Fully Funded Status of Canadian DB Plans Keeps Rising in Q2

The funded ratio for Canadian defined benefit pension funds rose during the second quarter and added to their fully funded status, according to consulting firms Mercer and Aon.

The Mercer Pension Health Pulse, which tracks the median solvency ratio of the defined pension funds in its database, climbed to 119% at the end of June, from 116% at the end of March. The firm attributed the increase to the combination of positive asset returns with rising bond yields, which lowered plans’ liabilities.

At the end of Q2, Mercer said 85% of the plans in its pension database were estimated to be in surplus on a solvency basis, up from 83% at the end of Q1. Approximately 8% are estimated to have ratios between 90% and 100%, compared with 9% at the end of the previous quarter, 3% are estimated to have ratios between 80% and 90%, compared with 4% at the end of the previous quarter, and 4% are estimated to have solvency ratios below 80%, which is unchanged from the end of the first quarter.

“DB pension plans’ funded positions continue to benefit from higher interest rates, with many plans now in surplus positions,” Ben Ukonga, principal and leader of Mercer’s wealth business in Calgary, Alberta, said in a release. “The question that should now be on plan sponsors’ minds is how best to manage this surplus, and potentially locking it in, in order not to re-experience the dark days of significant pension deficits.”

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According to Mercer, despite favorable market conditions for defined benefit plans, many risks remain, with inflation still well above central banks’ target ranges despite significant rate hikes taken worldwide. The firm reported that it is still unknown if additional rate increases will be required if the Bank of Canada’s data suggest inflation will remain high, or if recently reported declines in inflation will lead to a pause.

Defined benefit plans that are in surplus should be thinking of how best to use the surplus, the Mercer report stated. The firm suggested that plan sponsors should evaluate what impact alternative market conditions will have on their plans’ funded ratio, financial position and business. Mercer added that plan sponsors should be reviewing their risk appetite, risk exposures and governance processes.

“Despite the improved financial positions of most DB plans, DB plans sponsors need to remain vigilant given the level of uncertainty that still exists,” Ukonga said. “Plan sponsors should understand and be comfortable with the risks they are taking and hedge or transfer the risks they do not want to retain.”

Meanwhile, Aon’s pension risk tracker, which calculates the aggregate funded position on an accounting basis for companies in the S&P/TSX Composite Index with defined benefit plans, rose to 102.1% from 101.8% over the last three months.

Aon credited the increase in part to Canada’s long-term government bond yield rising seven basis points during the quarter, combined with credit spreads widening by four bps, which resulted in the interest rates used to value pension liabilities rising to 4.71% from 4.60%.

“The muted asset performance and the small increase in discount rates supported a small increase in funded status over the quarter amidst volatility,” Nathan LaPierre, a wealth solutions partner in Aon, said in release. “Pension plans treaded water at healthy funded positions over the last quarter, giving plan sponsors time to consider de-risking activities and shape better decisions.”