Canadian pension plans saw their funding decline in 2015 and are facing a rocky outlook for 2016 that could make it difficult to recoup their losses.
A review of 449 Canadian pension funds by consulting firm Aon Hewitt shows the average pension plan's solvency position fell to 87.6 per cent as of Dec. 16, a decline of three percentage points from 90.6 per cent at the end of 2014.
The funding deterioration came as interest rates dropped and Canada's S&P/TSX composite index fell by 7.4 per cent for the year, as of Dec. 16. Pension plans also took a hit from the adoption of new Canadian mortality tables that provide for longer life expectancies for Canadians.
Only 11.8 per cent of pension funds in Aon Hewitt's client database had a funding surplus as of Dec. 16, a decline from 13.6 per cent at the end of the third quarter and 18.5 per cent at the end of 2014.
William da Silva, Aon Hewitt's national retirement practice leader, said companies could be facing growing obligations to contribute cash to their pension plans to cover funding shortfalls.
"In terms of financial health, 2015 was not a great year for Canadian pension plans," he said. "Next year could well be a pivot point for many plan sponsors. Besides having to manage market volatility, they may need to evaluate their funding strategies, since lower-than-expected solvency ratios may lead to higher contributions."
Aon Hewitt said pension plans would have ended 2015 in an even worse position, but a 20-per-cent drop in the Canadian dollar against the U.S. dollar over the year helped to boost returns on their large portfolios of foreign stocks when translated back into Canadian dollars for reporting purposes.
U.S. equities climbed 22.7 per cent in Canadian dollars, for example, while global equities were up 18.7 per cent, Aon Hewitt said. If the loonie had remained stable, pension funds' U.S. and international equity holdings would have instead delivered low single-digit returns, reducing the average pension plan solvency ratio for the year to 84.4 per cent instead of 87.6 per cent.
Aon partner Ian Struthers said pension plans cannot expect the same currency benefit in 2016 because it is likely the Canadian dollar will stabilize.
"Canada's declining currency was the silver lining for plan solvency in 2015," Mr. Struthers said. "While that decline might continue, plan sponsors should not expect a similar outsized currency effect in 2016, and plan solvency will be more exposed to volatile equity markets and continued weak bond rates."
Aon Hewitt also warned it also sees a "great deal of uncertainty" for bond yields in 2016, despite this week's interest rate hike by the U.S. Federal Reserve. While the Fed's move could "indicate a global path towards rising yields," the firm said the Fed has been careful to leave its options open about the pace and extent of any further moves.
As well, Aon Hewitt said Canada's story is different, with the Bank of Canada giving no indication of matching the U.S. rate increase and speaking recently of an emergency contingency plan that would allow the key policy rate to fall below zero.
Pension funds that have "de-risked" by adopting investment strategies making them less vulnerable to interest rate volatility saw the benefits in 2015. Aon Hewitt said its clients with de-risking strategies saw their solvency position improve by one percentage point in 2015 from the end of 2014.