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The solvency position of Canadian pension plans fell slightly in 2015. The median solvency ratio of the pension plans of Mercer clients stood at 85% on December 31, 2015 down from 88% at the beginning of the year with about 9 out of 10 plans still being in solvency deficit position. The Mercer Pension Health Index, which represents the solvency ratio of a hypothetical plan finished 2015 at 93%, down from 95% at the beginning of the year.
The decline in funded status was due to poor equity market performance, the continued decline in long-term bond yields and new mortality tables that reflect increased life expectancy, partially offset by the positive impact of the decline in the Canadian dollar on foreign asset returns.
“There was considerable variability in the financial performance of pension plans in 2015,” said Manuel Monteiro, leader of Mercer’s Financial Strategy Group. “Pension plans with significant Canadian equity holdings and those that hedge their foreign currency exposure experienced larger than average declines in their solvency ratio.”
This past year was another that defied expectations with interest rates falling further and the Canadian dollar plummeting by almost 17% against the U.S. dollar. With weak economic conditions continuing to persist and central bankers discussing the possibility of negative interest rates, plan sponsors are coming to the conclusion that they cannot count on higher interest rates to erase their lingering pension deficits. Pension plan sponsors were served with another reminder in 2015 that they need to better understand the risks that they face, and to establish a robust risk management strategy to manage them.
Some governments have recognized the challenging economic conditions and are moving towards lessening the funding burden for defined benefit pension plan sponsors. Quebec is making the most significant changes by moving away from a solvency-based funding target starting in 2016. Alberta and British Columbia have also introduced helpful changes in the past few years. Most recently, the Ontario government announced that they will develop a set of reforms that would “focus on plan sustainability, affordability and benefit security while balancing the interests of pension stakeholders.”
From an investment standpoint
A typical balanced pension portfolio would have returned 2.9% during the fourth quarter and 5.3% for 2015. Detailed market returns for the quarter and year to date are shown in the table.
“Canadian equities were the poorest performing broad equity asset class, with a return of -8.3% over the last year. Two factors that particularly affected the Canadian economy were falling commodity prices and a continued ramp up in oil production, to a near all-time high, bringing the price per barrel down to around US$37” said Brian Dayes, partner at Mercer Investments.
US equities fared a bit better, but far from stellar, returning 1.4% in USD; a Canadian investor would have done well though, at close to 22% for the year, in CAD terms, given the fall of the Canadian dollar. International equities also performed better than Canadian equities with the MSCI EAFE returning 5.8% in local currency terms.
As well as being affected by the commodity and oil prices, most equity markets globally were also affected by China’s currency devaluation in August, making exports cheaper, thereby hurting other countries’ local producers, hence increasing fears of a prolonged global recession.
These three factors were some of the key reasons for the Federal Reserve’s decision not to tighten monetary policy in September - reflecting the Fed belief that there are still serious problems underlying the global economy. As subsequent data from the US continued to point in the direction of an improving US economy, the Fed finally pulled the long awaited trigger and increased rates by 25 basis points in December – noting that any future rate hikes are expected to be slow and measured. The January 4 news from China indicating that economic growth was deteriorating further could well put future rate hikes by the Fed on hold.
About the Mercer Pension Health Index
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% FTSE/TMX Universe Bond Total Return Index; 25% S&P/TSX Composite; 15% S&P 500 (CAD); 15% MSCI EAFE (CAD); 2.5% FTSE/TMX 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.
About Mercer
Mercer is a global consulting leader in health, wealth and careers. 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 more than 40 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global professional services firm offering clients advice and solutions in the areas of risk, strategy and people. With 57,000 employees worldwide and annual revenue exceeding $13 billion, Marsh & McLennan Companies is also the parent company of Marsh, a leader in insurance broking and risk management; Guy Carpenter, a leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a leader in management consulting. For more information, visit www.mercer.ca. Follow Mercer on Twitter @MercerCanada.
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