The solvency position of Canadian defined benefit pension plans remains unchanged following the second quarter of 2019. The Mercer Pension Health Index, which represents the solvency ratio of a hypothetical plan, stayed at 106 per cent on June 30th, up from 102 per cent at the beginning of the year and at the same level following the first quarter’s recovery. The median solvency ratio of the pension plans of Mercer clients was at 97 per cent on June 30th, equal to the number on March 31st, and up from 95 per cent at the end of 2018. More than one third of Canadian pension plans are fully funded and only 3 per cent are below 80 per cent funded on a solvency basis.
The funded position of pension plans reached a high point at the end of April before dropping back down due to a continued decline in interest rates. A 20-basis point drop in long-term interest rates in the second quarter, added to the 50-basis point drop for the year, has increased liabilities, with positive equity market returns preventing the fall of funded positions. A 100-basis point increase in interest rates typically results in a decrease of 10 per cent to 15 per cent in pension liabilities.
“Strong equity market performance has protected many otherwise exposed Canadian pension plans from a large swing in long-term interest rates in 2019,” said Andrew Whale, Principal in Mercer Canada’s Financial Strategy Group.
Any hope for relief from a low interest rate environment in the near-term is fading. While funded positions remain at high levels, plan sponsors, especially those of closed and frozen defined benefit plans, should take this opportunity to re-evaluate their de-risking strategies and revisit where they are in their journey plan. “Over the last couple decades, many common factors have led defined benefit plan sponsors to take risk off the table, chief among them the decline in interest rates that directly increased pension obligations,” continued Whale. “Though recent funding legislation in Ontario and Quebec has tackled the other main issue of contribution volatility, plan obligations and the associated risk exposure still remain unsuitably large for many plan sponsors.”
A typical balanced pension portfolio would have risen by 3.2 per cent during the second quarter of 2019. Equity markets and Canadian bonds advanced, but at lower levels than the first quarter.
Canadian equity returns were positive in the second quarter. The S&P/TSX Composite Index returned 2.6 per cent. Seven of the eleven sectors posted positive returns with Information Technology leading the way, while Communication Services, Real Estate, Energy and Health Care dragged.
Canadian fixed income markets rose over the quarter amidst lower yields, with long-term bonds (4.8 per cent) significantly outperforming universe bonds (2.5 per cent). Real return bonds (3.5 per cent) also rose over the second quarter.
The U.S. led global equity markets with a return of 4.3 per cent in USD terms (2.0 per cent CAD) following a very strong first quarter. Developed market equities were also up, with the MSCI World returning 3.8 per cent in local currency terms (1.9 per cent CAD). Emerging markets were slightly positive in local currency terms, returning 0.3 per cent, but negative in Canadian dollar terms (-1.5 per cent CAD) due to appreciation of the Canadian dollar over the quarter.
“The pace of global growth is expected to slow this year as unfolding trade tensions between the U.S. and China, as well as the announcement of tariffs on Mexico, weigh on market sentiment,” said Todd Nelson, Partner at Mercer Canada. “Signs of weaker global economic growth further added to volatility in the second quarter.”
Both the Bank of Canada and U.S. Federal Reserve held their targets for the overnight rate at 1.75 and 2.5 per cent, respectively, over the second 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. 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.
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