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Tough summer for pension plans

Thursday October 15, 2015 Written by  Retain Canada
The solvency position of Canadian pension plans decreased in the third quarter of 2015, according to the Mercer Pension Health Index.

The index, which represents the solvency ratio of a hypothetical plan, stood at 93 per cent on Sept. 24, down from 98 per cent on June 30 and 94 per cent at the beginning of the year.

The median solvency ratio of the pension plans of Mercer clients stood at 87 per cent, down from 92 per cent at the beginning of the third quarter, and 90 per cent at the beginning of the year.

“Both the key drivers of pension health – equity market returns and long-term interest rates – went in the wrong direction over the summer,” said Manuel Monteiro, leader of Mercer’s Financial Strategy Group.

Equity markets were firmly in negative territory for the third quarter and long-term government bond yields declined by around 10 basis points since June 30. For plans which do not hedge their foreign asset exposure, the drop in solvency ratio was somewhat buffered by the continued decline in the Canadian dollar.

“Many organizations remain more exposed to pension risk than they would like to be,” Monteiro said. “Organizations that have been counting on a rise in long-term interest rates have been disappointed for the better part of the last decade. We think it is time for pension plan sponsors to develop a robust risk management strategy that is less reliant on a hope that interest rates will rise.”

The solvency position of pension plans is expected to decline further in the fourth quarter by about one to two per cent as a result of a new mortality table being adopted by regulators as the basis for determining the value of lump sum benefits paid to pension plan members.

From an investment standpoint

A typical balanced pension portfolio would have returned -2.3 per cent during the third quarter (to Sept. 24).

“Equity markets had a poor performance during the third quarter. The U.S. equity market posted a return of -5.9 per cent (in USD terms), while the EAFE markets returned -10 per cent (in local currency terms). Due to the declining Canadian dollar relative to the US dollar and the Euro, U.S. equity and EAFE markets returned 0.7 per cent and -4.4 per cent, respectively, in Canadian dollar terms,” said Diane Alalouf, Eastern Canada leader in Mercer’s Investments business. “Canadian equities had a similar fate with a return of -7.7 per cent for the quarter, led downward by negative performance in a number of important sectors including materials, energy and financials. Emerging markets equity exposure provided a crushing return of -12.8 per cent (measured in Canadian dollar terms) over the same period.”

“The Canadian yield curve remained mostly at the same level this summer. A variety of factors – including lower prices of commodities and oil, uncertainty from the Fed regarding a rate increase, another surprise rate cut from the Bank of Canada moving from 0.75 to 0.50 and Canada officially entering a technical recession – pressured the curve downward. However, that was balanced by an increase in credit spreads,” she continued.

Although the Health Care sector has given up some ground in the third quarter, it still had an extraordinary year in 2015. On the other hand, weaknesses in commodities and oil led the energy and materials sectors to deliver particularly poor returns this quarter.

Large cap stocks outperformed small cap stocks in the third quarter and growth stocks outperformed value stocks. In the third quarter, emerging markets erased all positive returns delivered in the first two quarters of the year.

The Canadian dollar continued its decrease compared to the U.S. dollar in the third quarter.

The Mercer Pension Health Index shows the ratio of assets to liabilities for a model pension plan. The ratio has been arbitrarily set to 100 per cent at the beginning of the period. The new Pension Health Index assumes contributions equal to current service cost plus solvency deficit payments, and no plan improvements.

The index assumes that valuations are filed annually on a calendar year basis and that the deficit revealed in each valuation is funded on a monthly basis over the subsequent five years.

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