Pension risk challenges

Pension liabilities are determined using interest rates. Fluctuating interest rates can affect both the level of required cash contributions for the plan and pension costs disclosed in financial statements.

The discount rates used to calculate liabilities reflect a large proportion of credit such as corporate bonds. If the pension plan does not have enough credit exposure, its assets may not move the same way as its liabilities. 

Canadians are living longer than ever. It is great news for society, but for pension plans it means higher costs. When longevity improves so that an age 65 retiree is now expected to live one more year on average, this results in a 3-4% increase in cost for the pension plan (Sun Life). Pension payments need to be paid over a longer period. Investments in medical and anti-aging research and innovation could have a significant impact on longevity. (Source: Center for Disease Control, 2013)

Some pensions are increased periodically and linked to inflation. A change in inflation could lead to a change in pension funded status and required contributions if assets are not also linked to inflation.

Pension plans that invest in equities are exposed to additional risk because pension liabilities don’t behave like equities. Plans with significant equity exposure can experience more volatility in funded status and contribution requirements.

The yield on the pension plan assets should be at least equal to the liability discount rate. If there is a shortfall, the plan’s funded status could decrease as assets are not keeping up with liabilities.

This risk occurs when assets and liabilities aren't in the same currency. A change in foreign exchange rates could affect each of them differently. This could lead to a change in funded status and required contributions.