Canadian pension plans at highest level in 6 years | Mercer Canada

Canadian pension plans at highest level in 6 years

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Funded status of Canadian pension plans at highest level in 6 years

  • 01-October-2013
  • Canada, Toronto

The solvency position of Canadian pension plans improved significantly in the third quarter of 2013 due to strong equity returns and rising long-term interest rates. The Mercer Pension Health Index stands at 98 per cent on September 30th, up from 82 per cent at the start of the year and 94 per cent at June 30th. The Mercer Pension Health Index is now at its highest level since July 2007.

The Mercer Pension Health Index tracks the funded status of a hypothetical defined benefit pension plan. While the funded status of Canadian pension plans varies significantly, most plans have exhibited a considerable improvement in funded status in 2013. The chart below compares the distribution of the estimated solvency ratios of Mercer clients (covering 607 plans) at January 1, 2013 and September 30, 2013:

The proportion of pension plans that are fully funded on a solvency basis has increased from about 6 per cent at the beginning of 2013 to 14 per cent at the end of the third quarter. Even more remarkably, the proportion of pension plans that were less than 80 per cent funded has decreased from 60 per cent to just 11 per cent.

“So far, 2013 has been an extremely good year for most defined benefit pension plans. All the factors that drive funding levels have moved in the right direction. Pension plans assets have grown because equity returns have been strong and plan sponsors have been funding past deficits. At the same time, pension plan liabilities have declined as long-term interest rates have risen sharply,” said Manuel Monteiro, Partner in Mercer’s Financial Strategy Group. Long-term Government of Canada bond yields were slightly less than 3.1 per cent at the end of September, up from 2.3 per cent at the beginning of the year. A 1 per cent increase in long-term interest rates would reduce the liabilities of most pension plans by 10 per cent to 15 per cent.

“A typical balanced pension portfolio returned 3.3 per cent in the third quarter and 7.0 per cent year to date,” noted Mathieu Tanguay, Principal in Mercer’s Investment Consulting business. “During the quarter, global equity markets put up a strong performance, supported by stronger economic data and relative stability in developed markets. Canadian equity markets rebounded from the poor returns in the second quarter and slightly outperformed global equity markets. The strong equity performance more than offset negative returns on bonds arising from the continued rise in interest rates experienced in the third quarter. Overall, economic trends are improving. Despite a small dip in September, the U.S. Consumer Confidence Index remains strong. The unemployment rate keeps dropping in North America while the Eurozone recently came out of recession thanks to stronger exports and government spending. With an improving economy and a reduced perceived systemic risk, interest rates have moved higher than their level at the beginning of the year on the speculation that the Federal Reserve may begin to pull back on its quantitative easing programs in the near future.’’

“While the third quarter was very strong, it could have been even stronger. Equity markets pulled back and bond yields declined over the last few weeks, largely due to concerns about the impact of the U.S. government shutdown and potential failure to increase the debt ceiling” noted Tanguay.

Unfortunately, the story isn’t positive for all pension plans. The Canadian Institute of Actuaries has released new guidance which significantly increases solvency liabilities for pension plans that automatically index pensions based on CPI increases. For fully indexed plans, these changes negate most if not all of the positive impact of equity returns and interest rate increases in 2013. “While the changes to the actuarial guidance primarily affect the minority of Canadian pension plans that automatically index pensions, the impact on many of those plans is very significant” noted Monteiro.

In addition, further headwinds are expected following the July release of a Canadian Institute of Actuaries research report. The report shows that pensioner life expectancies are significantly higher than the current mortality tables indicate. It is expected that a new mortality table will be adopted for purposes of determining pension commuted values in late 2014. “We expect that a change in commuted value standards to reflect the new mortality table will reduce solvency ratios by about 2 per cent on average” indicated Monteiro.

“The current environment may provide a tactical opportunity for plan sponsors to reduce current contribution levels and/or stabilize their funding requirements over the next few years. In some circumstances, it may make sense for sponsors to file a valuation report as of an earlier date in order to capture the gains that have occurred” noted Monteiro.

Canadian equities returned 6.2 per cent in the third quarter which brought the year to date return to 5.3 per cent. For the third quarter:

  • The best performing S&P/TSX sectors were Health Care (+10.9 per cent), Consumer Discretionary (+8.3 per cent ) and Financials (+7.4 per cent ). The worst performing sectors were Utilities (-3.1 per cent ), Consumer Staples (+3.3 per cent ) and Industrials (+3.4 per cent ).
  • Small cap stocks (S&P/TSX SmallCap Index) returned 8.0 per cent , outperforming large cap stocks (S&P/TSX 60 Index) which returned 6.2 per cent during the quarter.
  • Value stocks outperformed growth stocks as measured by the S&P Canada BMI Value and Growth indices, which returned 7.3 per cent and 5.6 per cent respectively in the third quarter.

During the quarter, the Canadian dollar strengthened against the U.S. dollar and the Japanese Yen, but weakened against the British Pound and the Euro, which in general had a mixed impact on foreign equity returns expressed in Canadian dollars. In Canadian dollar terms, the S&P 500 Index returned 2.5 per cent for the quarter and 23.7 per cent year to date. International equities, as measured by the MSCI EAFE (CAD) index, generated a return of 8.7 per cent for the quarter and 20.4 per cent year to date. Emerging markets, as measured by the MSCI Emerging Markets (CAD) index, returned 3.2 per cent and -1.0 per cent in the third quarter and year to date respectively.

The DEX Universe Bond Index returned 0.1 per cent in the quarter which brought the year to date return to -1.6 per cent. The DEX Long Bond Index returned -1.1 per cent in the quarter and -5.9 per cent year to date. At the end of the third quarter, the yield on the DEX Universe Index was 2.71 per cent as compared to 2.66 per cent at the beginning of the quarter.

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. 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. 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.

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