Canadian pension plans are on a tear so far in 2013 with their assets climbing in value and their funding shortfalls shrinking.
Pension consulting firm Mercer said its pension health index – which measures the financial health of a model pension plan with typical asset allocations – improved to 91-per-cent funding as of the end of May, up from from 82 per cent at the start of 2013.
This means pension plans are getting closer to being fully funded, or having enough assets to cover their long-term funding obligations to plan members.
"For many pension plan sponsors, getting back to a fully funded status is now clearly in sight," said Mercer partner Manuel Monteiro.
The improvements are a reversal for many pension plans after years of dismal news. Pension plans have seen their funded status erode in recent years due in part to volatile stock markets and falling long-term interest rates. Declining rates have meant lower returns for the large bond portfolios of pension plans, but more significantly have caused their liabilities to grow because pension plans must value their payment obligations using long-term bond yields.
Mr. Monteiro said pension plans have been on a long, slow gain since May of last year, when Mercer's pension health index stood at only 76 per cent.
"It's been happening over the last year – over the last 11 months, things have improved fairly steadily," Mr. Monteiro said in an interview. "We had a big dip last May – last May was very bad – but since then it has been pretty steadily going up."
One key factor is the increase in long-term Canada bond yields, which were sitting at 2.6 per cent at the end of May, up from 2.4 per cent in January, he said.
While the difference seems modest, it translates into a reduction in pension funds' liabilities. For each 1-per-cent increase in interest rates, liabilities can drop by as much as 15 per cent, Mr. Monteiro said.
Mr. Monteiro said another strength for pension plans has come from their foreign stock holdings, with foreign equities climbing more than 15 per cent in 2013 to the end of May. He said that growth is pushed even higher when foreign equity gains are translated into Canadian dollars, because the loonie has sunk in value this year.
The U.S. S&P 500 index was up 15.4 per cent in 2013 by the end of May, but the gain was 19 per cent when converted to Canadian dollars, Mr. Monteiro said. It has more than offset the relatively disappointing 3-per-cent growth in Canada's S&P/TSX composite index this year.
While Mercer's pension health index is based on a theoretical model pension plan, Mr. Monteiro said its current 91-per-cent funding level appears typical for real pension plans that Mercer works with. "It's pretty close to what we think the median is for our clients," he said.
As pension plans moving closer to being fully funded, Mr. Monteiro said now is the time for funds to put into place strategies to "de-risk" the plans and make them less vulnerable to future market downturns.
It means plans can reduce the percentage of stocks that they hold and boost other investments, such as real-return bonds. Many pension funds have considered such moves in recent years, he said, but felt they could not give up the higher yield from equities while so deeply underfunded. "That excuse is going away now," Mr. Monteiro said.