The financial health of Canadian defined benefit pension plans was eroded in the fourth quarter by a combination of weak stock markets and low long-term interest rates, two pension advisory firms said Thursday in separate reports.
Mercer Canada and Aon each concluded that fewer than half of the country’s defined benefit pension plans were fully funded at the turn of the new year, and warned that the current outlook for 2019 is murky at best.
They also noted that defined benefit plans — only one of the ways that employers can provide for the post-retirement financial needs of their employees — were generally in good shape before the fourth quarter began in October.
The report was issued shortly before North American stock markets closed lower Thursday — continuing a bumpy downward ride that investors experienced through the fourth quarter.
“We don’t expect the volatility to end in 2019, but pension plans’ financial positions remain strong after the longest bull run in history,” said Calum Mackenzie, Aon’s head of investment for Canada.
He said plans were hit by a “double-whammy” of reduced stock prices and lower Canadian long-term bond yields.
Lower bond yields affect defined benefit plans but increasing how much they’ll need to earn from investments in stocks, real estate or other classes of investments.
Both firms noted that some of the fourth-quarter pain was offset by a decline in the value of Canada’s dollar, which had a positive impact on investments denominated in the U.S. dollar.
“Canadian pension plans took a significant hit in the fourth quarter, but thankfully they were starting from a very strong position,” said Manuel Monteiro, who leads Mercer Canada’s financial strategy group.
The Mercer Pension Health Index — based on a hypothetical, model plan — dropped to a solvency ratio of 102 per cent at Dec. 31 from 112 per cent at Sept. 28 and from 106 per cent at the beginning of 2018.
Meanwhile, the Aon Median Solvency Ratio fell in the fourth quarter to 95.3 per cent as of Jan. 1, 2019, a decline of nearly eight percentage points from the third quarter of 2018.
A solvency ratio of 100 or more indicates a plan is fully funded while anything less indicates there would be some shortfall if a plan had to be wound up — often a worst-case scenario for defined benefit plans.
Defined benefit plans are supposed to deliver a predictable retirement income for its members, supported by either the plan’s own investments or by a combination of investments and additional employer payments.
Mercer Canada estimated that less than 30 per cent of Canadian defined pension plans were fully funded at the end of 2018, while Aon estimated 38.5 per cent of plans were fully funded as of Jan. 1, 2019.
Both firms said that the impact on plan sponsors should be minimal because pension assets had been in surplus until the last part of 2018.
Mercer also noted that defined benefit plans within Ontario and Quebec jurisdictions will be helped by new provincial legislation that will reduce the need for cash infusions when solvency ratios fall below 100 per cent.
The percentage of paid workers with a defined benefit pension from their employer has dropped to 67.3 per cent in 2016, from more than 80 per cent in the 1980s, according to an annual report by Statistics Canada.
By contrast, about 17 per cent of paid workers with an employer pension are covered by a defined contribution plan and a smaller percentage are covered by a hybrid pension with aspects of both DB and DC plans.
With defined contribution plans and group retirement savings plans — employers make contributions but aren’t obliged to make up short-falls if investments don’t fare well.
Nevertheless, many employees in the private sector don’t have a company pension at all — with fewer than 6.3 million Canadians under a registered pension plan. Of those, 52.3 per cent were in the public sector, according to Statistics Canada.