The solvency levels of Canada’s corporate defined benefit pension plans improved by an average of 5% in 2004, but building on that growth will be a challenge, says Watson Wyatt Canada.

An analysis released today shows that the typical plan improved to a 90% funded level at the end of 2004, up from 85% funded at the start of the year.

Solvency represents the hypothetical funded status of a plan if it were wound up or discontinued.

“While this data shows that solvency levels are moving in the right direction, it is important to note that this improvement was in large part due to the extra contributions being made by many plan sponsors toward their pension deficits, as required by government regulations,” said Ian Markham, director, pension innovation, Watson Wyatt Canada, in a release.

“Without these contributions, solvency levels would only have modestly improved from last year. The gains created by the 8 to 10% investment returns typically experienced by pension funds in 2004 were mostly offset by losses caused by the lower bond yields that measure the solvency liabilities.”

Markham also noted that this improvement in solvency levels will likely be more than wiped out by new pension actuarial standards being introduced in 2005. New standards from the Canadian Institute of Actuaries for determining lump sum commuted values (the amount a plan member can transfer to a registered retirement savings plan when he/she leaves the pension plan) come into effect on February 1 and will affect solvency liabilities.

While these changes will generally provide improved benefits to employees leaving their employers before retirement, they will put increased pressure on plan sponsors in terms of increased costs. Markham speculated that if market conditions remain at current levels, solvency will likely decline by over 5% for many plans, and up to 10% for some, as a result of the new standards.

Barring extra contributions by plan sponsors, and assuming bond yields remain at current levels, Markham noted that it would take a 15% return on equities each year until the end of 2007 to get the typical pension plan to a 100% funded ratio.

Pension plans that were invested more heavily in equities and long bonds fared best in 2004. Canadian equities returned an average of 14.5% in 2004, and long bonds 10.2%, compared to just over 7% for a bond fund with a wide range of maturities, and 2.2% for 91 day Treasury Bills.