Despite the recent pull back in equity markets, pension plan funded ratios have posted a significant net improvement in 2007, according to an analysis by global consulting firm Watson Wyatt Worldwide.

The funded ratio (the ratio of plan assets to plan liabilities) of the typical pension plan has climbed to 106% at the end of December 2007, on a Generally Accepted Accounting Principles (GAAP) corporate accounting basis. The funded ratio of the typical plan is up from 96% at the end of December 2006.

“Canadian pension plans have not been in a position to report such high funded ratios since April 2002,” says David Burke, retirement practice director of Watson Wyatt’s Canadian offices in Toronto. “But while this is good news, this is no time for complacency. Significant cost volatility remains a key influence behind many of the decisions made by pension plan sponsors.”

Equity markets drew back in the last few months of 2007, a trend that was further aggravated for the typical fund by the increasing strength of the Canadian dollar. At the same time, the yields available on high quality corporate bonds increased, so the downturn in the equity markets did not have the expected effect of depressing funded ratios.

“This illustrates the hazards of basing pension plan liability assessments, measured on a GAAP basis, on point-in-time, mark-to-market pricing of bonds,” says Burke. “It greatly increases the volatility of reported liabilities.”

From 2003 through 2005, falling yields on AA-rated bonds negated the recovering asset values. In 2007, rising yields on AA-rated bonds caused funded ratios to rise, despite lackluster investment performance. These rising yields were driven in part by problems with asset-backed commercial paper and contrasted to falling yields on Government of Canada bonds.

“It remains essential not to forget risk,” Burke continues. Despite the impression that 2007 was a highly volatile year for equity markets, it was in fact one of the lower volatility years for pension assets since 1993 based on month-over-month changes, according to the Watson Wyatt asset index. While the volatility of the corresponding liability index was greater, even that was still modest compared to some earlier years. “It’s fair to assume that volatility in funded ratios could even be higher in 2008 and future years than it was in 2007.”