We are on the verge of a major change in the Canadian employee benefits insurance landscape.  Having survived the post-demutualization rounds of mergers and at least one near-failure in the not-too-distant past, there are now considerably fewer insurance companies in Canada, and fewer still in the group benefits area.  In 1992, the top five life insurers in Canada had about 50 per cent of the total group life insurance business in the country.  By 2011, the top five gathered 85 per cent of the market.  Market concentration may be cost efficient, but not necessarily better for the consumer.

Larger benefit plans are left unprotected from catastrophic drug claims

We have seen the confluence of two seemingly divergent trends: insurance companies moving away from…

Read more on these industry changes and on the various possible solutions offered by group insuance providers by clicking on the the following link: http://www.pbiactuarial.ca/wp-content/uploads/2012/05/Drugs-next-divide-4.pdf

After weeks of rumours, the Federal Budget finally confirmed that the retirement eligibility age of the Old Age Security (OAS) program will change.

Starting on April 1, 2023, the age of eligibility for the OAS and the Guaranteed Income Supplement (GIS) benefits programs will gradually increase from 65 to 67, with full implementation by January 2029.  The Budget confirms that this will not affect people who are already receiving benefits under this program, but only people under the age of 54 as of March 31, 2012.

Read more on these changes and PBI’s opinion by clicking on the following link: http://www.pbiactuarial.ca/wp-content/uploads/2012/04/Federal-Budget-2012-Final.pdf

There are many factors that could have a direct effect on a defined benefit pension plan; geopolitical risk is one of these. This risk has become more pronounced recently with the growing concerns regarding the possible development by Iran of nuclear weapons. Talks have started on April 13th between Iran’s chief nuclear negotiator and representatives from the US, Russia, China, UK, France and Germany. A previous meeting held a year ago ended in failure. The goal of this meeting is to defuse building tension over Iran’s nuclear enrichment program and to hopefully start laying the groundwork for the dismantlement of this program.

The possibility that Iran is developing a weapons-grade plutonium with the intent of arming a nuclear bomb poses a major threat to an area critical to the world economy. Iran is strategically located next to most of the world’s oil exporting nations and is a mere 600 kilometers from Israel. Israel has repeatedly threatened to act unilaterally and attack Iran should diplomatic efforts fail.

Effect on oil prices

Oil prices have already increased significantly due to concerns about the risks in the region.  The price is now close to the previous high that occurred in 2007.

Oil exports from OPEC constitute 40% of the World’s oil supply while the Gulf State countries account for 18 million of the 24 million barrels of oil exported daily.  A disruption of the exports from the Middle East would have immediate repercussions worldwide.  Oil prices would increase sharply and there would most probably be gasoline rationing in many countries.  The United States would be particularly vulnerable as it imports half of its daily oil needs.

The effect of a sharp rise in oil prices would be the equivalent of an increase in taxes.  The immediate effect would be a slowdown in the world economy as consumers would be forced to cut spending to pay for higher energy prices.  This would be a very difficult scenario for policy makers to resolve.  Interest rates are currently near historical lows, and developed countries are carrying very high levels of sovereign debt leaving very few options available.

For pension plans with the typical asset mix (60% Equities, 40% Bonds) this would be a highly negative outcome.  The most probable outcome would be a flight to quality with risk assets being sold and the funds invested in the government bond market.  Interest rates would fall increasing the value of Plan liabilities while asset returns would be low or negative.  The net effect would be a decrease in the funding ratios for most plans with this asset mix.  The effect would be less for Plans that have already de-risked and have a closer match between their assets and liabilities.

About PBI

PBI Actuarial Consultants Ltd. is an actuarial pension, benefits and investment consulting firm providing innovative, actuarially sound and cost-effective integrated solutions to fulfill our clients’ pension and benefits needs.

For more information about PBI, or this Economic Update, please contact Robert Laughton at 514-317-2341 or robert.laughton@pbiactuarial.ca.  Visit PBI at www.pbiactuarial.ca.

Stonebridge Financial Corporation (”Stonebridge“) is pleased to announce the successful closing of the Stonebridge Infrastructure Debt Fund I LP (the “Fund“), and commencement of the operations of the Fund, providing private debt loans for the construction and operation of infrastructure and energy assets.

The Fund is a closed-end fund developed in close cooperation with PBI Actuarial Consultants Ltd. (”PBI“), and with the support of PPP Canada Inc., and comprised primarily of Canadian pension funds as well as the Business Development Bank of Canada (”BDC”).

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If your disability benefits are self -insured, you probably need to take action

Over the last decade there has been an inconsistency between the deductions of EI and CPP contributions for employer-provided disability benefits. Recent changes to the Canada Pension Act now offer a consistent basis for the deductions of EI and CPP contributions: employer-paid self-insured disability benefits are included as pensionable earnings for CPP. However, Bill C-13 does not distinguish between trusteed and non-trusteed plans…

Read more by clicking on the following link: http://www.pbiactuarial.ca/wp-content/uploads/2012/03/Did-your-disability-costs-just-go-up-7.pdf

For most of the post World War II period the government bond markets in the developed countries were very predictable.  The rate of inflation was the most important factor in determining the level of interest rates and there was very little concern regarding default.  For these countries the return on government bonds was considered to be a “risk-free” rate that was used as the basis for evaluating the returns in other assets classes.  It was the developing countries that experienced defaults due to fiscal mismanagement and high inflation.

This has all changed in the past few years, with sovereign debt problems in countries such as Ireland, Iceland and Greece.  The losses can be quite high with investors in Greek sovereign bonds losing 70% of their investment as a result of the restructuring deal.  Is a similar deterioration underway today with other countries?  How can an investor evaluate the creditworthiness of sovereign bonds?

It was long assumed that countries with low levels of debt to GDP were good credits.  This has proven not to be adequate as the contingent liabilities must also be considered.  These contingent liabilities include; the strength of the banking sector, pension commitments, and health care costs. Countries such as Ireland and Iceland who initially had very low levels of debt to GDP were forced to rescue their banking sector and assume crushing debt burdens.  Demographics and generous social programs have crippled many countries in Europe, as promised payments are not supportable.

In using this approach to evaluating the sovereign bond market, it is the developing economies that are a better risk while the developed nations appear risky.  Countries such as the United States and Japan continue to borrow and increase their debt levels, while paying record low interest rates. This is being driven by the fact that the U.S. market is still viewed as a safe haven despite quickly deteriorating debt levels and a political system that appears unable to arrive at a solution.  Japan, a country virtually closed to immigration, has no plan to reduce its debt load but faces losing up to 40 million workers in the next 40 years due to the ageing of the population.  On a fundamental level these countries look vulnerable going forward.

Canada is doing better than most countries in the developing world. The federal government continues to cut spending and is also starting to address the issues of contingent liabilities such as the Canada Pension Plan and health care transfers.  As unpopular as it is, the current state of affairs requires that medical costs and pension benefits be controlled going forward.  At the provincial level the debt levels are higher and will require controls on spending and possibly higher taxes going forward.

In summary the world of sovereign bonds requires a different method for evaluating credit risk.  It is not just sufficient to look at current debt levels but also to closely examine the contingent liabilities that may someday result in higher levels of government debt.  Governments that are taking a proactive approach to reducing debt and the contingent liabilities will avoid the type of “solution” that was required by the Greek government.

About PBI

PBI Actuarial Consultants Ltd. is an actuarial pension, benefits and investment consulting firm providing innovative, actuarially sound and cost-effective integrated solutions to fulfill our clients’ pension and benefits needs.

For more information about PBI, or this Economic Update, please contact Robert Laughton at 514-317-2341 or robert.laughton@pbiactuarial.ca. Visit PBI at www.pbiactuarial.ca.

“On December 28^th, 2011, the Quebec Government published draft regulations announcing its intentions to extend the relief measures to defined benefit pension plan registered in Quebec…”

Read more by clicking on the following link: http://www.pbiactuarial.ca/en/publications/

Every new year brings emerging opportunities and fresh challenges. But potential challenges can often be turned into opportunities when one is aware of them.

In 2012, one of PBI’s resolutions is to create and publish more articles on our website. Our content will focus on news and advice we believe will help our readers understand pension, benefits and investment trends, and foresee potential challenges and opportunities.

Our first articles of the series are now available on our website. They discuss the issues of Pooled Registered Pension Plans, examine the future of biologic drugs and explain the latest success of Low-Volatility equity strategies. You can read them by clicking on the following link: http://www.pbiactuarial.ca/en/publications/

We are pleased to have this new opportunity to share more ideas and expert insights with you and we hope you find our 2012 Trends Update to be useful. We welcome your feedback and ideas for future articles.

About PBI

PBI Actuarial Consultants Ltd. is an actuarial pension, benefits and investment consulting firm providing innovative, actuarially sound and cost-effective integrated solutions to fulfill our clients’ pension and benefits needs.

For more information about PBI, or our Trends Updates, please contact Tony Williams at 604-647-3232 or tony.williams@pbiactuarial.ca. Visit PBI at www.pbiactuarial.ca.

Similar to a car with only forward gears and no reverse the European Community (EC) was not properly designed from the beginning.  The adoption of the Euro in 1999 as a single currency created a monetary union but not a fiscal union.  The fact that EU countries are not part of a fiscal union has greatly contributed to the current crisis.

A monetary union is an economic zone where various countries share the same currency.  A fiscal union is a common basis for controlling expenditures and budgets.

A Common Currency – A Disadvantage during a Recession

In Europe there are countries that are experiencing economic growth while others are in recession.  The currency of a country plays a major role when the economy is growing slowly or in a recession.  When this occurs, the devaluation of the currency (a lower value versus other currencies) is very useful in helping to restart the economy.

Recession and Currency Devaluation

(In this example we assume that Greece has its own currency and is not part of the EC.)

The chart above shows how currency devaluation works.  With a lower currency the cost for foreigners to buy Greek goods decreases, thereby increasing exports.  The higher cost of imported goods results in lower imports.  The improvement in the trade balance has the effect of increasing the wealth in Greece and helps to restart the economy.

This mechanism is no longer available to the countries that share the Euro.  The value of the Euro is based on the financial health of Europe as a whole, not on one particular country.  The EC was designed to work assuming that all countries were experiencing similar growth.  Like a car with no reverse gear the current EU structure is unable to deal with a situation where some countries such as Germany are strong whereas others such as Greece are doing poorly.

The high levels of sovereign debt for certain countries in the EC have further added to the problem.  Although there are provisions regarding levels of sovereign debt in the EU agreement, these rules are not strong enough and have not been well enforced.  The result is that various countries such as Greece, Italy, Portugal and Spain have borrowed in excess of allowed limits.  This heavy debt load had the effect of temporarily increasing economic growth but now is creating a huge drag on GDP as the debt needs to be paid back.

Currently the EC is trying to fashion an agreement which puts more control on the amount of debt that individual countries can borrow and establishes requirements for a balanced budget.  This is an effort to create a fiscal union.  This is a step in the right direction but does not address the issues that arise when the economic growth is different for countries within the EC.  The economies of the EU are quite different.  The recent expansion of the EU to include countries from the former Soviet Union has further added to the diversity.

The presumed advantage of the EU was that the free movement of both goods and labour within the zone and the larger markets for companies in member countries should produce more wealth.  It is the regional differences in economic growth that will continue to pose challenges to the Eurozone going forward.  It is now up to the politicians and policy experts to design a structure that like a car should be able to navigate in all directions.  This might include the maintenance of a free-trade zone with multiple currencies.

The issues concerning the EC will continue to add volatility to the markets and threaten at the extreme to cause yet another financial crisis similar to 2008.  The high levels of debt along with the inability of Europe’s leaders to agree upon a solution could provoke a situation where investors decide not to buy European government debt no matter how high the yields.

Implication for Pension Plans

The European situation poses a significant threat to the world economy.  Europe is clearly in recession and will remain so for the near future.  This has already been factored into economists’ forecasts.  The threat posed by Europe is the potential for a repeat of the 2008 Financial Crisis and the potential breakup of the European Union.  If investors decide that the risks in Europe are too high there is a real possibility that investors could decide to deny credit at any price.  We have already seen evidence of this in recent market activity.

A credit freeze or a breakup of the EC would cause widespread damage to the world banking system and the economy.  The markets would react in a now familiar manner – lower interest rates and negative returns for the stock market.  For ‘typical’ pension plans (60% equities, 40% bonds) this would be quite negative, as liabilities would increase while asset returns would be negative.

About PBI

PBI Actuarial Consultants Ltd. is an actuarial pension, benefits and investment consulting firm providing innovative, actuarially sound and cost-effective integrated solutions to fulfill our clients’ pension and benefits needs.

For more information about PBI, or this Economic Update, please contact Robert Laughton at 514-317-2341 or robert.laughton@pbiactuarial.ca.  Visit PBI at www.pbiactuarial.ca.