Canadian pension plans have returned to prepandemic solvency levels after a bruising 2020 thanks to a strong rebound in equity markets, although risks remain owing to low interest rates and uncertainty around the trajectory of the pandemic.
Funding ratios for defined benefit (DB) pension plans – the ratio of assets to the estimated cost of paying the future benefits promised by the plan – took a major hit last spring as stock markets collapsed and interest rates dropped. By the end of 2020, however, funding ratios for the typical Canadian pension plan had returned to their prepandemic levels, according to reports by two consulting firms published Monday.
Aon PLC said that the aggregate funded ratio for DB pension plans belonging to companies in the S&P/TSX Composite Index increased from 90.8 per cent to 91.2 per cent over the past 12 months.
Mercer Canada Ltd., which uses a “pension health index” to track the solvency ratio at a hypothetical Canadian DB plan, also reported a slight year-over-year improvement. The pension health index finished the year at 114 per cent, up from 107 per cent in September and 112 per cent at the end of 2019.
At the same time, the median solvency ratio for pension plans belonging to Mercer clients was 96 per cent at the end of 2020, up from 93 per cent in September, although still below 98 per cent a year ago.
“After a wild ride throughout the year – funded status cratered in late March, to almost 80 per cent – Canadian pension plans ended 2020 in a similar, if slightly better, funded position compared to how they started the year,” Nathan LaPierre, a partner with Aon’s Retirement Solutions group, said in a news release.
Despite the bounce back, DB pension plans still face significant risks. Ultralow interest rates are particularly challenging for pension plans, which estimate their current liabilities based on a discount rate that is tied to interest rates. Based on the math used to calculate future payouts, as the discount rate declines, the present value of liabilities increases.
At the same time, lower yields on government bonds mean that pension plan managers need to allocate more to riskier asset classes such as corporate bonds and equities. These riskier assets drove the recovery in pension funding ratios over the past three quarters, but pension managers have not necessarily adjusted their equity portfolios to properly balance risk and returns.
“Some pension plans did not realize the full benefit of the equity market rally, as some active equity managers underperformed their benchmark,” Erwan Pirou, Aon’s Canada chief investment officer, said in a statement. “One possible new year’s resolution: look at the structure of your equity portfolio to make sure it’s balanced across different equity styles and able to perform well in different environments.”
Ben Ukonga, a principal in Mercer’s financial strategy group, said that Canadian DB plans are well funded from a historical perspective, but plan sponsors need to remain vigilant.
“Looking ahead, we have to expect continued volatility as markets react to how governments and business leaders transition to the post-COVID global economy,” Mr. Ukonga said in a release. “Plan sponsors should not be complacent now that the end of the pandemic appears in sight.”
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