Canadian DB Pension Funds’ Cup Runneth Over

A strong US equity market and rising bond yields helped boost the funded status of Canadian defined benefit pension plans to levels not seen in nearly two decades, according to reports from consulting firm Mercer and professional services firm Aon.

At the end of the third quarter, the solvency position of Canadian defined benefit pension plans climbed to 112%, up from 107% at the end of the previous quarter—its highest level since November 2000, according to the Mercer Pension Health Index, which represents the solvency ratio of a hypothetical plan.

The median solvency ratio of the pension plans of Mercer clients was at 102% at the end of the quarter, up from 99% at the end of the second quarter, and 97% at the end of 2017. Mercer said that more than 60% of Canadian pension plans are now fully funded, and less than 5% of plans are below 80% funded.

Mercer said the plans’ position increased in the third quarter thanks to a surge of 20 basis points in long-term interest rates during the last few weeks of September. It said a 100-basis point increase in interest rates typically results in a decrease in pension liabilities of 10% to 15%.  The firm cited rising US and international equity markets as providing an additional boost, despite the Canadian equity markets continuing to lag.

The US led global equity markets with a 7.7% return during the quarter in US dollar terms, or 5.8% in Canadian dollars, while developed market equities were also strong, with the MSCI World returning 5.4% in local currency terms. Emerging markets continued to show weakness, returning 0.1% in local currency terms as trade war tensions, tariffs, and currency crises hindered performance.

Mercer said the sharp rise in funded positions over the past few years, and the changes to funding rules in Ontario and Quebec, have caused many plan sponsors to revisit their risk management strategy.

“Some plan sponsors, particularly those that are not fully funded and that remain open to new members, feel emboldened by the new funding rules to maintain or even increase investment risk,” said Mercer. “On the other hand, this seems like a particularly opportune time for sponsors of closed and frozen defined benefit plans to take risk off the table, either by changing the asset mix or through risk transfers.”

At the same time, professional services firm Aon’s quarterly median solvency ratio stood at 103.2% as of Oct. 1, up three percentage points from the previous quarter, and its highest level since the quarterly Median Solvency Ratio began in 2002.

“That’s really good news, but it also presents a great opportunity for pension plan sponsors to ask themselves some tough questions about risk,” William da Silva, retirement practice director at Aon, said in a release. “For instance: is their asset strategy optimized based on new funding rules in several jurisdictions? Can risk be further managed by making strategic contributions? And with funded status in such a healthy place, have sponsors taken a new look at plan settlement to further their strategies?”