The solvency position of Canadian pension plans decreased in the third quarter of 2015. The Mercer Pension Health Index, which represents the solvency ratio of a hypothetical plan, stands at 93% on September 24th, down from 98% at June 30th; and 94% at the beginning of the year. The median solvency ratio of the pension plans of Mercer clients stood at 87%, down from 92% at the beginning of the third quarter, and 90% at the beginning of the year.
“Both the key drivers of pension health –equity market returns and long-term interest rates – went in the wrong direction over the summer.” said Manuel Monteiro, leader of Mercer’s Financial Strategy Group. Equity markets were firmly in negative territory for the third quarter and long-term government bond yields declined by around 10 basis points since June 30. For plans which do not hedge their foreign asset exposure, the drop in solvency ratio was somewhat buffered by the continued decline in the Canadian dollar.
“Many organizations remain more exposed to pension risk than they would like to be” continued Monteiro “Organizations that have been counting on a rise in long-term interest rates have been disappointed for the better part of the last decade. We think it is time for pension plan sponsors to develop a robust risk management strategy that is less reliant on a hope that interest rates will rise.”
The solvency position of pension plans will decline further in the fourth quarter by about 1% to 2% as a result of a new mortality table being adopted by regulators as the basis for determining the value of lump sum benefits paid to pension plan members.
From an investment standpoint
A typical balanced pension portfolio would have returned -2.3 per cent during the third quarter (to September 24th). Detailed market returns for the quarter and bond yields are shown in the table beside. (Quarterly data as at September 24th 2015)
“Equity markets had a poor performance during the third quarter. The US equity market posted a return of -5.9% (in USD terms), while the EAFE markets returned
-10.0% (in local currency terms). Due to the declining Canadian dollar relative to the US dollar and the Euro, US equity and EAFE markets returned 0.7% and -4.4% respectively in Canadian dollar terms. Canadian equities had a similar fate with a return of -7.7% for the quarter, led downward by negative performance in a number of important sectors including Materials, Energy and Financials. Emerging markets equity exposure provided a crushing return of
-12.8% (measured in Canadian dollar terms) over the same period,” said Diane Alalouf, Eastern Canada leader in Mercer’s Investments business.
Diane Alalouf continued, “The Canadian yield curve remained mostly at the same level this summer. A variety of factors including lower prices of commodities and oil, uncertainty from the Fed regarding a rate increase, another surprise rate cut from the Bank of Canada moving from 0.75 to 0.50 and Canada officially entering a technical recession pressured the curve downward. However, that was balanced by an increase in credit spreads.”
Although the Health Care sector has given up some ground in the third quarter, it still had an extraordinary year 2015. On the other hand, weaknesses in commodities and oil led the Energy and Materials sectors to deliver particularly poor returns this quarter.
Large cap stocks outperformed small cap stocks in the third quarter and growth stocks outperformed value stocks. In the third quarter, emerging markets erased all positive returns delivered in the first two quarters of the year.
The Canadian dollar continued its decrease compared to the U.S. dollar in the third quarter.
About 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 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. 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 health, wealth and careers. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s more than 20,000 employees are based in more than 40 countries and the firm operates in over 130 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 57,000 employees worldwide and annual revenue exceeding $13 billion, 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.