Canadian pension plans have erased half their deficits on average so far this year thanks to higher long-term interest rates and strong stock markets, leaving many companies facing far smaller required pension contributions next year.
A review of 275 Canadian plans by pension consulting firm Aon Hewitt shows the average plan is 88 per cent funded as of Sept. 30, an increase from 77 per cent at the end of June and just 69 per cent at the beginning of the year.
That means pension plans have far smaller deficits and are closer to having assets that fully match their long-term obligations to fund pensions. The review looked at pension plans from the private, public and semi-public sectors.
Aon Hewitt senior partner Will da Silva said the average pension plan has erased more than 50 per cent of its solvency deficit since the beginning of 2013.
“For the strategic plan sponsor, this result is a significant reduction in their minimum required contributions in 2014 and beyond,” Mr. da Silva said.
“The potential reduction in contributions gives sponsors greatly increased flexibility as it not only reduces the level of required contributions, but it could also provide some plan sponsors with cost certainty over the coming years.”
Also Tuesday, pension consulting firm Mercer said a review of 607 pension plans that are Mercer clients shows 14 per cent of them are now fully funded, up from 6 per cent at the start of the year.
Even more remarkably, the proportion of pension plans that were less than 80 per cent funded has decreased from 60 per cent to just 11 per cent, Mercer said.
“So far, 2013 has been an extremely good year for most defined benefit pension plans,” said Mercer partner Manuel Monteiro. “All the factors that drive funding levels have moved in the right direction.”
Mr. Monteiro said a key change has been the increase in long-term Government of Canada bond yields, which are used by pension plans to calculate the size of their pension obligation to plan members.
Long-term rates were at 3.1 per cent at the end of September, up from 2.3 per cent at the beginning of the year. The difference is significant for a pension plans, because even a 1-per-cent increase in interest rates will reduce the size of the pension liability of most plans by 10 per cent to 15 per cent, Mercer said.
As well, Aon Hewitt said the 6.4-per-cent increase in global stock markets in the third quarter has continued to improve the strength of pension plans’ investment portfolios. Canadian equities earned 6.7 per cent in the third quarter, while non-North American markets climbed by 10 per cent.
Another key factor is the amount of cash many companies have contributed to their plans in the past few years to fund shortfalls.
Ian Struthers, a partner in Aon’s investment consulting practice, said the improvements in markets, interest rates and company contributions meant “all three of the major factors that influence plan solvency were aligned favourably” in the third quarter.
The recent improvement means pension plans have returned to funding levels last seen at the end of 2009, Aon said. Pension funding hit its low point in mid-2012, when the average plan in Aon Hewitt’s survey was just 66 per cent funded.
Mercer said its pension health index now stands at 98 per cent, up from 82 per cent at the start of the year, which suggests a typical pension plan in Canada is almost fully funded now.
The pension health index shows the solvency position of a hypothetical pension plan tracked by Mercer with typical investment asset allocations. The index is now at its highest level since July, 2007, before the recent economic downturn.