Equity Market Performance Strengthens DB Solvency
Mercer report shows good news - but can it last?
BY Martha Porado | January 4, 2018
Canada’s defined benefit pension plans moved into a stronger solvency position by year end 2017, largely due to strong equity markets.
The Mercer pension health index, which assesses the health of a hypothetical plan, showed a 106 per cent solvency ratio on Dec. 29, 2017. The ratio was four percentage points higher than at the start of the year. Adding to the positive numbers was a report by Aon Hewitt on Thursday that put the median solvency ratio at 99.2 per cent at the end of the fourth quarter of 2017.
In a press release about the findings, Mercer attributed much of the gains by the plans to positive equity markets, especially during the final quarter of the year. However, the long-running upward trend in the markets has some people wondering whether they can continue to rise.
“It’s the longest bull market in history. I think it’s pricing in that the U.S. tax changes and other things will be positive,” says Manuel Monteiro, leader of Mercer Canada’s financial strategy group.
“I’m personally quite skeptical that things will continue to be as rosy as they’ve been for the last several years,” he adds.
While open plans need to maintain a healthy allocation to equities in order to ensure decent returns, closed and frozen plans should exercise more caution, according to Monteiro. “If you’re fully funded and if you’re closed and frozen, it’s not clear why you’d want to take a lot of risk at that point. If things go badly, then you suddenly have a big deficit, and if markets do well, all you get is a surplus,” he says.
“There are so many things that could go wrong, and the upside benefit of having a surplus is much less than the downside of having a big deficit,” he adds.
During the final quarter of 2017, a balanced pension portfolio would have returned 5.3 per cent, according to the release, which noted the positive performance of both equity and fixed-income markets. Domestically, Canadian equities did well, with the health-care sector leading the pack. The sector was up 46.7 per cent in the final quarter, with energy remaining a laggard at a loss of seven per cent over the year and rising only slightly during the final quarter.
“Although Canadian equities are up over the fourth quarter and overall for the year, we have observed a heightened level of volatility in the domestic equity market over recent periods given the concentrated reliance on cyclical resource-based sectors,” said Sofia Assaf, principal and senior investment consultant at Mercer Canada, is a release.
”We see a persistent and growing trend among institutional investors in reducing domestic equity bias and shifting toward a holistic global approach to equity management, in large part due to the implications of the Canadian equity market sector concentration on potential risk/return outcomes.”
Plans are also relying less on the public markets, says Monteiro. “Now, more and more plans are moving into private stuff: infrastructure, real estate, hedge funds, private equity, all kinds of things, to diversify their sources of return, and not to get the full shock of an equity crash, if that happens.”
While the Mercer report noted the positive contribution by the equity markets, the Aon Hewitt findings noted lower bond yields did have a negative impact on pension solvency in the final quarter of 2017. The median solvency ratio in the fourth quarter was down slightly from 99.3 per cent in the previous period. Overall, however, the outlook remains positive.
“From a financial point of view, 2017 was a very good year for the plans many Canadians will rely on in retirement, and pension plans are entering 2018 on solid footing,” said William da Silva, senior partner and retirement practice director at Aon Hewitt.
“With solvency near 100 per cent, it seems very clear that plan sponsors are looking at another manageable year regarding funding, and 2018 is also shaping up to be a good year for settlements, as one of the key impediments to fully settling liabilities — cash outlay — is now less of a concern.”
This article was originally published by our companion publication, Benefits Canada, on www.benefitscanada.com