment, interest rate, inflation, and longevity. During the 90s, pension funds “saw only asset risk,” he said. They were confined to low volatility stocks and thus to the short end of the yield curve.

Lately, the changes to a portfolio have been aimed at getting the same expected return, but with less liability risk. He called this a “glide path strategy,” referring to a formula that defines the asset allocation mix based on the number of years to the target date. The allocation becomes more conservative as the target date draws near.

pensionfund_man_boy“Pension funds will trade growth for hedging assets as their funded status improves,” da Silva said.

Longevity risk, another major risk facing pension plans, is cumulative over time, and major advances in healthcare and lifestyle have had a profound effect. Da Silva challenged the audience to guess the difference between average lifespans of a male born in 1938 (his father) with a male born in 2006 (his son). The answer was 17 years. It was startling to most, judging from audience laughter that evening.

“A classic way that pension plans would deal with [pension plan shortfall due to longevity] was to offload to insurance companies,” he said. Now, annuities are being looked at as a possible solution. ª

Click here to read a summary of the first presentation. ª

Click here to read a review of a recent book on pension planning and longevity risk.