In a time of market turbulence, the typical Canadian pension plan is actually getting healthier.
Consulting firm Mercer Canada Ltd. said its Mercer Pension Health Pulse, which tracks the median solvency ratio of the defined benefit (DB) pension plans of Mercer clients, increased from 108 per cent on March 31 to 109 per cent by June 30. The measure was 96 per cent at the end of 2020 and 103 per cent at the end of 2021.
A DB plan’s solvency funding is the ratio of its assets to its liabilities, which are the estimated total costs of paying the benefits the plan has promised. A fully funded plan is at 100 per cent. Plans at more than 100 per cent have a funding surplus, while plans under 100 are not fully funded.
Aon PLC AON-N said its pension risk tracker, which measures the aggregate solvency of DB pension plans of companies in the S&P/TSX Composite Index, increased from 100.5 per cent to 101.5 per cent during the past three months. It has risen all the way from 89.4 per cent at the end of 2020 and 97.2 per cent at the end of 2021.
The numbers may surprise investors who watched their personal accounts take a beating in the second quarter. The S&P/TSX Composite Index, a measure of 200-plus big Canadian stocks, fell almost 14 per cent from March 31 to June 30. Aon says the typical pension plan’s portfolio, which also includes bonds and other assets that blunt the decline of stocks, fell 11.9 per cent in the quarter.
But the investments are just one side of the ledger for a pension plan. And interest rates, now rapidly rising, are doing more for pension plans’ liabilities than they have in years.
When a pension plan estimates the current value of its pension payouts, it must use an interest rate to discount those payments to the present day. Low interest rates result in a bigger estimated obligation, whereas higher rates mean a smaller obligation.
Aon said the long-term Government of Canada bond yield increased 0.77 percentage points in the second quarter. Credit spreads – the margin above the government rate that riskier borrowers pay – also widened, by 0.38 percentage points. This combination, Aon said, resulted in an increase in the rates it used to value pension liabilities from 3.78 per cent to 4.93 per cent.
“The rapid rise of interest rates has lowered liabilities, offsetting the poor asset performance over the quarter,” said Nathan LaPierre, a partner in Aon’s Wealth Solutions group, in a statement.
Mercer estimated rates increased between 0.8 and 1 percentage points during the second quarter and between 1.6 and 2.3 percentage points since the beginning of the year, “a remarkable increase in such a short period,” said Ben Ukonga, the principal and leader of Mercer’s wealth business in Calgary, in a statement.
Individual plans’ results can differ from the average for a wide range of reasons, including asset mix. Mercer said it estimates 73 per cent of its pension customers are in a surplus position on a “solvency” basis, the tougher of two widely used valuation measures. It said another 16 per cent of plans have funding ratios of between 90 per cent and 100 per cent, while 5 per cent have solvency ratios of between 80 per cent and 90 per cent, and 6 per cent have solvency ratios of less than 80 per cent.
Ontario rules require DB pension plans to have a solvency ratio of at least 85 per cent. If a plan does not, the employer must make extra contributions to the plan to push it to that level.
Both Aon and Mercer suggested continued market volatility will also lead to rapid change in plan funding. And both suggested pensions may try to “de-risk” by buying annuities while funding levels are high.
Last month, LifeWorks (Canada) Ltd. said it purchased $1.33-billion of annuities for the 7,114 members of United Steelworkers Local 1005 in Hamilton who were in the legacy pension plans of Stelco STLC-T before its 2016 bankruptcy plan. The deal ensured that all plan members will continue to receive their full benefits without interruption, according to the Financial Services Regulatory Authority of Ontario.
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David Milstead