Canadian pension plans continued their bounce back to financial health in June, buoyed by a sharp spike in long-term bond yields over the past two weeks.
After struggling for years with large deficits, pension plans are quickly seeing their financial health return closer to full funding, according to two pension surveys released Tuesday. The rapid recovery, however, is raising questions about whether it is sustainable or simply a blip that could just as quickly be reversed.
Consulting firm Aon Hewitt said data from 275 Canadian pension plans show they had average funding of 77 per cent by the end of June, up from 69 per cent at the end of 2012, which means plans are moving closer to having enough assets to cover their long-term funding obligations to members.
Aon Hewitt said 95 per cent of the pension plans it tracks still have a funding shortfall, however.
The key factor in the improvement is rising interest rates, which are used by pension plans to calculate the size of their funding commitment to plan members. Aon Hewitt partner Ian Struthers said the increase in bond yields has more than offset the decline in pension funds' equity portfolios owing to tumbling stock markets.
"Normally, lacklustre market performance means bad news for pension plans, but in the latest quarter, the increase in interest rates helped improve the situation for plan sponsors," Mr. Struthers said.
In a separate release Tuesday, pension consulting firm Mercer reported its model Canadian pension plan is now 94-per-cent funded, a rapid gain from 82 per cent at the beginning of the year. Mercer's calculations are based on its pension health index, which tracks the financial health of a hypothetical Canadian pension plan assuming typical investment portfolio weightings.
Mercer said June alone saw funding improve three percentage points from 91 per cent at the end of May, all thanks to rising long-term bond yields.
Mercer partner Manuel Monteiro said the improvement came from a "significant increase" in bond yields during the last two weeks of June.
Long-term Government of Canada bonds were yielding about 3 per cent by the end of June, up from 2.3 per cent at the beginning of the year and 2.5 per cent at the start of June. The change may seem small, but each percentage point improvement in long-term interest rates can reduce the liabilities of most pension plans by between 10 per cent and 15 per cent, Mercer said.
"The first half of 2013 has been very good for pension plans," Mr. Monteiro said. "In the first five months, the story was primarily one of strong equity returns, particularly in foreign markets. In June, rising interest rates took over as equity markets pulled back."
Mr. Monteiro said interest rates have moved so dramatically within a few weeks that it is unclear whether this is the start of a long-term trend or just a temporary spike. He said most pension plan sponsors are still facing significant "interest rate risk," which means they could see their funding erode quickly if rates fall again.
Mercer said a typical pension fund's balanced portfolio of stocks and bonds earned 3.6 per cent in the first half of 2013, all from gains in the first quarter of the year. Returns averaged -0.5 per cent in the second quarter.