08/22/2012 08:43 EDT | Updated 10/22/2012 05:12 EDT

DBRS rating agency finds funding gaps at defined benefit pensions have widened

TORONTO - A review of 451 defined-benefit pension plans in Canada and the United States by debt rating agency DBRS has found the gap between plan assets and obligations widened significantly last year.

DBRS says several factors have contributed to the revised outlook, including continuing low interest rates.

The review found the combined funding deficit at the 451 defined-benefit plans ballooned to an unprecedented $389 billion in 2011.

DBRS said that more than two-thirds of the defined benefit plans it reviewed this past year were underfunded by "a significant margin."

Under defined benefit plans, employees generally make set contributions and are guaranteed a specific monthly retirement income. Any shortfall in the ability of the plan to make those payments is usually the employer's responsibility, although there have been cases where the cost threatens the business.

DBRS says the funding gap has forced employers and their employees to increase contributions and the rating agency warned that this can put companies with defined benefit plans at a competitive disadvantage.

“In order for companies to address this funding gap employers will have to maintain high levels of contributions, as many plans have now entered the danger zone of funded status,” DBRS senior vice-president James Jung said in the report

Although there is no set number for adequate funding, DBRS has identified 80 per cent as "a reasonable funding threshold."

Based on this threshold, more than two-thirds of plans reviewed this past year were underfunded by a significant margin, it said.

Moreover, DBRS said it believes that defined-benefit plans will be slowly unwound and removed over the next 40 years.

“These plans are difficult to manage and they are overly burdensome,” Jung said. "We’re seeing fewer companies offering defined benefits to new employees.”

The study notes a growing trend of employers offering workers defined-contribution plans rather than defined-benefit plans in the United States, which is reflective of the trend in Canada and abroad as well.

Defined-contribution plans effectively shift the risk of investment performance to the employee since both employer and employee make set contributions and the eventual payout is subject to vagaries of the market.