Canadian Defined BenefitPension Plans
Solvency Increased 3% in the Second Quarter,
Despite Market Decline
July 2, 2013
Defined benefit (DB) pension plan sponsors in Canada saw a marked improvement intheir solvency funding in the second quarter of 2013, despite bond and equity markets falling, according tothe latest survey by AonHewitt, the global human resource solutions business of Aon plc AON.
The AonHewitt survey indicates the median pension solvency funded ratio, or the ratio of the market value ofplan assets to liabilities, was approximately 3 percentage points higher at the end of June than at the end of March 2013. This improvement is mainly the result of the 70 basis point rise in interest rates seen inthelast two months of the second quarter. [EXPAND Read more]
Two of the three major factors that influence pension plans solvency positions were favourable in the most recent quarter. The first was interest rates which, while remaining close to record low levels, reversed theirconsistent decline of the past few years. While bond sell-off has resulted in falling bond prices, which isanegative for pension plan assets, it also reduced the value of pension plan liabilities. Since the size oftheliabilities is greater than the typical plan’s bond portfolio, and the duration is longer, thedecline inliabilities far outweighs any poor bond returns. The result is improvement in solvency funding.
The second favourable factor was contributions since plan sponsors contributed towards their deficits to meet minimum solvency funding requirements.
The third factor was the performance of equity markets which was mixed for the second quarter. US Equities performed best with a 6.7% gain for the quarter, followed by International Equities (2.1%), Canadian Equities (-5.1%) and Emerging Market Equities (-7.2%). Pension plans with investments in alternative asset classes such as Infrastructure and Global Real Estate had recently been rewarded but, over the last quarter, theresults were more modest at 2.8% and -1.1% respectively for these two asset classes.
“Normally, lackluster market performance means bad news for pension plans but, in the latest quarter, theincrease in interest rates helped improve the situation for plan sponsors,” said Ian Struthers, Partner, Investment Consulting Practice, AonHewitt Canada.
The combination of these factors led to a rise in the AonHewitt survey’s median solvency funded ratio ofalarge sample ofpension plans from 74% at March 31, 2013 to 77% at the end of June. About 95% ofpension plans in that sample had a solvency deficiency at the end of the second quarter. The solvency funded ratio measures the financial health of a defined benefit pension plan by comparing the amount ofassets to total pension liabilities in the event of a plan termination.
The following graph depicts the movement of assets, liabilities and funded ratios for the survey’s median pension plan since January 1, 2010.
“The solvency gap grew since December 31, 2009 because asset values only increased 28%, whileliabilities have increased by 42%, driven by the drop in long-term interest rates. Therecent reversal in long-term rates has had a big impact,” said Struthers.
Impact of de-riskingAs well as the typical plan, AonHewitt has also tracked the performance of a plan that has employed afewsimple de-risking strategies since January 1, 2011. Namely:
–Increased investment in bonds from 40 percent to 60 percent of the portfolio
–Investment in long bonds instead of shorter duration bonds to better match liabilities.
The de-risked plan would have experienced an 85% solvency ratio at the end of June 2013 as opposed to 77% for the median plan.
About AonHewitt’s Median Solvency RatioAonHewitt’s Median Solvency Ratio is developed using a database of more than 275 pension plans from allsectors (public, semi-public and private) and from most Canadian provinces. Each plan’s characteristics and data are used to project their solvency ratio on a monthly basis. These projections take into account theincrease in financial indices for various asset classes, as well as the applicable interest rates to value liabilities on a solvency basis.
“The main advantage of AonHewitt’s median is that it takes into account the specific features of each oftheplans included in our large database,” Struthers said. “It is important to ensure the survey graph isbased on real data, and that it captures the effect of each individual plan’s investment policy, minimum contributions required, and the effect of any relief measures adopted by the plan sponsor. AonHewitt’s median therefore truly reflects the Canadian pension plan universe.”
About Aon Hewitt Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk whileproviding new levels of financial security, and redefine health solutions for greater choice, affordability andwellness. Aon Hewitt is the global leader in human resource solutions, with over 30,000 professionals in90countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit www.aonhewitt.com. [/EXPAND]