Defined benefit (DB) pension funds were in better shape at the end of 2024 than they have been since the dot-com bubble days at the turn of the century. That’s according to a pair of surveys released Thursday.
DB plans sponsored by companies on the S&P/TSX Composite Index reported an aggregate funded ratio of 105.5% in the fourth quarter of 2024, up from 100.7% at the end of 2023. The Q4 result was down slightly, from 105.8% in the third quarter.
The year-end figure is the highest recorded since the Aon Pension Risk Tracker was introduced in 2012.
“It’s mostly a story of interest rates having risen and stock markets having also done well since they fell significantly during the pandemic,” said Nathan LaPierre, partner, Wealth Solutions, Aon.
Public sector DB funds — which aren’t included in the Aon tracker — have ramped up their alternative asset management capabilities and exposure in recent years to boost returns. Private sector DB funds tend to have less exposure to alternatives.
The pension funds in the study delivered a whopping 12.6% investment return in 2024, on average.
A separate study, conducted by Mercer, reported that the median solvency ratio among the 450 plans in its client database climbed nine percentage points last year to 125% — also a year-end record high.
The Mercer Pension Health Pulse was launched in 2008. Eighty-eight per cent of the funds in Mercer’s database have a solvency ratio of 100% or better.
Besides covering a different universe of DB plans, the Mercer study measures solvency ratio, which is a fund’s ability to meet its obligations if it were wound up immediately. The Aon study tracks funding ratio, which is a comparison of assets to liabilities based on the assumption that the fund continues to operate under normal conditions.
Jared Mickall, principal and leader of Mercer’s Wealth practice, said it’s been nearly a quarter-century since the industry enjoyed funding levels like this.
“When I started working in 1999, many plans were very well-funded,” he said. Benefit enhancements and early-retirement subsidies were common.
“In some cases, members may have been on a partial [contribution] holiday, and companies were on a partial holiday,” Mickall said.
The bubble burst, and soon after came the 2001 terrorist attacks. “Interest rates started to decline, so [plan] liabilities were going up. And then we ran into the global financial crisis.”
DB funds are de-risking
The average funded ratio in the Aon study dipped below 80% in March 2020, as pandemic lockdowns kicked in. By that summer, the ratio had begun a relatively steady climb that saw it crack 100% in March 2022. Mercer’s clients enjoyed a similar trajectory over the same time period.
As their numbers improved, DB plan sponsors took steps to de-risk their portfolios with fixed income investments. Many went further, entering into group annuity purchases with companies like Sun Life, Brookfield Annuity and RBC Insurance.
“That’s been going on for a while,” LaPierre said. “But they certainly did it in large numbers last year. I don’t see any reason why that wouldn’t continue this year, at least if conditions remain as they are.”
The consultancy WTW (formerly Willis Towers Watson) reported last year that an estimated $5.9 billion of group annuity sales had been booked by the end of Q3, a record number.
“Higher interest rates resulted in lower liabilities, which meant that the purchase may have been a bit more affordable,” Mickall said. “[Funding] surpluses, coupled with interest rates, helped fuel this demand for group annuity purchases.”
He agreed that we will see more deals in 2025. “We do expect there to continue to be a healthy volume of activity,” Mickall said. “While times are good, perhaps now is the time to really transfer those risks off.”
When DB plan sponsors partner with an insurance provider, they’re handing off the obligation to pay members the retirement income they’re owed from the plan. Agreements often cover retirees and members who’ve left the plan but haven’t started collecting their pension yet.
“Those are the two groups that are typically part of a group annuity purchase,” LaPierre said. “You don’t have to go and purchase [a group annuity] for that full population. If you only wanted to do a part of the population, you can certainly do that.”
It’s a move that makes sense for a lot of DB plan sponsors burned by years of historically low interest rates. Still, it’s one that triggers stress among members who don’t understand how group annuities work, and worry that the pension they’ve earned may be jeopardized by the switch.
“It’s human nature to be concerned with change, in particular when it comes down to the pension,” Mickall said.
“Advisors should inform them about what is happening. You’re still going to be getting your cheque… It’s now going to be backed by this insurance company. And it is important as well to mention Assuris.”
That’s a not-for-profit group that protects Canadian insurance customers should their company fail. Group annuity plan members are covered for 90% of their pension in the case of an insurance company default.
“I would personally sleep easier at night, backed by the big insurance companies,” Mickall said, “as opposed to backed by a company that may not even be focused on this anymore in the future.”