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NEWS & VIEWS

© 2012 Morneau Shepell October 2012 | Volume 9, issue 10 | 1 of 11

IN THIS ISSUE Annuities—should you tAke Another look?

At retirement, people can transfer their RRSP balance to a RRIF or they can buy an annuity.

Buying an annuity means you receive a monthly payment for life, so you no longer need to worry about outliving your savings. It also removes the need to make investment decisions during your retirement. Finally, the Canadian insurance industry is solid, so your annuity is safe. So why are not more people buying annuities?

Some may feel that the insurance industry is making excessive profits on these products and, therefore, it is a bad buy. This fear may stem from what was happening in the U.S. during the 1970s to 1990s when the present value of the annuity payments made equaled only 80% to 90% of the premiums paid. But that has changed in recent years. Generally, the present value of annuity payments now equals 95% to over 100% of the premiums paid. Therefore, the fear of overfeeding insurance company profits is currently unfounded.

Other people are afraid to annuitize because they feel that their savings will go to the insurers rather than their family if they die early. However, there are annuities that come with generous death benefits, so this fear can also be addressed (albeit at an additional premium).

Other reasons people give for not investing in annuities: not being able to access funds should there be an emergency, the preference for variable rather than fixed payments, and expectations about being able to get high returns in a RRIF. But mostly people seem to be put off by the very nature of annuities. People are not

1 Annuities—should you take another look?

2 US Politics and Stock Markets

5 Economic Turbulence has Negative Impact on Projected Salary Increases for Next Year

6 Update: Adoption of IFRS by Entities with Rate‑Regulated Activities

7 Alberta Provides Temporary Solvency Funding Relief

8 Market Indices

9 Tracking the Funded Status of Pension Plans

10 Impact on Pension Expense under International Accounting

11 About Us


enthusiastic about handing their money over to an insurance company just so that they can be paid a seemingly low allowance in return.

Nonetheless, annuities can simplify your life. And you do not have to go all in. For example, you could purchase an annuity with the portion of your RRIF that is currently invested in fixed income, and leave the equity portion of your RRIF whole. This provides you with a stable monthly allowance plus a pool of assets on the side to invest as you please or have in case of an emergency.

Even if you are not interested in purchasing an annuity as you start retirement, you should consider looking at them as you approach age 75. At that age, the annuity may be more interesting than a RRIF. This is best illustrated by example.

Let us say John is 75 and has $100,000 in his RRIF invested safely in GICs earning 2%/year. The minimum rate for RRIFs is 7.85% at age 75. If he withdraws the minimum, he would get $7,850 that year.

Given his safe investment strategy and the minimum amounts he is required to withdraw due to RRIF rules, John’s RRIF balance declines quickly. By age 85, John’s minimum withdrawal will have decreased to $5,093 that year, even though the minimum annual withdrawal rate will have risen to 10.33% from 7.85%. At age 95, John’s minimum withdrawal will be $2,701 (one‑third of his withdrawal at 75), and his RRIF balance will be $13,507.

Had John used his $100,000 to buy an annuity at age 75, he could have received instead a monthly payment of $690, which works out to $8,280 a year. This amount would have been guaranteed for 10 years; after 10 years, payments would have continued to be paid to John until his death. (Annuity information was based on competitive quotes for non‑indexed annuities as provided by CANNEX Financial Exchanges).

Of course, you do not want to be earning 2% in your RRIF. For the sake of the example, let us optimistically assume that John invested more heavily in equities and that there is no volatility attached to these equity investments. So instead of 2%, John earns a steady 7% a year net of expenses. In that case, the RRIF and the annuity provide similar results. In some years the RRIF gives a bit more than $8,280, in others less. Realistically, however, there is a lot more risk attached to the RRIF. Since the 1930s, the longest equities have gone before veering into negative return territory was six years.

So take another look at annuities, especially if you are nearing age 75.

u.s. Politics And stock MArkets

The U.S. presidential election is a highly anticipated event that garners much of the public’s attention. Major news outlets put huge efforts into reporting, discussing and debating the merits of the candidates, parties and policies put forth. Americans (and Canadians for that matter) are highly engaged in finding out who the next “leader of the free world” will be, and how potential outcomes will affect them. In this article we try to gain insight into the following two questions:

1. Historically, which party has the stock market preferred?

2. How sensitive is the market to presidential elections?

s&P 500 And Presidents

Under which American party has the stock market performed better historically? Analyzing historical and current platforms for the Democratic and Republican parties, one could conclude that market participants should have a favorite:


2012 nAtionAl PlAtforMs

deMocrAtic1 rePublicAn2

zz The middle class bargain

zz Cutting waste, reducing the deficit, asking all to pay their fair share

zz Wall Street reform

zz Lobbying and campaign finance reform

zz Tax relief to grow the economy and create jobs

zz Fundamental tax principles

zz Reining in spending, balancing budgets, ensuring sound monetary policy

Although these lists of platform positions are far from exhaustive, they are representative of the fact that Republicans have been known historically as the “party of Wall Street”. To test this hypothesis, we analyzed the S&P 500 from the election of Herbert Hoover to the present, and measured which party has been the better performer on an annualized basis3. The results are summarized in the figure below:

1 http://www.democrats.org/democratic‑national‑platform2 http://www.gop.com/2012‑republican‑platform_home/3 The annualized performance was measured from election dates, and not based on the actual inauguration, which occurs approximately three months after

the election date.

s&P 500 Price index froM noveMber 1928 to August 2012

To get a better idea of how the price index translates into returns, Table 1 shows the annualized returns for each presidential term. This result was quite profound, so we further tested the results by removing outliers for both parties. In particular, the annualized returns

were measured without the highest and lowest return for each party (for example, Herbert Hoover was not measured). The difference was still fairly significant, with the Democrats at 9.78% annualized and the Republicans at 3.14% annualized.


tAble 1 – AnnuAlized returns

yeAr President PArty return

1928 Herbert Hoover Republican ‑24.59%

1932 Franklin Roosevelt Democratic 25.51%

1936 Franklin Roosevelt Democratic ‑10.55%

1940 Franklin Roosevelt Democratic 4.69%

1944 Franklin Roosevelt/Harry Truman Democratic 6.58%

1948 Harry Truman Democratic 11.48%

1952 Dwight Eisenhower Republican 17.86%

1956 Dwight Eisenhower Republican 4.00%

1960 John Kennedy/Lyndon Johnson Democratic 11.38%

1964 Lyndon Johnson Democratic 4.90%

yeAr President PArty return

1968 Richard Nixon Republican 2.50%

1972 Richard Nixon/Gerald Ford Republican ‑2.34%

1976 James Carter Democratic 6.08%

1980 Ronald Reagan Republican 6.73%

1984 Ronald Reagan Republican 12.93%

1988 George Bush Republican 11.33%

1992 Bill Clinton Democratic 14.39%

1996 Bill Clinton Democratic 18.56%

2000 George W. Bush Republican ‑5.36%

2004 George W. Bush Republican ‑3.15%

2008 Barack Obama Democratic 10.78%

s&P 500 volAtility

the vix And election Periods

We then explored the volatility of equity markets in times of elections. Given market uncertainty during elections, we set out to measure how volatile the S&P 500 was in election years versus non‑election years. One method to measure volatility is to use the Chicago Board of Options Exchange Volatility Index (VIX). Roughly speaking, the VIX measures the market

expectation of near term volatility (30 days) conveyed by a basket of S&P 500 index options with various strike prices4. The VIX was created in 1993, and backfilled to the beginning of 1990. We used a similar methodology to run the U.S. market volatility back over 80+ years.

4 http://www.cboe.com/micro/vix/faq.aspx


At first glance, election periods appear no more volatile than non‑election periods, with the exception of the 1932 and 2008 elections. However, the volatility in both these time periods would have been further exacerbated by credit problems, which are more likely attributable to this fact. For further illustrative

purposes, Table 2 shows the average values of the VIX one month and one year before the election, and three years after the election during the past twenty years. Clearly, there does not appear to be much support to the argument that equity markets in the U.S. become more volatile leading up to an election.

tAble 2 – AverAge vAlue of vix before And After recent u.s. elections

yeAr President one yeAr before election

one Month before election

three yeArs After election

1992 Bill Clinton 16.25 17.64 13.06

1996 Bill Clinton 15.60 16.51 23.89

2000 George W. Bush 22.62 25.65 25.46

2004 George W. Bush 16.17 15.08 13.82

2008 Barack Obama 27.48 61.89 27.62

AdditionAl considerAtions

If the current market looks eerily similar to the markets of the 1930s, then there may very well be continued volatility on the horizon and an “austerity piece”. This would coincide with the argument that the U.S. needs to find some way to reduce its debt levels before the markets resume with confidence. Interestingly enough, it took many years after the 1930s before interest rates began rising. Like today, many investors then believed rates to be at all‑time lows with nowhere to go but up. Investors might be wise to expect nothing but a modest increase in rates in the near future; large increases may be far off or even a pipe dream at best. The biggest problem facing both parties is the unprecedented debt level the United States government continues to add to with no solution agreed upon between parties.

conclusion

Looking at the data, two points jump out: the S&P 500 has fared far better under a Democratic regime than a Republican one, and election uncertainty does not necessarily spillover into stock market uncertainty. So, even though following the Romney and Obama campaigns makes for good entertainment, don’t plan on trying to capitalize on any indeterminacy in the

market over the short term. Expect to hear more about taxes and debt levels over the coming month and try not to get too caught up in the market noise that is unfairly attributed to the election. Investors should maintain well diversified portfolios and look to reduce unwanted risks where possible. This U.S. election, like others before it, should not persuade investors off the long‑term path.

econoMic turbulence hAs negAtive iMPAct on Projected sAlAry increAses for next yeAr

Canadian employers expect salaries to rise by an average of 2.6% in 2013, according to Morneau Shepell’s annual Compensation Survey. This is a 0.2% drop from the responses in last year’s survey. The 2.6% average includes expected salary freezes and excludes promotional or special salary adjustments. Respondents say that projected base salary increases for 2013 are within the range observed last year, which was between 2% and 3.5%.


Overall, respondents appear to be less optimistic than last year in terms of growth and profitability in their organizations.

Morneau Shepell’s 30th annual Compensation – Trends and Projections survey was conducted between mid‑June and mid‑August, 2012, with input from over 250 organizations employing one million people in Canada. The benchmark organizations are mostly from the manufacturing (28%), services (24%), and finance (14%) sectors.

Respondents in the finance sector expect the greatest drop in salary increases, with a forecast of 2.7% increases for management and professionals in 2013, compared to 3.4% last year.

The overall expected average increase of 2.6% is twice the rate of increase in the Consumer Price Index, which at the time the survey was conducted was 1.3%.

According to survey respondents, for sponsors of defined benefit pension plans, the key priority is to rein in escalating pension costs. Although interest rates are at historical lows, these sponsors are implementing liability‑driven, investing strategies. And as a response to exploding pension costs, employers are looking into all available alternatives to modify pension cost sharing and risk.

For sponsors of defined contribution plans, the trend is to establish a realistic retirement income scenario. In addition to retirement income calculators and other decision tools, the trend is to show a personalized scenario to participants so that they can make adjustments to their retirement savings strategy.

Survey respondents again identified cost control and disability management as their top priorities for 2013 for their benefits program. Faced with continuous cost increases and higher utilization rates of expensive drugs, employers are finding it a challenge to implement cost‑control strategies without reducing access to medical therapies for employees.

Morneau Shepell has noted a trend to increased use of Employee and Family Assistance programs (EFAP) to address mental health issues in the workplace, as well as employees and family members accessing EFAP through new technologies which allow them to get help immediately.

According to the survey, for 2013, the key human resource priorities for employers are the same as last year—talent acquisition and employee retention—especially in the context of an aging population.

uPdAte: AdoPtion of ifrs by entities with rAte‑regulAted Activities

Following its meeting on September 5‑6, 2012, the Canadian Accounting Standards Board (AcSB) will extend again the existing deferral of the mandatory IFRS changeover date for entities with qualifying rate‑regulated activities. The deferral has been extended by an additional year to January 1, 2014. The AcSB will monitor future developments of the International Accounting Standards Board (IASB) and consider the need for a further deferral should an interim solution not occur within a year. The AcSB expects to formalize the extension by issuing amendment to the Introduction to Part I of the Handbook in October 2012.

The AcSB had previously extended the changeover date to January 1, 2013 (see News & Views, April 2012), anticipating that the IASB would include entities with rate‑regulated activities in its future agenda. This time around, the AcSB has decided to end stakeholder uncertainty about a further extension quickly, rather than waiting until closer to the end of 2012 to do so.

http://www.morneaushepell.com/_private/getpdffile.asp%3FdocId%3D1686


AlbertA Provides teMPorAry solvency funding relief

Alberta has enacted regulations to provide temporary solvency funding relief. The regulations, which were adopted on September 19, 2012, apply to defined benefit pension plans registered in Alberta other than specified multi‑employer pension plans.

The regulations provide two forms of solvency funding relief:

zz Consolidation of all existing solvency deficiencies into a single new solvency deficiency; and

zz Extending the amortization period for solvency deficiencies from five to ten years.

A plan administrator is permitted to make a single application for solvency funding relief together with an actuarial valuation report with a review date between December 31, 2011, and December 31, 2012, inclusively.

If an actuarial valuation report has already been filed in respect of a December 31, 2011, valuation, replacement pages for the already filed valuation report are acceptable.


As At september 30, 2012

MArket indices

The following table shows the Morneau Shepell monthly summary of returns from various market indices. It also includes returns from benchmark portfolios used by pension funds.

In Asset Management, we provide objective advice on all aspects of asset management for pension funds, including investment policy statements, portfolio manager searches, investment performance measurement and investment strategy.

Jean Bergeron, FSA, FCIA, CFA, Partner Tel.: 514.392.7852 Fax: 514.875.2673 E‑mail: [email protected]

Robert F. Boston, CFA, Partner Tel.: 416.380.2765 Fax: 416.445.1858 E‑mail: [email protected]

In risk Management, we provide a structured, comprehensive approach to pension risk management, including implementation of liability‑driven investment strategies, advice on allocation of the risk budget within an asset‑liability framework and execution of continuous and dynamic processes for risk reduction.

Patrick De Roy, FSA, FCIA, CFA, FRM, CERA, Partner Tel.: 514.392.7835 Fax: 514.875.2673 E‑mail: [email protected]

ASSET & RISk MANAGEMENT

returns

Monthly Quarter to date

year to date 1 year

tsx grouP/Pc bond indicesDEX Universe Bond 0.7% 1.2% 3.3% 5.5%DEX 91 Day Treasury Bill 0.1% 0.2% 0.7% 0.9%DEX Short Term Bond 0.4% 0.7% 1.7% 2.2%DEX Mid Term Bond 0.8% 1.4% 4.2% 6.3%DEX Long Term Bond 0.9% 1.9% 5.0% 10.2%DEX High Yield Bond 1.4% 4.1% 10.9% 13.6%DEX Real Return Bond 0.9% 1.2% 2.8% 10.8%cAnAdiAn eQuity indicesS&P/TSX Composite (Total Return) 3.4% 7.0% 5.4% 9.2%S&P/TSX Composite Capped 3.4% 7.0% 5.4% 9.2%S&P/TSX MegaCap 3.2% 5.9% 4.2% 7.5%S&P/TSX 60 (Total Return) 3.2% 6.7% 5.6% 8.6%S&P/TSX Completion 4.1% 7.8% 4.8% 10.8%S&P/TSX Small Cap 2.9% 8.3% ‑0.2% 5.6%BMO Small Cap Unweighted 5.3% 11.5% 1.2% 6.3%BMO Small Cap Weighted 4.5% 10.2% 3.6% 9.0%u.s. eQuity indicesS&P 500 (US$) 2.6% 6.4% 16.4% 30.2%S&P 500 (C$) 2.3% 2.7% 12.6% 22.1%foreign eQuity indices1

MSCI ACWI (C$) 2.8% 3.1% 9.1% 14.2%MSCI World (C$) 2.4% 3.0% 9.2% 14.8%MSCI EAFE (C$) 2.7% 3.2% 6.4% 7.4%MSCI Europe (C$) 2.6% 4.9% 7.6% 10.8%MSCI Pacific (C$) 2.6% 0.1% 4.4% 1.7%MSCI Emerging Markets(C$) 5.7% 4.1% 8.5% 10.8%otherConsumer Price Index (Canada, August 2012) 0.2% 0.2% 1.3% 1.2%

Exchange Rate US$/C$ ‑0.3% ‑3.4% ‑3.3% ‑6.2%MorneAu shePell benchMArk Portfolios2

60% Equity/40% Bonds 2.0% 3.5% 5.8% 9.4%55% Equity/45% Bonds 1.9% 3.3% 5.6% 9.1%50% Equity/50% Bonds 1.8% 3.1% 5.4% 8.8%45% Equity/55% Bonds 1.7% 2.9% 5.2% 8.4%40% Equity/60% Bonds 1.6% 2.7% 4.9% 8.1%

1 Returns net of taxes on dividends, except for MSCI Emerging Markets.2 The returns are compounded monthly.



Solvency Liabilities ($M)Assets ($M)

2008 2009 2010 2011 2012

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q47580859095

100105110115

120125130135140145150155160

trAcking the funded stAtus of Pension PlAns

This graph shows the changes in the financial position of a typical defined benefit plan since December 31, 2007. For this illustration, assets and liabilities of the plan were each arbitrarily set at $100 million as at December 31, 2007. The graph shows the impact of past returns on plan assets and the effect of interest rate changes on solvency liabilities.

Financial markets around the world got a strong boost from the European Central Bank’s announcement of a bond‑buying program and from the Federal Reserve’s announcement of a third round of quantitative easing, or “QE3”, in September 2012. Consequently, assets increased and the solvency deficit decreased. Assets climbed by 1.9% to about $114.6 million, its highest level experienced during the period shown, and liabilities fell by 1.0% to $157.1 million. The combined result was that the deficit has decreased this month by 8.2% to $42.5 million. Nonetheless, the current solvency deficit of this typical pension plan is still at its fourth highest level experienced during the period shown.

Since the beginning of the year, the funded status of this typical pension plan has deteriorated. The deficit has increased by $4.6 million (a 12.0% increase).

Please contact your Morneau Shepell consultant for a customized analysis of your pension plan.

the evolution of the finAnciAl situAtion of Pension PlAns since deceMber 31, 2007

comments:

1. No consideration has been made for contributions paid into the plan or for benefits paid out of the plan.

2. Solvency liabilities are projected using the rates prescribed by the Canadian Institute of Actuaries for the purpose of determining pension commuted values. Early application of the 2009 standards is not reflected.

3. The underlying typical defined benefit plan is a final average plan with no pension indexing.

4. Solvency liability calculations take into account revised CIA guidance on the solvency valuation assumptions (annuity proxy).

5. Assets are shown at full market value. Returns on assets are based on those of the Morneau Shepell benchmark portfolio (55% equities and 45% fixed income).

cAnAdA bond yields

yield (closing) chAnge 2012dec. 2011 sePt. 2012

Overnight rate target

1.00%

1.00%

0 bp

3 months 0.82% 0.97% 15 bps2 years 0.95% 1.07% 12 bps5 years 1.27% 1.30% 3 bps7 years 1.51% 1.45% ‑6 bps10 years 1.94% 1.73% ‑21 bps30 years 2.49% 2.32% ‑17 bps

Source: Bank of Canada



comments:

1. The discount rates shown reflect the educational note published by the Canadian Institute of Actuaries entitled Accounting Discount Rate Assumption for Pension and Post-employment Benefit Plans (September 2011).

2. The expense is established as at December 31, 2011, based on the average financial position of the pension plans used in our 2011 Survey of Economic Assumptions in Accounting for Pensions and Other Post-Retirement Benefits report (i.e. a ratio of assets to obligation value of 85% as at December 31, 2010). Also, we are assuming that, under the international accounting, the employer elected the exemption at transition with regards to past gains and losses, and that future gains and losses are recognized in other comprehensive income (excluded from expenses shown).

3. The return on assets corresponds to the return on the Morneau Shepell benchmark portfolio (55% equities and 45% fixed income).

4. The actuarial obligation is that of a final average earnings plan, without indexing (two scenarios: with and without employee contributions).

iMPAct on Pension exPense under internAtionAl Accounting

Every year, companies must establish an expense for their defined benefit pension plans.

The following graph shows the expense impact for a typical pension plan that starts the year at an arbitrary value of 100 (expense index). The expense is influenced by changes in the discount rate based on high‑quality corporate and provincial (adjusted) bonds1 and the median return of pension fund assets.

The pension expense has risen by 18% since the beginning of the year due to a decrease in the discount rate since December 31, 2011. However, the pension expense has remained stable this month due to returns on plan assets that were above expectations, despite the fact that the discount rate decreased again in September 2012.

The table below shows the discount rates for varying durations and the change since the beginning of the year. A plan’s duration generally varies between 10 (mature plan) and 20 (young plan).

Please contact your Morneau Shepell consultant for a customized analysis of your pension plan.

discount rAte

durAtion deceMber 2011

sePteMber 2012

chAnge in 2012

11 4.16% 3.57% ‑59 bps14 4.39% 3.75% ‑64 bps17 4.51% 3.88% ‑63 bps20 4.58% 3.95% ‑63 bps

(In %)Discountrate 4.3 4.2 4.2 4.1 4.2 4.0 4.1 3.8 3.8 3.7Return on assets(55% equities) n/a 2.4 1.1 0.1 -0.7 -1.9 1,3 0.4 0.9 1.9

Non-contributory planContributory plan

31-1230-0930-0631-0331-12

95.0

97.5

100.0

102.5

105.0

107.5

110.0

112.5

115.0

117.5

120.0

exPense index froM deceMber 31, 2011


Please contact your Morneau

Shepell consultant for additional

information about this newsletter.

About us

Morneau Shepell is the largest Canada‑based human resource consulting and outsourcing firm focused on pensions, benefits, employee assistance program (EAP) and workplace health management and productivity solutions. We offer business solutions that help our clients reduce costs, increase employee productivity and improve their competitive positions by supporting their employees’ financial security, health and well‑being.

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OTTAWA613.238.4272

PITTSBURGH412.919.4800

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ST. JOHN’S709.753.4500

TORONTO416.445.2700

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[email protected]

@

morneaushepell.com

CoNTRIbuTING EdIToRS

Michel dubé, Ph.d. Compensation Consulting

darin eddy, bsc Asset & Risk Management

steve Mahoney, cfA, fsA, cAiA, PrM Asset & Risk Management

sébastien rannaud, fsA, fciA Retirement Consulting

fred vettese, fsA, fciA Retirement Consulting

Andrew zur, ll.b. Pension Legislation

mailto://[email protected]

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news & views - morneau shepell · 1980 ronald reagan republican 6.73% 1984 ronald reagan...

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