Air Canada pension turnaround signals optimism
Canadian plans moving quickly into healthy territory
TORONTO— In the early months of 2012, Calin Rovinescu, Air Canada chief executive, found himself on the defensive during the company’s first quarter conference call.
The first-quarter loss at the country’s largest carrier had just swelled tenfold amid testy disputes with its labour unions, high fuel prices and the collapse of the company’s former maintenance unit, Aveos Fleet Performance Inc.
Adding fuel to the fire, Air Canada’s pension solvency deficit hit a gut-clenching $4.4 billion at the start of the year — double what it was a year earlier — as low interest rates and poor equity market performance conspired to increase its funding obligations.
Servicing its pension obligations was completely unmanageable for the company, and so the grumblings started anew that the carrier was once again heading for a brush with insolvency.
Rovinescu admitted the easiest thing to do would be to rip everything up and start fresh. “Sadly, life doesn’t work like that,” he lamented on the call.
Instead, he said Air Canada would just keep chipping away at the legacy structure of the airline in an effort to return to it to profitability and a more manageable cost structure.
By the end of that year, Rovinescu had achieved one those goals with Air Canada returning to the black in 2012 for the first time in five years, kicking off a rally that saw the airline become the top performer on the S&P/TSX Composite Index i n 2013, gaining 316 per cent over the course of the year.
But one of the final pieces of the puzzle was only put in place Wednesday with Air Canada announcing its multi-billion-dollar pension solvency deficit had been eliminated.
While the numbers are still being finalized, management said it expected a “small” surplus in its pension plan at the start of 2014 for the first time since 2001.
At the start of 2013, its pension solvency deficit sat at $3.7 billion.
The reversal of fortunes at Air Canada is in many ways indicative of the state of several previously distressed pension plans in the country.
The health of Canadian pension plans improved sharply again in the fourth quarter of 2013, according to the Mercer Pension Health Index, which tracks the funded status of a series of hypothetical, defined benefit pension plans. Nearly 40 per cent of the pension plans in the index were fully funded at the start of 2014, compared to six per cent the year before. In fact, less than six per cent of the plans entered in 2014, less than 80 per cent were funded, Mercer figures show.
“It’s hard to overstate how good 2013 was for most defined benefit pension plans. Stock markets soared, long-term interest rates rose sharply, and the Canadian dollar weakened which further magnified foreign returns,” said Manuel Monteiro, Mercer Financial Strategy Group partner, announcing the numbers earlier this month.
There have been several factors that have contributed to the elimination of Air Canada’s massive solvency deficit over the past year, not the least of these has been a rise in the discount rate that calculates what is owed. Air Canada said the discount rate rose to 3.9 per cent this year from three per cent in 2013. Every 10 basis point rise in the discount rate — which is based on rising long-term government bond yields — results in a $150 million change in solvency liability, translating into $1.35 billion in savings, Air Canada says.
The company also said it yielded a 13.8 per cent return on its investments last year.
This comes in addition the $970 million in savings it reaped from the implementation of previously disclosed changes to its pension benefits, including moving the bulk of its new hires into a hybrid defined benefit/contribution pension plans.
The carrier said it also contributed $225 million to the plan last year.
Like Air Canada, several Canadian companies suddenly in a similar surplus position are re-evaluating the amount of risk they are willing to assume in their defined benefit plans in order to avoid the sort of volatility they have experienced over the past five years, according to Ian Markham, Towers Watson senior actuary.
“By now, I think, pretty well all parties that have an interest in defined benefit plans generally have got the message that things are a lot different than the heady days when we had surpluses and they could be spent on benefit improvements,” he said.
Returning Air Canada’s pension plan to the black was no small feat. Like many companies saddled with volatility of a defined-benefits pension plan, the airline has been actively trying to de-risk its plan.
It is trying to protect against future fluctuating in interest rates, for example, by covering 70 per cent of its pension liabilities to fixed income products with the goal of reaching 100 per cent in the medium term.
Markham said Air Canada is not alone in taking these sorts of actions now that its pension funding obligations have subsided, Markham said.
“There is a significant degree of action in what might be called ‘de-risking,’ ” he said.
Many companies are viewing a fully funded pension plan as an ideal time to cut back on the return-seeking assets in their plans, such as equities, he said.
“By making it less volatile, it means that the pension plan will be less of a burden on the company and perhaps the pension plan can continue for longer,” he said.
Air Canada’s pension problems were so bad in 2012 that it reached out to the federal government and its employees for further relief on its funding obligations.
In March 2013, Ottawa announced an arrangement whereby Air Canada would only be required to contribute at least $150 million a year to the pension plan annually through to the end of 2020. At the end of the seven-year term, at least $1.4 billion has to be contributed to its employee’s pension plan, under the terms of the agreement.
There were several strings attached to the deal: executive compensation was frozen at the rate of inflation, special bonuses were prohibited and limits were imposed on the executive incentive plans. The airline was also prohibited from issuing dividends and initiating share buybacks throughout the term of the arrangement, in addition to other constraints.
The company managed to look significantly hamstrung. But it was a gamble that afforded Air Canada the stability it needed to not only push forward with its plans to launch its new low-cost carrier, Rouge, last year, but also place an order for a new narrow-body aircraft, refinance some of its long-term debt, and better position it financially to take delivery of its new 787s Dreamliners when they start to arrive in March.
Air Canada said Wednesday it is now considering opting out of the arrangement with Ottawa and its employees. However, no decision is expected on the matter this year.