More than one-third of Canadian pension plans have erased their deficits and are now operating with a surplus as they benefit from higher long-term interest rates and stronger equity markets.
An analysis of 275 pension plans by pension consulting firm Aon Hewitt shows the average plan is now 95.4 per cent funded as of March 27, an increase from 93 per cent at the end of 2013. A year ago, as of March 31, 2013, pension plans had average funding of just 74 per cent.
Aon Hewitt said 36 per cent of pension plans now have a surplus – up from just 3 per cent a year ago – which means they have more assets than needed to fund their pension obligations on a solvency basis. The survey showed 26 per cent had a surplus at the end of 2013.
The numbers illustrate the rapid reversal of fortunes seen by Canada's pension plans over the past 12 months as interest rates have climbed and investment returns have strengthened.
William da Silva, senior partner in Aon Hewitt's retirement practice, said the turnaround is good news for companies and plan members, but the speed of the reversal means things could also quickly change for the worse. As a result, he is advising companies to adopt investment strategies that are less risky and reduce potential funding swings.
"Volatility in the capital markets still exists," he said. "As before, we think the current strong financial health of [defined benefit] plans should encourage plan sponsors to truly understand their risks and to potentially rethink their funding and investment strategies to manage these risks."
Aon Hewitt said the big driver of improvements in the first quarter of 2014 was the strong performance of North American stock markets. Canadian equities earned 4.9 per cent in the quarter, while U.S. equities climbed 4.6 per cent.
The gains offset declining bond yields and weak stock returns in emerging markets, which earned just 1.5 per cent in the first quarter. Aon Hewitt said the declining Canadian dollar also contributed to stronger returns because it increased the market value of pension funds' U.S. assets.
Ian Struthers, a partner in Aon Hewitt's investment consulting practice, said markets in the first quarter continued to show plenty of volatility for investors, and pension plans had different experiences depending on how they have invested their assets.
"Currency volatility was a positive or negative depending on how a plan was positioned," Mr. Struthers said in a statement. "Currencies will remain volatile and in an uncertain world, understanding risk and investment strategy is critical."
All the pension plans used in the analysis are clients of Aon Hewitt.