The solvency position of Canadian pension plans dipped slightly in the first quarter of 2015. The Mercer Pension Health Index stands at 94 per cent on March 31st, down from 95 per cent at the start of the year. The small decline in the funded status masks a quarter of significant volatility in the key variables that affect the funded status of pension plans. Long-term interest rates fell 50 basis points in the quarter, pushing pension liabilities higher. However, pension assets grew almost as much as pension liabilities due to strong equity returns, the positive impact of falling interest rates on bond portfolios and the magnifying effect of the declining Canadian dollar on the value of foreign asset holdings.
“Many pension plans remain more exposed to interest rate movements and equity market performance than they would like to be. However, plan sponsors have been reluctant to reduce their exposure to these factors at a time when interest rates are testing historical lows,” said Manuel Monteiro, Partner in Mercer’s Financial Strategy Group. “Nevertheless, there is increasing awareness of the importance of establishing a risk management strategy in advance, which would allow plan sponsors to act quickly when opportunities present themselves again.”
The 1st quarter of 2015 was highlighted by the pension longevity insurance transaction between Bell Canada and Sun Life, covering $5 billion in liabilities. This is the first such transaction involving a pension plan outside of the United Kingdom. Mercer is proud to have acted as lead advisor on the transaction. The transaction illustrates the increasing attention that plan sponsors are paying to longevity risk, and the availability of new solutions to manage this risk. A new mortality table that recognizes increased longevity is expected to be adopted for purposes of determining lump sum values paid from a pension plan in August 2015. This change will decrease the solvency position of pension plans by about 2 per cent on average.
“Falling oil and food prices allowed many central banks to hold back on interest rate rises, which ultimately led to strong global equity performance in the first quarter this year,” said Mathieu Tanguay, Partner in Mercer’s Investments business. “EAFE equity markets reached double digit performance, as a whole, as did equities in most of its constituent regions. The US equity market posted returns that hovered around 1 per cent (in USD terms) while Canadian equity market returns were only modestly higher. A harsh winter is said to be partly to blame for this underwhelming performance.”
Mathieu Tanguay continued, “On the bond side, continued uncertainty about oil prices and monetary policy has investors betting on a slowing Canadian growth and inflation rate. This has led long term federal bond yields to continue the descent, ending the quarter below 2%.”
A typical balanced pension portfolio returned 6.2 per cent in the first quarter of 2015. Other results:
- Long-term Government of Canada bond yields ended the first quarter at 1.9 per cent, down from 2.3 per cent at the beginning of the year.
- For the quarter, the best performing S&P/TSX sectors were Health Care (+45.1 per cent), Information Technology (+8.7 per cent) and Consumer Discretionary (+6.1 per cent). The worst performing sectors were Energy (-1.1 per cent), Financials (-0.2 per cent) and Telecom Services (+0.2 per cent).
- Large cap stocks (S&P/TSX 60 Index) returned 2.4 per cent, outperforming small cap stocks (S&P/TSX SmallCap Index) which returned -0.3 per cent during the quarter.
- Growth stocks outperformed value stocks as measured by the S&P Canada BMI Growth and Value indices. The indices returned 3.2 per cent and 1.9 per cent in the first quarter, respectively.
- The S&P 500 Index returned 10.4 per cent for the quarter in Canadian dollar terms. International equities, as measured by the MSCI EAFE (CAD) index, generated a return of 14.8 per cent for the quarter. Emerging markets, as measured by the MSCI Emerging Markets (CAD) index, returned 11.8 per cent in the first quarter.
- The FTSE TMX Canada Universe Bond Index returned 4.2 per cent in the first quarter, while the FTSE TMX Canada Long Term Overall Bond Index returned 7.1 per cent. At the end of the quarter, the yield on the FTSE TMX Canada Universe Index was 1.7 per cent as compared to 2.7 per cent for the Long Bond Index.
The chart below compares the distribution of the estimated solvency ratios of Mercer clients (covering 600 plans) at January 1, 2015 and March 31, 2015:
While there are outliers on either side, about 70% of Canadian pension plans are between 80 and 100 per cent funded on a solvency basis as of March 31, 2015.
Mercer Pension Health Index
The Mercer Pension Health Index tracks the funded status of a hypothetical defined benefit pension plan.
The Mercer Pension Health Index shows the ratio of assets to liabilities for a model pension plan. The ratio has been arbitrarily set to 100 % at the beginning of the period. The new Pension Health Index assumes contributions equal to current service cost plus solvency deficit payments, and no plan improvements. The Mercer Pension Health Index assumes that valuations are filed annually on a calendar year basis and that the deficit revealed in each valuation is funded on a monthly basis over the subsequent five years.
Assets: Passive portfolio with asset mix of: Asset mix: 42.5% DEX Universe Bond Total Return Index; 25% S&P/TSX Composite; 15% S&P 500 (CAD); 15% MSCI EAFE (CAD); 2.5% DEX 91 day T-Bills
Liabilities: 50 % active members, 50 % retired members. 60% of benefits for active members assumed to be settled through commuted values based on the Canadian Institute of Actuaries transfer value standards without the one-month lag, and the remaining 40 % assumed to be settled through an annuity purchase. Benefits for retired members assumed to be settled through an annuity purchase. Annuity prices determined based on the CIA guidance for the medium duration illustrative block. Results will vary by pension plan.
Mercer is a global consulting leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s more than 20,000 employees are based in 43 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital. With 55,000 employees worldwide and annual revenue exceeding $12 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a global leader in management consulting.
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