Pension funds are threatened by an extended period of low interest rates and by increases in how long retirees are living, Bank of Canada Deputy Governor Larry Schembri said.
Canada’s 8,000 pension funds rely on returns from long-term investments such as bonds to generate funds needed for future payouts, Schembri said. Central banks worldwide cut policy rates to record lows through the 2008 global financial crisis, helping to suppress longer-term bond yields.
“By far the biggest challenge faced by defined-benefits pension funds since the financial crisis has been the low level of long-term interest rates,” Schembri, 57, said in the text of a speech he’s giving today in Quebec City, Quebec. “Interest rates are likely to remain relatively low for an extended period as the Canadian and global economies slowly recover.”
Canadian policy makers have sought to create more secure pensions amid concern that household savings rates are too low and as companies turn away from defined-benefit payouts. Another risk comes from signs that a growing retiree population is living longer, Schembri said, which could boost pension obligations by as much as 7 percent.
That may lead to changes to contribution rates and benefits, the deputy governor said. Pension funds are already the second-biggest source of wealth in Canada after the country’s banking system, holding C$1.2 trillion ($1.1 trillion) of assets, or 13 percent of the total, he said.
Ontario Finance Minister Charles Sousa proposed a plan to increase retirement income modeled on the public Canada Pension Plan that’s funded in part by payroll taxes. The proposal was made on May 2, just before the Liberal government called an election for June 12.
Schembri’s speech didn’t comment on the Ontario proposal or give a view on the next move in the central bank’s policy interest rate, which has been 1 percent since September, 2010. The central bank has a responsibility to protect overall financial stability without having direct oversight of specific funds.
Proposals by the Group of 20 nations to create a safer financial system should benefit pension funds, Schembri said. Fund managers may opt to buy new “bail-in” securities that large financial institutions will create in order to fund any needed wind-up of operations, he said.
The Bank of Canada is encouraging some of the largest pension funds to join a central clearinghouse that handles trading in repos and over-the-counter securities, Schembri said. Pensions may be allowed to join the system without paying into a fund that protects investors against losses from the collapse of a trading partner, he said.
“Such participation will greatly enhance the resilience of the repo market,” he said.
The long investment horizon of pension funds have often made them among the least risky participants in the financial system, Schembri said.
“They are the Warren Buffetts of the financial system. In other words, pension funds can more easily bear market and liquidity risk and earn the associated risk premiums because they can diversify these risks over time,” he said.