July 4, 2018

Canada, Toronto

The solvency position of Canadian defined benefit pension plans continued to improve during the second quarter of 2018. The Mercer Pension Health Index, which represents the solvency ratio of a hypothetical plan, stood at 107 per cent on June 29th up from 106 per cent on March 30th and the beginning of the year. The median solvency ratio of the pension plans of Mercer clients was at 99 per cent on June 29th up from 98 per cent at March 30th and 97 per cent at the end of 2017. Almost half of all Canadian pension plans are now fully funded.

The funded position of pension plans was boosted by strong equity market performance, despite the retreat in the last few weeks of June. Long-term interest rates ended the quarter roughly unchanged from the end of the first quarter.

“Canadian pension plans are remarkably well funded, despite the stubborn persistence of ultra-low interest rates” said Manuel Monteiro, Leader of Mercer Canada’s Financial Strategy Group.

However, financial markets remain volatile due to geo-political uncertainty, particularly whether the current drift towards protectionist policies will accelerate or recede.

Sponsors of closed and frozen defined benefit plans need to urgently consider whether their current risk profile makes sense given their strong financial position and the risks looming on the horizon. “Many of these plans are far too exposed to investment risk given their strong funded position and shrinking time horizon. The upside benefit of generating further surplus is far outweighed by the downside risk of large deficits re-emerging,” continued Monteiro.

From An Investment Standpoint

A typical balanced pension portfolio would have increased by 2.5 per cent during the second quarter of 2018. Broad-market Canadian bonds and developed equity markets were generally up over the quarter, while emerging market equities declined.

Canadian equities surged over the second quarter, with the S&P/TSX Composite Index returning 6.8 per cent, its largest quarterly gain in over four years. Ten of eleven sectors posted gains in the broad-based rally, which followed a 4.5 per cent decline in the first quarter. Energy (+15.8 per cent) benefited from rising crude oil prices and regulatory approvals expected to relieve transportation bottlenecks. Health Care (+14.3 per cent) and Information Technology (+10.9 per cent) also posted double-digit returns.

Canadian fixed income markets posted modest returns over the quarter, with long term bonds (+0.9 per cent) outperforming universe bonds (+0.5 per cent). Real return bonds (+2.0 per cent) continued to outpace nominal bonds, while yields ended the quarter almost unchanged.

Trade tensions continued to escalate, as NAFTA negotiations stalled and President Trump announced tariffs on China and Canada. “The return of volatility to financial markets remains a key theme so far in 2018,” said Todd Nelson, Principal at Mercer Canada. “Equity markets have generally bounced back nicely following the sharp selloff we saw earlier this year, but ongoing geopolitical issues combined with rising trade tensions remain a major concern. Despite the rally we saw during most of the second quarter, the market remains sensitive to these overriding issues.”

U.S. equity returns were positive in USD terms (+3.4 per cent) and even stronger on a CAD basis (+5.5 per cent) due to depreciation of the CAD versus the USD over the quarter. The CAD appreciated against the Euro and GBP, however, leading Canadian dollar investors to underperform local currency returns in international (EAFE) equity markets (+1.0 per cent CAD and +3.8 per cent local currency). In a reversal of recent trends, emerging markets lagged developed markets, declining by 6.0 per cent in CAD (-3.4 per cent in local currency terms) over the second quarter.

The Bank of Canada held its target for the overnight rate at 1.25 per cent over the quarter, while the U.S. Federal Reserve continued on a tightening path, raising its target rate by a quarter percentage point to between 1.75 per cent and 2.00 per cent.

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.  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 delivers advice and technology-driven solutions that help organizations meet the health, wealth and career needs of a changing workforce. Mercer’s more than 22,000 employees are based in 44 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), the leading global professional services firm in the areas of risk, strategy and people. With more than 65,000 colleagues and annual revenue over $14 billion, through its market-leading companies including Marsh, Guy Carpenter and Oliver Wyman, Marsh & McLennan helps clients navigate an increasingly dynamic and complex environment. For more information, visit Follow Mercer on Twitter @MercerCanada.