Strong stock market returns and climbing interest rates contributed to a slight improvement in financial health of pension plans in the fourth quarter, consulting and investment services firm Mercer reports.

The Mercer Pension Health Index, which shows the ratio of assets to liabilities for a model pension plan, increased to 74% by the end of the fourth quarter, up 1% from the beginning of the quarter.

The index increased by 15 percentage points during the year, from 59% at the end of 2008.

“Both domestic and foreign equity markets had solid gains in the fourth quarter, capping off a terrific year for equities as they rebounded from the market crash in the fourth quarter of 2008 and first of 2009,” said Yvan Breton, leader of Mercer’s investment consulting business in Canada. “However, the continued strengthening of the Canadian dollar offset much of the return on foreign equity investments.”

An increase in federal bond yields in the fourth quarter reduced the solvency liabilities for pension plans, noted Paul Forestell, retirement, risk and finance business leader for Central Canada. But despite the investment gains in 2009, Mercer estimates that more than half of pension plans in Canada remain less than 80% funded on a solvency basis at the end of 2009.

Mercer expects the funded ratio of pension plans as shown in year-end 2009 corporate pension disclosures to drop by a few percentage points compared to last year. The firm points out that the significant widening of credit spreads between yields on government and high-quality corporate bonds seen in the fall of 2008 was largely reversed in 2009, which will result in higher reported pension obligations, offsetting the year’s investment gains.

The Mercer Pension Health Index assumes a passively managed portfolio with the following asset mix: 42.5% DEX Universe Bond Total Return Index; 25% S&P/TSX composite index; 15% S&P 500 (CAD); 15% MSCI EAFE (CAD); 2.5% DEX 91 day T-Bills.

The firm pointed out that Canadian equities were the best performing asset class in 2009, with a return of 35.1%. The S&P/TSX returned 3.9% in the fourth quarter.

Canadian bond performance, as measured by the DEX Universe Bond index, returned 5.4% in 2009, led by mid term bonds which gained 7.5%. The DEX Universe Bond index returned -0.2% in the fourth quarter.

The strengthening of Canadian dollar versus most other major currencies had an overall negative impact on foreign equities during 2009.