Canadian pension plans have recovered their financial footing more quickly than their U.S. counterparts, but are unlikely to return to fully funded status this year.
A study of pension health to be released Monday by Toronto-based rating agency DBRS Ltd. shows the funded status of 450 pension plans based in Canada, the United States, Japan and Europe improved sharply in 2013, with average funding levels climbing to 88.4 per cent, up from 78 per cent at the end of 2012.
The improvements were due to strong stock market returns and higher long-term interest rates. Pension plans are fully funded when their assets reach 100 per cent of their long-term liability for providing pensions to members.
DBRS considers pension plans to be in “critical condition” when their funding falls below 80 per cent, and raised alarm bells when average 2012 funding hit 78 per cent. The improvement in 2013 has moved pensions “out of the danger zone,” and back to their highest funding level since before the 2008 global financial crisis.
Canadian pension funds had average funding of 94.7 per cent by the end of 2013, DBRS said, while U.S. funds, by comparison, were 88.4-per-cent funded. DBRS said the samples studied in Japan and Europe were too small to calculate accurate regional averages.
DBRS senior vice-president James Jung said Canadian and U.S. pension funds invest in broadly similar ways, so there is no clear investment reason why the Canadian funds outperformed the U.S. funds.
He said the Canadian group includes many financial services companies that have been highly profitable, so the different industry weightings in the sample may affect the comparative data.
Despite the rapid improvements, DBRS said it has revised a prediction it published last year forecasting that the average pension plan would return to fully funded status in 2014.
DBRS said that timing now appears unlikely because interest rates have fallen slightly in the first half of 2014, offsetting asset gains on equity investments. Instead, the debt rating agency said it now believes it is likely pension plans on average will reach full funding by the end of 2015.
The rating agency said it modelled a number of scenarios to determine the future funded status of pension plans, all of which predicted full funding by 2017 at the latest. The most likely scenario was a return to fully funded status by the end of 2015 if there is a 0.5 per cent increase in long-term interest rates over 2014 and 2015, as well as an annual 7-per-cent return on investments.
“In a rising interest rate environment, this would definitely become a plausible scenario,” Mr. Jung said. “The big question mark is what will be the movement of interest rates, which will have a direct implication on the discount rates that are used in pension calculations.”
While pension plans have benefited from soaring equity markets in the past year, DBRS said returns have not been as high as they could have been. That’s because many plans have reduced their investments in stocks to favour less-volatile assets such as real estate in an attempt to reduce the level of risk in their investment portfolios.
At the end of 2013, pension plans held an average of 44 per cent of their assets in equities, which is the lowest proportion in six years.
In 2008, pension funds recorded an average 25-per-cent drop in assets as world markets tumbled, with the DBRS sample plans finishing the year with $1.37-trillion in total assets. In 2013, total assets reached an all-time high of $2.02-trillion, up almost 7 per cent from $1.89-trillion in 2012, DBRS said.
The rating agency said three of the 64 Canadian pension plans it studied still had funding levels below 70 per cent.