A long month in the long life of a Defined Benefit plan as markets react to coronavirus pandemic

April 2, 2020

Canada, Toronto


The Mercer Pension Health Index, which represents the solvency ratio of a hypothetical defined benefit (DB) plan, decreased from 112 per cent at the end of 2019 and 103 per cent at the end of February to 93 per cent at the end of March. The median solvency ratio of the pension plans of Mercer clients was at 84 per cent on March 31st, down from 98 per cent on December 31st and 93% on February 29th.


As the coronavirus pandemic and COVID-19 continue to disrupt life around the world, so too have defined benefit plan sponsors felt an impact to plan assets and liabilities. Funded statuses hit their lowest point since 2013 during the month of March 2020, but since had a small bounce back with increases in long-term bond yields just prior to quarter end.


“There is no doubt that funded positions are down and almost every defined benefit plan will feel this economic and public health crisis, but we’re optimistic that plan sponsors can avoid a pension crisis with smart and strategic decision making,” said Andrew Whale, Principal in Mercer Canada’s Financial Strategy Group.


Many DB plan sponsors may not experience immediate cash implications where recent reform has lowered solvency funding, such as in Ontario and Quebec.


“That these market shocks occurred in Q1 has granted flexibility for these plan sponsors to take action with 2020 regulatory filings,” said Whale. “Performing an actuarial valuation at the end of 2019 will grant a fixed contribution schedule until 2022 and allow time for the markets to hopefully recover.”


In addition, Mercer and many other stakeholders are advocating for several forms of funding and administrative relief for plan sponsors and members. These measures are aimed at ensuring Canada’s retirement system can withstand the challenges posed by COVID-19, helping to buttress Canadians’ retirement security in an uncertain time.


Other market effects include an increase in provincial and corporate bond spreads as long-term federal bond yields fell. This phenomenon is likely fleeting if rating agencies downgrade bond issuers; however, it has introduced short-term uncertainty in measuring the liabilities of a DB plan.


“Recent market experience has had a variety of different impacts on DB plan financials,” continued Whale. “It’s important to consider that the day-to-day volatility will create some unexpected results. Plan sponsors must remain calm as markets figure things out, but stay alert as opportunities arise.”


From an investment standpoint


A typical balanced pension portfolio would have fallen by 8.7 per cent during the first quarter of 2020. Equity markets deteriorated significantly in all regions as the coronavirus continued to have a major impact on markets across the globe.


The Canadian equity market underperformed all developed markets in Canadian dollar terms in the first quarter. The S&P/TSX Composite Index returned -20.9 per cent. All eleven sectors posted negative returns with the Energy sector experiencing the largest decline.


Within the Canadian fixed income market, universe bonds added the most value (1.6 per cent). Long term bonds were modestly positive (0.2 per cent), while real return bonds were flat.


Equity markets also declined significantly on a global basis, however the depreciation of the Canadian dollar against all major currencies provided a cushion for unhedged exposures. International equities detracted the most value, with the MSCI EAFE returning -20.4 per cent in local currency terms (-15.2 per cent in CAD). The U.S. equity market returned -19.6 per cent in USD terms (-11.7 per cent CAD). Developed market equities were also down, with the MSCI World returning -20.0 per cent in local currency terms (-13.2 per cent CAD). Emerging markets returned -19.0 per cent in local currency terms (-16.1 per cent in CAD).


“Despite the uncertainty, our message to plan sponsors is not to panic; be calm, but not complacent. Resist the temptation to try to time leaving or entering markets, engage active managers where possible, and take advantage of market dislocations” said Todd Nelson, Partner at Mercer Canada. “Most importantly, make sure you are clear on your long term objectives and review how you will achieve them if needed.”


Both the U.S. Federal Reserve and Bank of Canada cut their target rates by 1.50 per cent from 1.75 per cent to 0.25 per cent though several individual rate cuts over the quarter in an effort to continue to combat the economic fallout from the coronavirus.


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 23,000 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 75,000 colleagues and annualized revenue approaching $17 billion through its market-leading companies including MarshGuy Carpenter and Oliver Wyman, Marsh & McLennan helps clients navigate an increasingly dynamic and complex environment. For more information, visit www.mercer.ca. Follow Mercer on Twitter @MercerCanada.


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