Pension plan facing difficult funding challenge: volatile stock markets and low interest rates batter our fund.

The past year was a tough one for pension plans in Canada - and around the world. The Church's pension plan was no exception. Despite our solid 85-year track record, sound governance and investment practices, and recent contribution increases, the plan now faces a significant (and growing) funding shortfall.

How did we get here?

Like most pension plans, our plan was still recovering from the market losses of 2008 when it was hit by the 2011 downturn. The Toronto Stock Exchange finished 2011 with a return of - 9%. Non-Canadian stocks performed slightly better, but still finished the year in the red. Our plan managed to end the year with a return of 1.5% better than most plans, but still short of expectations.

To make matters worse, interest rates sank below the already record lows we've seen over the past few years. Interest rates are a key part of calculating how much money is needed to pay the pensions earned by members. When interest rates drop, the plan is required to set aside more money to pay those pensions. Our pension plan is a mature plan - there are fewer younger members enrolling in the plan and more members retiring. When you add the impact of longer life expectancy, the plan needs more money to pay these pensions for longer periods of time.

Two sides of the pension plan

Defined benefit (DB) pension plans like ours have to strike a balance between assets and liabilities. Assets refer to the money in the pension fund (made up of member and employer contributions, plus investment earnings). Liabilities, on the other hand, refer to the cost of providing the pensions earned by members. In short, assets are what we have; liabilities are what we owe. If liabilities are greater than assets, we have a funding shortfall. Clearly, this presents a huge challenge for our plan.

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The law requires that all DB pension plans, like ours, file a valuation report with the pension regulator at least once every three years (or every year if the funding shortfall gets too big). The purpose of the report is to keep track of the financial health of the plan. Each report must include:

* A going-concern valuation that tests the health of the plan, assuming it will continue to operate well into the future. Going-concern funding shortfalls must be paid off over 15 years.

* A solvency valuation that tests the health of the plan in the unlikely event it suddenly stops operating and has to pay all the benefits earned by active, inactive and retired members in a single lump sum as of that date. Solvency shortfalls must be paid off over five years.

Our plan was required to file a valuation report as of June 30, 2011. The previous report, which was filed as of June 30, 2008, showed that our plan had a going-concern surplus of $12.3 million and a solvency funding shortfall of $0.9 million. Despite contribution increases and special payments to address the solvency shortfall, the June 30, 2011 report found that our solvency shortfall had ballooned to $34.3 million. We had also acquired a going-concern shortfall of $10.3 million. The market downturn in the last six months of 2011, combined with the additional drop in interest rates, inflicted further damage. By December 31, 2011, our plan had an estimated solvency shortfall of $51.5 million and a going-concern shortfall of $16.8 million.

Moreover, because the solvency funding level has dropped below 85%, we are now required to file valuation reports with the regulator every year. This means we have to take immediate action to deal with our funding problem.

We're not alone

The factors that have led to funding problems lie largely outside the control of pension plan sponsors. As a result, several provinces, including Ontario (where the plan is registered), have introduced special funding relief measures to help plans. While our plan its taking full advantage of these measures, they do not relieve us of our obligation to fund the solvency shortfall - they simply give us more flexibility over how and when we do it. Clearly, this presents a huge challenge for our plan.

We also know that Ontario will soon be announcing significant changes to its pension legislation. These changes may provide a permanent exemption from solvency funding for plans that meet certain conditions. Unfortunately, the timing of the changes - and how they might work - is still unknown and we can't wait. With that in mind, we have initiated discussions with the regulators to make them aware of our concerns.

Of course, we are hopeful that our funding situation may be eased over the long term by improved economic conditions, such as higher investment returns and/or higher interest rates. A 1% increase in the long-term interest rate alone would reduce our solvency shortfall by approximately $20 million. In the short term, however, given the timing of our next valuation and the urgency of our situation, the Board must took for new sources of pension funding or will need to consider changes to benefits to close the funding gap.

The Pension and Benefits Board is developing an action plan that it will take to the General Assembly in June, for full discussion.

We believe that pensions are a key component of long-term security for our ministers and lay staff. That's why we intend to do everything in our power to ensure our plan remains financially viable and sustainable.

How you can help protect the pension promise

You might be asking if there is anything that ordinary congregational members can do to help with the pension fund deficit and the answer is "yes." Any donation that you make to the Church can be specifically designated to support the pension plan. This includes the common shares of any publicly traded company such as a bank, utility, insurance, pipeline, etc. In most cases, there are no capital gains taxes on donated shares and you'll get a tax credit on 100% of your donation. Your investment adviser can assist you with the paperwork. You can also name the Church as the beneficiary of a life insurance policy - with special instructions to apply the proceeds to the pension plan.

So, there is a lot that you can do and, together, we can build the plan to the size that it needs to be to secure the retirements of our wonderful ministers and staff.

According to a recent study, solvency funding levels in Canada fell from a median of 83% at the beginning of 2011 to a median of 68% at the beginning of 2012. With a solvency funding level of 69%, our plan sits just above the midpoint of all plans in Canada.

Why investments are important

Pensions are paid from the pension fund, which is made up of contributions and investment income on contributions. Over the long term, investment income plays a far bigger role than contributions in funding our pension plan.

The Church's pension plan is designed to provide a modest pension that rewards long-service clergy and lay employees with a basic level of financial security in retirement. The average pension paid from the plan is $14,000 per year.

A 1% increase in long-term interest rates alone would reduce our solvency shortfall by approximately 40%.

How our membership has changed

                December 31, 1995  June 30, 2011

                  Average age of   Average age of
                    actives-48       actives-52

Actives                       49%             38%

Retirees                      38%             49%

Deferred vested               13%             13%
members*

Note: Table made from pie chart.

Annual investment returns for past 10 years

2002   -4.4%
2003   12.0%
2004    8.8%
2005   10.4%
2006   11.3%
2007   -2.1%
2008  -11.7%
2009   15.0%
2010    9.3%
2011    1.5%

Note: Table made from bar graph.