Canadian pension plan solvency improves

Slight boost not due to economic improvement, however.

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thermometerThe solvency position of Canadian pension plans made slight improvements in 2012, according to reports from two industry consultancy firms.

The Mercer Pension Health Index, which shows the ratio of assets to liabilities for a model pension plan, stood at 82% on December 31, up 6% on the year. But according to Manuel Monteiro, partner in Mercer’s Financial Strategy Group, the improved position was due to plan sponsor intervention rather than economic improvement.

“While the index increased by 6% in 2012, only 1% was due to economic factors. The remaining 5% was due to employer contributions to fund the deficits,” he said.

New data from Aon Hewitt also shows modest improvements for Canadian plans. According to the firm, the median solvency ratio for DB plans increased to 69%, up 1% from the previous year.

“There are mainly three ways that plan sponsors will see themselves out of this solvency conundrum,” said Thomas Ault, an associate partner in Aon Hewitt’s retirement consulting practice. “Through an increase in interest rates, favorable equity and alternative market returns, or through higher employer contributions. We had two out of three this year,” he said, pointing to the latter two as key factors.

“After a devastating 2011, 2012 was not the bounce-back year that pension plan sponsors had hoped for. We estimate that only about one in 20 pension plans is fully funded on a solvency basis as of Dec. 31, 2012,” noted Monteiro. “This will translate into higher cash funding requirements over the next few years, although this impact could be deferred through the use of temporary funding relief legislation as well as the use of letters of credit.”

Monteiro said the volatility in the funded position of pension plans is a result of employers continuing to take significant risk in their plans. While employers could mitigate the risk by shifting assets from equities into long-term bonds, many see this as an ineffective strategy in the short to medium term due to anticipated increases in interest rates.

“The markets have dug most of the current hole. By continuing to take risk, plan sponsors are hoping that the markets will now fill in much of the hole. While this could certainly be the case, it also leaves plan sponsors, and possibly plan members, vulnerable to further downside risk. With all the global economic uncertainty surrounding us, this feels uncomfortable to many,” said Monteiro.

Aon Hewitt has also tracked the performance of a model plan that has employed de-risking strategies since January 1, 2011, including increasing its investment in bonds from 40% of the portfolio to 60%, and investing in long bonds rather than universe bonds to better match plan liabilities. The de-risked plan had a 79% solvency ratio as of December 31, 2012.

Market movement

Canadian equities returned 1.7% in the fourth quarter, which brought the overall 2012 return from this asset class to 7.2%.

For the year, the best performing S&P/TSX sectors were healthcare (24.7%), consumer staples (22.6%) and consumer discretionary (22.1%). The worst performing sectors were materials (-5.7%), information technology (-2.9%) and energy (-0.6%).

Large cap stocks (S&P/TSX 60 Index) returned 8.1%, significantly outperforming small cap stocks (S&P/TSX SmallCap Index), which returned -2.2%.

Value stocks outperformed growth stocks as measured by the S&P Canada BMI Value and Growth indexes, returning 7.7% and 5.7%, respectively.

In Canadian dollar terms, the S&P 500 Index returned 0.8% for the quarter and 13.4% for the year. International equities, as measured by the MSCI EAFE (CAD) Index, generated 7.9% for the quarter and 15.3% for the year. Emerging markets, as measured by the MSCI Emerging Markets (CAD) Index, enjoyed a strong quarter (return of 6.9%), bringing the 2012 return to 16%. During the year, the Canadian dollar strengthened against the U.S. dollar and the euro, which reduced foreign equity returns expressed in Canadian dollars.

At the end of the year, the yield on the DEX Universe Index was 2.3% as compared to 3.3% for the Long Bond Index. The DEX Universe Bond Index returned 0.3% in the fourth quarter and 3.6% in 2012. The DEX Long Bond Index returned 0.1% in the quarter and 5.2% for the year.

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