Over the last several weeks, we have witnessed an unprecedented financial crisis in the US, Canadian and international markets which has had (and will continue to have) a significant impact worldwide. Canadian pension funds are not immune to the effects of this crisis.
The Emergency Economic Stabilization Act of 2008, the financial package put together and adopted by legislators in Washington on October 3, 2008, and other recent measures announced by central banks have generally been viewed as “steps in the right direction,” but have not restored investor confidence and markets remain extremely volatile. The effects of the crisis are unlikely to be short-lived.
The Impact on Pension Funds
Pension funds, like other investors, are exposed to plummeting asset values as a result of recent capital market free falls. In Canada, a number of pension funds will have varying degrees of additional exposure, particularly those that invested either directly in securities (such as bonds, notes, equities and CDS) issued or guaranteed by failed or rescued financial institutions (Lehman Brothers, AIG, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia) or indirectly through investments in hedge funds, funds-of-funds, etc.
In addition, recent events could trigger a number of secondary effects (also known as knock-on effects) for pension funds or the funds offered under DC arrangements, such as the marking down of similar investments held with other financial institutions.
Finally, the significant downturn in market values coupled with the expected lowering of long-term interest rates will also severely impact the solvency ratios of defined benefit plans.
The proper discharge of fiduciary obligations by pension fund management will be subjected to heightened attention by pension plan members and by pension regulators. Plan sponsors will need to assess the impact of the crisis on the funding and solvency positions of their plans as a steep decline in those positions could trigger significant increases in employer contributions and member anxiety over benefit security.
What Actions Should be Taken in Response
In response, plan sponsors and administrators should consider the actions they should take to best address the needs of their plans, including reviewing:
- The Statement of Investment Policy and Procedures (SIP&P) quality requirements for equities, fixed income instruments and other investments. The review should determine whether securities held have fallen outside the parameters and whether current parameters need to be amended;
- Securities lending conducted either directly by the pension fund or by external investment managers. The review should address more particularly the process for recovering lent securities and determine the loss exposure for the pension fund;
- Derivative contracts and counterparty management process being conducted to determine exposure and mitigate risk;
- SIP&P and investment options for any DC arrangements to determine whether changes are required to address current market conditions; and
- Determining whether communication with plan members is warranted, particularly those participating in DC arrangements.