Perspectives. Accounting for Canadian Pensions and other Postretirement Benefits

Transcription

1 Perspectives Accounting for Canadian Pensions and other Postretirement Benefits

2 Accounting for Canadian Pensions and other Postretriement Benefits Introduction This report summarizes the assumptions used by companies in the calculation of plan accounting costs for defined benefit pension and other postretirement benefits (primarily retiree health and life insurance benefits). This study also analyzes funding on an accounting basis for both pensions and other postretirement benefits. All figures in this report are shown in Canadian Dollars at an exchange rate of 1 USD = CAD. We define fiscal year-end (FYE) 2014 as the period between October 1, 2014 and February 28, If you have any questions about this report or are interested in more detailed or specialized analysis, please contact your local Willis Towers Watson consultant. Background This analysis is based on a Willis Towers Watson proprietary dataset composed of financial information from the largest global companies. This includes companies in the U.S. Fortune 1000, the U.K. FTSE 350 as well as the largest 500 non-u.s. companies based on company revenues. The database includes key pension financial information collected from public financial statement disclosures. For this analysis, a subset list of 92 Canadian companies with fiscal-yearend dates ending after October 1st, 2014 with disclosed defined benefit (DB) pension liabilities, was selected as a proxy for the biggest Canadian publicly traded companies by revenues. Figure 1 shows the distribution by industry of organizations in our analysis. Energy and Financial Services are the most prevalent, representing 23% and 18% of our total sample. The other category includes Business Services, Health Care, High Tech, Leisure Time, Property and Wholesale. As shown in Figure 2, in terms of size of projected benefit obligations (PBO) rather than number of companies, Financial Services, Energy and Transportation represent almost three quarters of total PBO in our report. Our overall sample held $314.5 and $283.4 billion in PBO and plan assets respectively. The average plan held $3.4 billion in PBO and $3.1 billion in pension plan assets at the end of fiscal year The transportation industry had the largest plans on average (see Figure 3). Figure 1. Overall sample by industry Figure 2. Sample distribution by percentage of PBO 10% 9% 11% 3% 12% 10% 4% 23% 18% Energy Financial Services Retail Communications Manufacturing Food Natural Resources Transportation Other 24% 4% 1% 2% 7% 12% 1% 24% 25% Energy Financial Services Retail Communications Manufacturing Food Natural Resources Transportation Other 2 willistowerswatson.com

3 Pension Costs and Assumptions The determination of pension costs and obligations is based on the attribution of projected future pension benefits to periods of employee service, and the use of actuarial assumptions to calculate the present value of such benefits. Actuarial assumptions reflect the time value of money and the probability of payment. The following three key economic assumptions can have significant influence on pension costs: The discount rate The expected long-term rate of return on plan assets The salary scale Discount rate Discount rates are used to calculate the present value of pension obligations and the service and interest cost components of the net periodic pension cost. The discount rate is typically intended to represent the rate at which pension benefit obligations could be effectively settled, and is usually based on high quality corporate bond yields. However, for certain types of organizations discount rates under Canadian GAAP can be based on an expected rate of return assumption (EROA) approach versus a method based on corporate bond yields. Therefore, we decided to exclude companies reporting under Canadian GAAP from this section (2 out of 92). Figure 4 shows that discount rates ranged between 3.76% and 4.00% for half of the companies reporting under IFRS or US GAAP, with 3.90% being the average discount rate for the sample. As shown in Figure 5, discount rates were lower for 88 out of 90 companies (98%) compared to FYE At the end of FYE 2013 the average discount rate was 4.67%. Figure 3. Average Plan assets and PBO per industry, CAD billion Industry PBO Plan Assets Transportation Financial Services Communications Energy Other Food Natural Resources Retail Manufacturing Total Figure 4. Distribution of pension discount rates, FYE % 10% 20% 30% 40% 50% More than 4.51% % - 4.5% % % % % % % 19 Less than 3.50% 9 n=90 Figure 5. Change in pension discount rates assumptions, FYE Current-year rate greater than prior-year rate 2% 1 to 49 basis points 1% 50 or more basis points 1% Rates are the same in both years 0% Current-year rate less than prior-year rate 98% 1 to 49 basis points 4% 50 to 99 basis points 77% 100 basis points or more 17% Total 100% n=90 3 Accounting for Canadian Pensions and other Postretirement Benefits

4 Figure 6. Distribution of EROA assumptions, FYE % 10% 20% 30% 40% 50% 60% More than 7.01% 6.51% % 6.01% % 5.51% % Less than 5.50% n= Figure 7. Change in pension EROA, FYE Current-year rate greater than prior-year rate 33% 1 to 24 basis points 27% 25 basis points or more 7% Rates are the same in both years 33% Current-year rate less than prior-year rate 33% 1 to 24 basis points 13% 25 to 49 basis points 13% 50 basis points or more 7% Total 100% n=15 27 Figure 8. Distribution of actual rates of return on pension assets, FY % 10% 20% 30% 40% 50% 60% More than 20.00% 2 53 Expected rate of return on plan assets The expected rate of return on assets (EROA) assumption is the long-term expectation of the pension fund s annual rate of investment returns. The EROA assumption reduces the net periodic pension cost. Under IFRS, there is no explicit concept of an EROA (implicitly the EROA is set equal to the discount rate, which is based on corporate bond yields). Under Canadian GAAP, the EROA may be based on the IFRS approach or it could be based on the expected investment return on plan assets, which is usually reduced by a margin for conservatism. Since only companies reporting under U.S. GAAP are required to disclose EROA, the results below are only shown for companies using these accounting standards. Figure 6 shows the distribution of EROA for FYE The EROAs range from 3.75% to 7.75% with an average expected rate of return of 6.39%. Around half of companies had an EROA between 6.01% and 6.50%. As shown in Figure 7, rates stayed the same over the past fiscal year (FY) for one third of the companies with 33% lowering and 33% increasing their assumptions. The average EROA was 6.50% at FYE % % % % % % 34 Less than 5% 1 n=89 4 willistowerswatson.com

5 Actual rate of return on pension assets The actual rate of return on assets is the investment growth realized in the pension fund during the plan year. Typically, the actual return on investments is a significant driver in the change of a pension plan s assets. The average rate of return on pension assets was 11.64% for FY 2014 compared to 11.96% for FY Figure 8 depicts the distribution of actual rates of return on pension plan assets over FY Just over half of the companies realized an actual investment return on plan assets between 10.00% and 14.99%. Figure 9. Distribution of pension salary scale assumptions, FYE % 10% 20% 30% 40% More than 3.51% % % % % % % % % 6 Less than 2.50% 15 n=80 Salary scale The salary scale assumption is used to project current salaries into the future. The assumption is a factor for payrelated plans in determining the PBO and the service cost. Year-to-year growth in compensation results from long-term trends in: Price inflation Productivity improvements Merit or promotional increases Seniority increases Figure 10. Change in pension salary scale assumptions, FYE Current-year rate greater than prior-year rate 11% 1 to 49 basis points 5% 50 or more basis points 6% Rates are the same in both years 57% Current-year rate less than prior-year rate 32% 1 to 49 basis points 24% 50 to 99 basis points 5% 100 basis points or more 3% Total 100% n=79 Salary scale assumptions ranged between 1.00% and 5.00% in FYE 2014 (Figure 9), with an average rate of 3.13%. As shown in Figure 10, 57% did not change their salary scale assumption from the prior year and 32% used a lower rate for Accounting for Canadian Pensions and other Postretirement Benefits

6 Figure 11. Service cost as a percentage of total revenue, FY % 0.2% 0.4% 0.6% 0.8% 1.0% Retail Food Manufacturing Natural Resources Energy Pension costs The adverse impact of pension costs on a company s income statement is a key concern for executives and investors. Defined benefit pension expense affects both the balance sheet and the income statement. One component of pension expense is the service cost. Service cost is the present value of benefits earned by plan participants over the year. Total Financial Services Other Communications Transportation Figure 11 shows the ratio of DB service cost to company revenues. Total service cost in aggregate represented 0.57% of total company revenues. Sectors such as Communications and Transportation had considerably higher relative service costs compared to other sectors in this analysis. The decrease in average DB service cost (from $71 million for FY 2013 to $60 million for FY 2014 or 15%) led to a decrease in the share of service cost to PBO as seen in Figure 12. Average Aggregate Funded Status of Pension Plans n=90 Figure 12. Service cost as a percentage of PBO 3.0% 2.55% 2.5% 2.18% 1.95% 2.0% 1.73% 1.5% 1.0% 0.5% 0.0% n=89 Average Aggregate Funded status measures the financial health of a pension plan and is typically defined as the relationship between plan assets and PBO. If a plan has a funded status above 100%, then the projected benefit obligation is fully funded. PBO Funded Status The PBO funded status is defined as the fair value of plan assets over the plan s PBO. The PBO is the actuarial present value of all benefits attributed by the benefit formula to service before the measurement date. This includes the effect of expected future compensation increases on plans where that is part of the benefit formula or where benefit increases connected 6 willistowerswatson.com

7 to salary raises are likely. Figure 13 shows the changes in the PBO funded status from FYE 2012 to FYE The average funded status for plan sponsors increased from 78% at FYE 2012 to 89% at FYE This substantial increase in funding levels was attributed to strong returns on plan assets during 2013 coupled with a rise in discount rates which lowered PBO. Despite another good year for investment returns in FY 2014 (11.6%), average PBO funded status decreased from 89% to 85% at FYE This was due to a decrease in discount rates, which grew PBO at a faster rate than plan assets over the past year. Figure 14 shows the distribution of PBO funded status results for companies in this report at FYE 2012, FYE 2013 and FYE At FYE 2014, 68% of companies had funded ratios greater than 80%, compared to 79% at FYE Sponsors were still in a much better funded position compared to FYE 2012 when only half of the companies had funded levels over 80%. Figure 13. Distribution of PBO funded status, FYE % 20% 40% 60% 80% 100% Average Aggregate n=91 Figure 14. Distribution of PBO funded status, FYE % 5% 10% 15% 20% 25% 30% 35% 100% or more % - 99% % - 89% % - 79% Less than 70% n= Accounting for Canadian Pensions and other Postretirement Benefits

8 Figure 15. PBO funded status per industry, FYE % 20% 40% 60% 80% 100% Food Transportation Retail Communications Financial Services Total Manufacturing Energy Figure 15 shows the funded status by industry. Food, Transportation, Retail, Communications and Financial Services sectors had stronger funded levels relative to other sectors. Size of PBO In order to provide a comprehensive analysis of the pension risk faced by companies other than just their funded status, it is important to look at the amount of PBO a company manages in relation to the size of the company. A comparison between the PBO and total corporate liabilities can be found in Figure 16. Despite having higher funded levels compared to other sectors, Transportation and Communication also have larger relative PBO. The financial services sector not only has one of the highest funded levels but also maintains the least amount of PBO relative to corporate liabilities. Employer contributions Natural Resources Other Average n=91 Aggregate Besides investment performance, employers contributions to their plans can increase funded levels. In this analysis the employer contribution rate is defined as the ratio between the employer s pension contributions during FY 2014 and fair value of pension plan assets at the beginning of year. 8 willistowerswatson.com

9 Figure 16. PBO as a percent of total corporate liabilities, FYE % 20% 40% 60% 80% 100% 120% In order to provide a comprehensive analysis of the pension risk faced by companies other than just their funded status, it is important to look at the amount of PBO a company manages in relation to the size of the company. Financial Services 3 2 Total 5 Manufacturing Food Other Average employer contribution rates decreased from 6.47% in FY 2013 to 4.13% in FY 2014 while the average plan contribution declined from $123 million to $83 million. As expected, the level of funding seems to affect contribution amounts. Figure 17 shows a downward trend between pension contribution rates and prior year funded status as sponsors with lower funded levels are more inclined to make larger contributions to help lift them out of substantial funding deficits. The higher levels of contributions during 2013 could be explained in part due to low funded levels at FYE On the other side of the spectrum, the higher levels of funded status at FYE 2013 could have also played into lower contribution rates Energy Natural Resources Retail Communications Transportation Average n=92 Figure 17. Employer contribution rate versus beginning of the year (BOY) funded status 2014* 12% 10% Aggregate Contribution rate 8% 6% 4% 2% 0% 70% 80% 90% 100% PY funding ratio *Values outside the 10 percent 90 percent percentile range were excluded 9 Accounting for Canadian Pensions and other Postretirement Benefits

10 Asset Allocation of Pension Plans The allocation of assets in pension plans is an important determinant of the plan s overall investment performance. More specifically, asset allocation strongly influences volatility in the plan s funded status and the plan sponsor s cash and accounting cost. The sponsor s creditors, investors, regulators and participants, as well as other interested parties, want to know about asset allocation in order to evaluate the plan s risk exposure and long-term expected cost. In this analysis, Foreign Fixed Income assets were categorized as Other while Alternatives mainly include Hedge Funds and Private Equity assets. Figure 18. Average allocations of pension plan assets, FYE % 3% 2% 4% 47% 42% % Equity Domestic Fixed income Real Estate Alternatives Other 2% 3% 4% Cash Figure 18 shows the average distribution of assets among the main categories. From FYE 2013 to FYE 2014, the average allocation to domestic fixed income increased at the expense of equities. This change was likely driven by plan sponsors implementing their pension de-risking strategies, combined with rebalancing to their target asset allocations, following the strong investment performance of equities in n=86 38% 52% 10 willistowerswatson.com

11 Figure 19. Average allocations of pension plan assets per industry, FYE % 20% 40% 60% 80% 100% Communications Financial Services Food Retail Natural Resources Energy Other Transportation Manufacturing Figure 20. Allocation in equities and funding status, FYE 2014 Equity investments (% of total assets) Domestic Fixed income n=86 80% 70% 60% 50% 40% 30% 20% 10% 0% /1/ /2/7/ /0/1/ /3/2/ /0/1/ /1/2/ /2/11/ /8/1/ /0/10/4 Equity Real Estate Alternatives Other Cash 70% 80% 90% 100% PY funding ratio *Values outside the 10 percent 90 percent percentile range were excluded When looking at asset allocations by industry, the Communications and Financial Services sectors have lower investment risk exposure with higher allocations to domestic fixed income compared to other industries (see Figure 19). Larger allocations to Equities can lead to greater fluctuations in funded levels due to the volatile nature of stock markets compared to fixed income assets. However, Equities usually come along with higher rates of long-term return and therefore can sometimes be used to improve the funded level of plans. As shown in Figure 20, plans with lower funded levels tend to allocate a higher percentage of assets into Equities. On average, companies with fully funded pension plans allocate 42% of their assets to equities. Sponsors with funded levels near 75% allocate a larger share of their holdings to equities (52% on average). Other Post-Retirement Benefits (OPRBs) Many employers provide retiree benefit programs to cover the cost of services not included in provincial medical plans, i.e. pre-65 prescription drugs. Employers are increasingly faced with cost pressure as the number of services funded through the public medical care system are reduced. Seventy-two out of 92 (78%) of the analyzed companies manage postretirement medical benefits in addition to their defined benefit pension plans. This section focuses on post-retirement medical and life insurance plans although other post-employment benefits (OPEBs), such as self-insured Long-Term Disability plans, were included in the liabilities when these were disclosed together with postretirement benefits. 11 Accounting for Canadian Pensions and other Postretirement Benefits

12 The determination of the costs and obligations for post-retirement benefits other than pensions is based on the calculation of the actuarial present value of the post-retirement benefits that are expected to be paid to or on behalf of current and future retirees under the terms of the plan, and the attribution of such present value to periods of service. Figure 21. Distribution of initial health care cost trend rates, FYE % 10% 20% 30% More than 7.51% % 7.50% 6 The accumulated post-retirement benefit obligation (APBO) as of a particular date is the actuarial present value of expected benefits attributed to current and former employees service rendered to that date. A postretirement benefit plan s APBO includes salary progression if some of the plan s benefits are pay related, such as in the case of life insurance. 6.51% 7.00% 6.01% 6.50% 5.51% 6.00% 5.01% 5.50% 4.51% 5.00% The health care cost trend rate, which is a key assumption for determining obligations for post-retirement benefits, will be analyzed in the next section of this report. Less than 4.50% n=66 15 Health care cost trend rates The health care cost trend rate is a unique assumption to measure the obligation and cost of post-retirement health care benefits. Also unique to these measurements are the per capita claim cost at each age at which the participant is expected to receive benefits. Of these assumptions, only information on the health care cost trend rate is a required disclosure item in the financial statements in particular, the initial health care cost trend rate, the ultimate rate and the year the ultimate rate is reached. The initial trend rate is determined based on expected short-term medical inflation considering the plan s claims Figure 22. Distribution of ultimate health care cost trend rates, FYE % 10% 20% 30% 40% 50% More than 5.01% % 5.00% 4.51% 4.75% % 4.50% 4.01% 4.25% 3 Less than 4.00% 7 n= willistowerswatson.com

13 Figure 23. Distribution of the number of years to reach the ultimate health care cost trend rate, FYE % 10% 20% 30% 17 years or more years years 8 10 years 5 7 years 2 4 years 1 year or less n=57 Figure 24. Average and aggregate funded status for companies with funded OPRBs/OPEBs, FYE % 15% 10% 5% 0% n= Average Aggregate 30 experience, the plan provisions, the demographic profile of the covered population as well as the impact of provincial plans coordination. In setting the ultimate trend rate, considerations include future long-term inflation expectation, future GDP growth and a margin for health care specific inflation. The average initial health care cost trend rate decreased from 6.41% at FYE 2013 to 6.17% at FYE As shown in Figure 21, over half of the companies (58%) reported an initial health care cost trend rate between 5.51% and 7.00%. As shown in Figure 22, almost half of the companies (48%) reported an ultimate health care cost trend rate between 4.26% and 4.50%. More specifically, 38% of the companies reported a rate of 4.50%. Twenty-four percent of companies reported a rate of 5.00%. The average ultimate health care cost trend rate remained virtually unchanged at FYE 2014 at 4.58%, up from 4.56% at FYE Figure 23 shows the distribution of the number of years before the ultimate health care cost trend rate is expected to be achieved. For 30, the ultimate health care cost trend rate is expected to be reached in 14 to 16 years. The average number of years to reach the ultimate health care cost trend rate is nine while median number of years is ten. 13 Accounting for Canadian Pensions and other Postretirement Benefits

14 Funded status of other post-retirement benefits Due to lack of tax incentives, most of the companies in this study who manage other post-retirement and post-employment benefits (56 out of 72) choose not to fund their plans and manage them on a pay-as-you-go basis. Figure 24 shows funded levels for companies with funded post-retirement and post-employment benefits. This remained broadly unchanged in FYE 2014 and are still heavily underfunded due to lack of tax incentives. Only one company in this sample had a funded status over 80%. Size of APBO A comparison between the APBO and total corporate liabilities can be found in Figure 25. Similar to the results found for pensions, the Financial Services sector had the smallest relative APBO and therefore the lowest risk. On average, APBO represented 4% of total company liabilities while as shown previously, pension liabilities were on average 36% of total company liabilities. Figure 25. APBO as a percent of total corporate liabilities, FYE % 3% 6% 9% 12% 15% Financial Services Total Other Food Natural Resources Energy Manufacturing Retail Communications Transportation Average Aggregate n=72 14 willistowerswatson.com

15 Appendix Companies Analyzed Agnico-Eagle Mines Agrium Inc. Air Canada AltaGas Ltd. Atco Ltd. Bank of Canada Bank of Montreal Bank of Nova Scotia Barrick Gold BCE Inc. Bombardier Inc. Brookfield Asset Management Cameco Corporation Canada Post Canadian Imperial Bank of Commerce Canadian National Railway Company Canadian Oil Sands Trust Canadian Pacific Railway Limited Canexus Corporation Canfor Corporation CanWel Building Materials Ltd. Cascades Inc. Catalyst Paper CCL Industries Inc. Celestica Inc. Cenovus Energy Inc. Coopérative Fédérée de Québec Cott Corporation Desjardins Group Eldorado Gold Emera Inc. Enbridge Inc. EnCana Corporation Extendicare Inc. Finning International Fortis Incorporated George Weston Ltd. Hudson s Bay Company Husky Energy Inc. Hydro One Incorporated Hydro-Québec Imperial Oil Ltd. Industrial-Alliance Insurance and Financial Services Intact Financial Corporation Inter Pipeline Fund Interfor Corporation Intertape Polymer Group Incorporated Laurentian Bank of Canada MacDonald Dettwiler & Association Magna International Inc. Manulife Financial Corporation Maple Leaf Foods Inc. Methanex Corporation MTS AllStream National Bank of Canada Norbord Inc. Onex Corporation Ontario Power Generation Pembina Pipeline Corp. Potash Corporation of Saskatchewan Inc. Power Corporation of Canada Quebecor Inc. Reitmans Resolute Forest Products Inc. Rogers Communications Inc. RONA Incorporated Royal Bank of Canada Saskatchewan Power Corporation Sears Canada Inc. ShawCor Ltd. SNC-Lavalin Group Inc. Sun Life Financial Inc. Suncor Energy Inc. Talisman Energy Inc. TD Bank Financial Group Teck Resources Limited TELUS Corporation The Wawanesa Mutual Insurance Company Thomson Reuters Corporation TMX Group Incorporated Toromont Industries Ltd. Torstar Corporation TransAlta Corporation Transat A.T. Inc. TransCanada Corporation Transcontinental Inc. Transforce Inc. TVA Group Incorporated VIA Rail Canada West Fraser Timber Corporation Limited Westshore Terminals Investment Corp. YPG Financing Inc. 15 Accounting for Canadian Pensions and other Postretirement Benefits

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