High equity prices and rising interest rates mean Canadian pension plans keep on getting healthier.
Two companies that measure Canadian plans’ funding say that the funding status of the typical defined-benefit pension plan improved markedly in the first quarter.
Consultants Mercer Canada Ltd. said its Pension Health Index, which represents the solvency ratio of a hypothetical plan, increased from 114 per cent at the end of 2020 to 124 per cent at the end of March, which Mercer says is an all-time high. The median solvency ratio of the pension plans of Mercer clients – a measure of real figures, not hypothetical ones – was at 104 per cent on March 31, up from 96 per cent on Dec. 31.
A plan’s solvency funding is the ratio of its assets to its liabilities, the estimated cost of paying the future benefits the plan has promised. A fully funded plan is at 100 per cent; Ontario pension funding rules require DB plans to have a solvency ratio of at least 85 per cent, or else employers have to make extra payments to push their pensions back to that level.
Pension plans were hit by a double-whammy in the early days of the COVID-19 market crisis. Stocks plummeted by more than a third, damaging the value of plan assets. And interest rates on government bonds fell, which, according to pension math, made the current value of DB plans’ future liabilities bigger.
Since then, stocks have rebounded and stayed high. Interest-rate movements have been largely favourable.
Aon estimates that pension assets lost value by 2.3 per cent in the first quarter. Bond prices fell, hurting fixed-income returns, but stock gains helped offset that.
The bigger change came on the liability side. Aon says the long-term Government of Canada bond yield increased 0.74 percentage points over the quarter. Credit spreads – the difference between those rates and what borrowers pay – narrowed. The combination caused an increase in the interest rates used to value pension liabilities, which made the liabilities smaller.
Nathan LaPierre, a partner in Aon’s retirement solutions group, said accelerating vaccination campaigns in the U.S. have bolstered confidence in the economy, which has increased interest rates and allowed stocks to continue to perform well.
“The second quarter will be a test case for vaccinations and the ensuing economic recovery,” he said. “The United States will have a large portion of the population vaccinated in the second quarter – and the question is how effectively will that halt the spread of the virus and fuel the economic recovery?”
Ben Ukonga, a principal in Mercer’s financial strategy group, said, “In March, 2020, as markets were experiencing a gut-wrenching freefall, nobody would believe that pension plans would be breaking funded position records only a year later.”
Pension consultants expressed concern during the 2020 stock-market rebound that equity prices had gotten ahead of the real economy, putting plans at risk from a market reversal. While post-COVID-19 hopes may have eased those concerns, Aon’s Erwan Pirou, the chief investment officer of the retirement solutions group, said his company’s clients are interested in diversifying their risk by putting more money into real assets such as real estate and infrastructure, or into other “opportunistic” strategies.
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