Love low interest rates? Some pensioners worry about the risks

Years of low interest rates are putting pressure on Canadian pension funds and highlight the need for tougher regulations, says a pension advocacy group.

"When interest rates are low, the contributions that have to be made to the pension plan to keep it running tend to be on the high side," says Bob Farmer of the Canadian Federation of Pensioners. "The lower the interest rate, the higher the cost."

• Lower interest rates may be the new normal, Stephen Poloz says

In addition to higher costs, Farmer says the sustained period of low rates has made it difficult for defined benefit pension funds to rely on normally reliable sources of income such as bonds. Farmer says this is a potential problem because many defined benefits plans are underfunded.

"The chickens come home to roost if the pension plan gets into trouble because the employer gets into trouble," Farmer says. "And then it's quite possible that if the employer goes bankrupt that [employees'] pensions will be reduced."

Wildfires, Brexit will likely keep rates low

Farmer is unlikely to see any help on the interest rate side anytime soon. The Bank of Canada's overnight lending rate has been at one per cent or below since January of 2009. It's currently at 0.5 per cent, and few analysts expect a change — let alone an increase — when the Bank of Canada makes its interest rate announcement on Wednesday.  

The wildfires in Alberta and Saskatchewan earlier this year, combined with soft export numbers and continued uncertainty in Europe over the fallout of the Brexit vote, has many analysts anticipating low interest rates for the foreseeable future.

In April, Bank of Canada Governor Stephen Poloz warned that pension funds should brace for a new normal of low interest rates.

"Those in the pension business need to get used to it. They need to adapt to it," Poloz told a Wall Street audience. 

Since the 2008 global financial crisis, pension funds around the world have had to contend with market uncertainty, feeble growth and record low interest rates.

Pension funds use long-term interest rates to calculate their liabilities. The lower the rates, the more money plans need to have to ensure they will be able to pay future benefits.

With monetary policy unlikely to change, Farmer is pushing for legislative changes at the federal and provincial levels.

"We have to make sure that the pension legislation is capable of making sure that pension plans remain healthy and pensions can still be delivered even in a low-interest-rate environment," Farmers says.

In particular, he wants a requirement for pension funds to maintain higher funding levels and to replace market losses over a shorter period of time than the current 10 years.

Low interest rates a risk to be managed

The federal finance department says Canada's pension funds are largely healthy and the country has a retirement system that is rated well internationally by groups such as the Organization for Economic Co-Operation and Development.

But spokesman Daniel Lauzon said in a statement the department is "very aware" that many Canadians, particularly younger people, are concerned about retirement as fewer jobs come with workplace pensions. 

As for Farmer's call for tougher pension regulations, Lauzon says current regulations are aimed at ensuring that pension plan assets are sufficient to meet obligations. 

"That being said, our government recognizes the importance of a safe, secure and dignified retirement, and assesses the rules and regulations with the best long-term interests of middle-class Canadians, and those working hard to join them, in mind," Lauzon said. 

Like market losses, the finance department says low returns from low interest rates is just another risk that pension funds have to manage. 

Big pension funds adapting

A recent Bank of Canada analysis shows that the country's largest pension funds — the so called Big Eight — are doing just that.

Those funds — which includes funds such as the Canada Pension Plan, the Quebec Pension Plan and the Ontario Teachers' Pension Plan — have responded to the challenge of low interest rates by investing in alternative assets such as real estate and infrastructure projects, or by taking on debt to finance a series of risk-mitigation strategies.

But the central bank's analysis warns: "If not properly managed, these trends may lead in the future to a vulnerability that could create challenges in a severely stressed financial environment."