Pension plans end 2019 in strong financial health

Rising bond yields and a stock market rally at year-end propelled the solvency level of defined benefits plans to historic heights. 

Two global actuary firms published their year-end indices of defined benefits pension plans. These plans guarantee payment of pension benefits for life, the amount of which is determined by the employee’s number of years of service.

In both indices, based on the firms’ respective clienteles, the solvency level remained above the 100% mark, and even increased sharply in 2019. However, the actuaries point out that low interest rates are increasing the burden of future obligations that pension fund managers must bear. This has a direct impact on their balance sheet.

Records

The last survey by Aon Canada reported a median solvency ratio of 102.5%.

“Driven by rising bond yields and a late-year equity rally, the solvency positions of Canadian defined benefit pension plans increased sharply in the fourth quarter of 2019 to approach all-time highs,” Aon notes.

During the year, Aon’s median solvency ratio advanced by nearly 7.2 percentage points. This increase is close to the quarterly record reached in Q3 2018, Aon says. The overall return on Aon’s pension fund assets in Canada was 15.9% in 2019.

The Mercer index of financial health of pension plans reports a solvency level of 112%. This represents an increase from the 105% obtained at the end of third-quarter 2019, continuing the rising trend from the level of 102% reported in early 2019.

Lowest interest rates in 60 years

The Mercer index suggests that the positive return of the equity market throughout 2019 resulted in an impressive year for plans despite the fact that long-term bond yields were at their lowest point in 60 years. “DB plans with substantial equity allocations owe the markets once again for saving them from what could have been a disastrous year,” says F. Hubert Tremblay, Wealth Management Principal at Mercer Canada.

Mercer expects pressure on pension funds’ balance sheet to intensify in 2020. Tremblay predicts that pension plan sponsors will see an annual increase in the defined benefit obligation on their balance sheet of nearly 15% during the year due to unprecedented interest rate weakness and flattening yield curves in 2019. “A one year increase of 15% on the balance sheet may cause CFOs and investors alike to take notice of legacy DB liabilities that they may have otherwise glossed over,” Tremblay explains.

Transfers of risks and nontraditional assets

Transferring obligations toward pensioners to an insurer has suddenly become more appealing for some plan sponsors, Tremblay adds.

Risk transfer may be a solution to reduce obligations, but it is not suited to all plan sponsors. “Others are looking for different ways to manage DB asset volatility and seek yield in this era of ultra-low interest rates, yield inversion and uncertainty in the equity markets. This has led to increased allocations to alternative assets and a movement of assets from public to private markets,” Mercer explains.

2020: last prosperous year?

Erwan Pirou, Canada Chief Investment Officer, Aon, points out that in early 2019, financial markets had not yet recovered from a gruelling 2018. “Equities climbed a wall of uncertainty throughout much of the year as a global growth slowdown and trade disputes clouded the outlook for investors,” he explains. These tensions eventually gave way to optimism.

The actuary firm does not foresee a rosy long-term outlook. Plan sponsors must distinguish recent events from long-term trends, says Claude Lockhead, executive partner, retirement practice at Aon. “Despite a rise in yields through the fourth quarter, the long-term trend is still towards ‘lower for longer,’ given subdued inflation expectations and slowing global growth,” he adds. Bond yields are another cause for concern.