Rising rates and strong markets help pension funds improve in Q3

The index, which tracks the health of a hypothetical plan, was up from 94 per cent at June 30 and 82 per cent at the start of the year.

“All the factors that drive funding levels have moved in the right direction,” said Manuel Monteiro, a partner in Mercer’s financial strategy group.

“Pension plans assets have grown because equity returns have been strong and plan sponsors have been funding past deficits. At the same time, pension plan liabilities have declined as long-term interest rates have risen sharply.”

Mercer noted that long-term Government of Canada bond yields, a key factor in calculating pension plan liabilities, were slightly less than 3.1 per cent at the end of September, up from 2.3 per cent at the beginning of the year.

The firm estimated that a one percentage point increase in long-term interest rates would reduce the liabilities of most pension plans by 10 to 15 per cent.

Consulting firm Aon Hewitt reported similar results as it said Tuesday that the median ratio of pension plan assets to liabilities in plans that it surveyed increased to 88 per cent at the end of the quarter.

The results were up 11 percentage points from the end of June and 19 percentage points higher than the end of 2012.

Long-term interest rates, which are used to calculate the liabilities of pension plans, rose by 0.4 per cent in the quarter, Aon Hewitt said.

The improvement came as Canadian stock markets gained 6.7 per cent in the quarter and U.S. stocks added 3.4 per cent. Non-North American equities were up 10 per cent, while emerging markets gained 4.6 per cent.

Approximately 85 per cent of the more than 275 plans surveyed had a solvency deficit at the end of the third quarter, compared with 95 per cent in the previous quarter.

“Improved market conditions, interest rates and contributions meant that all three of the major factors that influence plan solvency were aligned favourably for plan sponsors in the third quarter,” said Ian Struthers, a partner in Aon Hewitt’s investment consulting practice.

“Plan sponsors who were strategic in managing their assets within a risk-based framework really benefited. The result was the best solvency ratio in almost three years, creating an opportunity for sponsors to initiate or build on de-risking or funding strategies.”

According to Statistics Canada, nearly 4.5 million Canadians were members of a defined benefit pension plan in 2011. That compared with nearly one million members of defined contribution plans.

Under a defined benefit pension, a plan pays a promised amount to retirees, while under a defined contribution plan, a member receives a set amount that they then invest to pay for their retirement.

Low interest rates and volatile stock markets have combined to hammer defined benefit pension plans in recent years, forcing many companies to make large contributions to plans with large deficits.

Defined contribution pension plans have gained popularity with companies as the costs associated with them are more predictable than a defined benefit plan.