The solvency position of Canadian defined-benefit (DB) pension plans saw a small jump in the second quarter (Q2) of 2015, according to Mercer LLC’s Pension Health Index.
The index, which tracks the funded status of a hypothetical DB pension, stood at 100% on Friday, up from 94% on March 31. Rising long-term interest rates, which pushed pension liabilities for most DB pension plan down by between 5% and 8%, drove the increase in the funded status of DB pension plans.
However, Mercer notes that asset returns were poor because of sputtering equity markets and the negative impact of rising interest rates on bond portfolios.
“Pension plans remain exposed to significant risk, particularly the possibility of an equity market downturn or another drop in interest rates,” says Manuel Monteiro, leader of Mercer’s financial strategy group, in a statement. “With funded positions being relatively healthy, it is an opportune time for plan sponsors to adjust their pension risk exposure to their desired level.”
This could mean that DB pension plan sponsors reduce their risk exposure by increasing allocations to fixed-income or by offloading portions of their liabilities to an insurance company through an annuity transaction, Monteiro adds.
DB pension plan sponsors could also benefit from more attractive pricing for annuities thanks to a slow market in the first half of 2015. Insurers are likely to narrow profit margins in the second half of this year to meet their targets, according to Mercer’s statement.
Equity markets saw a mixed but still subdued performance during Q2. Both the U.S. and EAFE equity markets experienced returns of close to 2% in local currencies while Canadian equities lagged with a return of 0.6% up to June 25. The latter can be attributed to a negative performance from sectors such as energy, materials, industrials, utilities and information technology, says David Zanutto, a partner in Mercer’s investments business, in the statement.
However, there is a positive note with Canadian long-term yields seeing a significant increase this spring, resulting from such factors as higher oil prices, rising yields in the U.S. and cautious optimism about the Canadian economy.
“After reduced consumer spending brought on by the tough winter and a lower Canadian dollar,” says Zanutto, “demand for Canadian goods and services is expected to finally increase from both sides of the border.”
Mercer notes that a typical balanced portfolio had a loss of approximately 1% in Q2.