The solvency position of Canadian pension plans held steady in the first quarter of 2017. The Mercer Pension Health Index, which represents the solvency ratio of a hypothetical plan, stands at 102 per cent on March 30th, unchanged from where it stood at the beginning of the year. The median solvency ratio of the pension plans of Mercer clients also remains unchanged from the beginning of the year at 93 per cent.
Pension assets were boosted in the first quarter by strong equity market performance, particularly in international markets. However, the gain in plan assets was largely offset by an 8 basis point drop in long-term interest rates and an increase in the estimated cost of purchasing annuities.
“Pension plans have largely held on to the significant gains that occurred in the fourth quarter of 2016, particularly after the U.S. election,” said Manuel Monteiro, leader of Mercer Canada’s Financial Strategy Group.
While the recent improvement in the financial health of pension plans is certainly welcome news, plan sponsors are increasingly concerned about the heightened risks on the horizon. In the last few weeks, equity markets have faltered as some of the euphoria following the U.S. election has worn off. The failure to pass a new health care regulation through the Republican controlled congress has cast further doubt as to whether the election promises of lower taxes, less regulation and large fiscal stimulus programs will be fulfilled. Furthermore, global geo-political risks and anti-globalization sentiments remain at the forefront.
The strong financial position of pension plans combined with a heightened concern about future risks is driving many pension plan sponsors to revisit their risk management strategy. “We expect that many pension plan sponsors will bank their recent gains and reduce risk exposure by moving away from equities into bonds and alternative assets. We also expect 2017 to be a breakout year for the group annuity market with many sponsors choosing to transfer risk through annuity transactions,” continued Monteiro.
Annuity transactions and shifts to fixed income will not make sense for all sponsors. However, all plan sponsors should review their current risk profile to ensure that they understand and are comfortable with their exposure.
Long-term interest rates ended the first quarter of 2017 8 basis points lower than where they began the year.
A typical balanced pension portfolio would have returned 3.7 per cent during the first quarter of 2017. Broad-market Canadian bonds provided a low but positive return, while equity markets were generally up for the quarter, most notably for developed markets outside of the U.S. and Canada, as well as for emerging markets.
“Canadian equities began the year positively with a return of 2.6 per cent over the first quarter,” said Sofia Assaf, Principal, Senior Investment Consultant at Mercer Canada. “Two sectors posted notably negative returns dampening the overall performance of the S&P/TSX. Health Care (-10.1 per cent) extended its decline from the previous year, while Energy (‑5.7 per cent) took a hit as oil prices declined sharply in March. On the positive end, Utilities (+7.3 per cent) and Consumer Discretionary (+7.3 per cent) led the pack.”
U.S. equity returns were strong in both USD (6.0 per cent) and CAD (5.1 per cent) terms. While the CAD appreciated slightly versus the USD, it depreciated against both the British pound and the Euro over the quarter. As a result, international equities, which did well in local currency as the MSCI EAFE returned 5.1 per cent, performed even better for Canadian investors, with a return of 6.9 per cent in CAD. Emerging markets performed exceptionally well during the quarter, returning 8.5 per cent in local currency terms and 11.8 per cent in CAD.
As expected, the U.S. Federal Open Market Committee raised their target interest rate by a quarter percentage point to between 0.75 per cent and 1.00 per cent in March, while the projected pace of potential future increases remained unchanged. The Bank of Canada continued to hold its interest rate target constant at 0.50 per cent this quarter, with a relatively low expectation of rate increases in the remainder of 2017.
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. Asset mix for periods up to December 31, 2016 of: 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. Asset mix for periods on or after January 1, 2017 of 42.5% FTSE/TMX Long Bond Total Return Index; 15% S&P/TSX Composite; 40% MSCI World (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.
Mercer is a global consulting leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and careers 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 140 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 annual revenue of $13 billion and 60,000 colleagues worldwide, 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.