Canadian pension plans faced a sharp drop in solvency in the first quarter of 2016 as a result of roller-coaster equity markets and a stronger Canadian dollar.
A review of 449 client pension plans by consulting firm Aon Hewitt shows the median solvency of Canadian plans hit 83.1 per cent as of March 29, down 4.5 percentage points from 87.6 per cent at the end of December. Pension plans are 100-per-cent funded when they have investment assets equal to the estimated long-term cost of providing pensions for plan members.
The median funding level for pension plans was almost 91 per cent at the start of 2015, but slid throughout 2015 as interest rates declined, and faced even sharper declines in the early part of 2016. Aon Hewitt said the median funding level dipped below 80 per cent in mid-February, but recovered ground over the past month as a result of a rally in stocks and improving bond yields.
Nonetheless, the review found only 8 per cent of pension plans were fully funded by the end of the first quarter, down from 11.8 per cent at the end of December.
Will Da Silva, Aon's national retirement practice leader, said companies need to "use all the levers they have in their risk-management toolkit" to deal with the volatility.
"For many plan sponsors, this volatility could translate into unwanted surprises in organizations' cash positions, as well as their financial statements," he said in a statement.
Companies do not have to immediately fund shortfalls in their pension plans, but must record the costs in their financial statements and must contribute cash to make up the gaps if they persist over time.
Aon Hewitt said many pension plans benefited last year from the drop in the Canadian dollar because they have large holdings of U.S. and foreign investments, which were worth more in Canadian-dollar terms. But the dollar has staged a comeback in 2016 from 69 cents (U.S.) in mid-January to 77 cents by late March. The result has lowered returns on non-Canadian investments.
Ian Struthers, a partner in Aon's investment consulting practice, said companies have to take a long view on investing and manage their exposures. While gains on foreign holdings last year were erased by the stronger loonie in the first quarter of 2016, for example, he said companies that use smart hedging and other "derisking" strategies were able to mitigate that volatility.