Company pension plans are among the clear winner following Donald Trump’s U.S. election victory. Funded status of plans has risen 5 per centage points since November.unknown/Getty Images/iStockphoto
As investors debate the potential pros and cons of Donald Trump's election victory, there is one group in the business community that is undeniably benefiting: companies with pension plans.
Since Mr. Trump's victory on Nov. 8, bond yields have climbed steadily, adding to gains that began in September. The impact on pension plans has been dramatic, pushing the average funded status of plans up by five percentage points since early November alone.
"We've had a huge movement in bonds in a short period of time, so that has really driven it," said Ian Struthers, a partner in the investment consulting practice at pension plan consulting firm Aon Hewitt. "And we had good returns in equity markets, so you get a double lift."
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Aon Hewitt data show the average solvency level of pension plans stood at 91 per cent on Dec. 1, up sharply from 86.1 per cent at the start of November, due largely to rising bond yields.
Pension plans are considered 100-per-cent funded when they have assets equal to the estimated long-term cost of funding pensions in the event they have to be wound-up.
With bond yields continuing to rise since Dec. 1, average solvency levels are still climbing. The Bank of Canada's benchmark index for long-term bond yields has climbed 42 basis points since Nov. 8 to a yield of 2.34 per cent at Friday's close, its highest level since mid-2015 and a steep increase from a low of 1.55 per cent on July 8.
Yields on U.S. government 10-year bonds have also soared, closing at 2.48 per cent Monday, while Canadian government 10-year bond yields climbed Monday to 1.75 per cent, both closing at their highest levels since mid-2015.
While the changes may appear modest, pension plans are highly sensitive to bond yields because they must calculate their required funding level based on current long-term bond yields, and the movement is significant in percentage terms, with yields up above 50 per cent since early July.
The downside to rising bond yields is that bond prices have fallen, delivering a hit to pension plans' bond portfolios, which typically account for 40 per cent or more of their investment holdings.
However, the benefit to solvency funding far outweighs the portfolio impact of lower bond prices for typical pension plans, said Manuel Monteiro, leader of the financial strategy group at pension consulting firm Mercer.
"For most plans it would be like a two-to-one thing, like they would lose a dollar in terms of the value of their bond portfolio but their [solvency] liabilities would go down by two dollars or more," Mr. Monteiro said.
Mr. Monteiro said many companies with pension plans, particularly in Ontario, are particularly poised to benefit from the recent run-up in bond yields because they are required to do formal valuations at least every three years, which determine how much cash they must contribute to make up shortfalls in their plans.
Many companies voluntarily opted to do valuations at the end of 2013 because it was a good year for pension funding, which means they are now facing the next deadline to do valuations again.
While plans are typically not as well funded now as they were at the end of 2013, Mr. Monteiro said their status is now looking far better than it was earlier this year thanks to the "Trump effect" on interest rates.
"In discussions earlier this year, we were gearing up our clients for larger contributions next year, and they're still going to be larger next year, but probably not as large as we thought a few months ago," Mr. Monteiro said.
The question now is whether the improvement in bond yields is likely to endure, with pension experts warning there are significant risks in the global economy that make it unsafe to assume current bond yields are the new normal. Markets have pushed yields up on optimism about Mr. Trump's ability to stimulate U.S. economic growth through infrastructure spending and corporate tax cuts, but it is uncertain whether other policies – such as threats to renegotiate trade deals – will put a damper on broader global growth.
As more pension plans approach fully funded status, many are moving to reduce risks in their portfolios, either by moving out of higher-risk equity investment categories to safer fixed-income or bond investments, or by reducing maturities on their average bond holdings, or even by purchasing annuities to lock-in and insure their pension obligations.
Mr. Monteiro said he has seen an increase in pension plans buying annuities late this year, but he anticipates even more growth in 2017 after plans do their three-year valuations.
"I think 2016 is going to end up being another record year for annuities, and I think 2017 has the potential to be much, much bigger because a lot of plan sponsors will file valuations and they will see improved funded positions and all the risks on the horizon and they'll say, 'Maybe now is a good time to cash out some of those risks.'"
Janet McFarland