The solvency positions of Canadian defined benefit pension plans declined slightly in the third quarter of 2019, according to new surveys from Aon and Mercer.
Aon’s latest median solvency ratio survey reported a drop to 98.6 per cent from 99.3 per cent in the second quarter, while Mercer’s pension health index recorded 94 per cent compared to 95 per cent in the previous quarter.
Overall, plan solvency remained high, but with bond yields declining and asset returns stalling in response to global economic uncertainty, Aon is painting a murky economic picture that should be seen as a warning sign for plan sponsors.
Read: Canadian DB pension solvency on the rise but volatility ahead
“Bond yields continued to fall in the third quarter, and the risk that equity returns are going to follow them is become more and more clear,” said Erwan Pirou, chief investment officer for Aon’s delegated investment solutions in Canada. “Economic uncertainty seems to have set in to financial markets, which means we don’t foresee a sustainable rebound in yields anytime soon. That’s increasing plan liabilities at the same time that the return horizon for equities is looking murky.
“Aon’s research shows that plan sponsors are increasingly turning to alternative investments in search of yield and diversification, and that makes sense. But it might not go far enough. Plan sponsors need to consider every means to take risk off the table, including hedging strategies. Time might be running out.”
The survey found 52 per cent of plans were in solvency shortfall at Sept. 30, 2019, up 0.2 percentage points since the end of the second quarter. During the quarter, pension assets returned 2.2 per cent, compared with 2.7 per cent in the second quarter of the year.
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During the quarter, most equity indexes had positive but weak returns, led by the Canadian S&P/TSX composite (up 3.1 per cent), the U.S. S&P 500 (up 3.6 per cent), global MSCI World (up 2.3 per cent) and international MSCI EAFE (up 0.3 per cent). Meanwhile, the MSCI emerging markets index declined by 2.3 per cent.
With investors seeking diversification from equity exposures, real asset returns were on the rise — global real estate was up 5.6 per cent in Canadian dollar terms, while global infrastructure increased by 4.4 per cent. In fixed income, falling bond yields drove prices higher, with the FTSE TMX long-term bond index rose by 2.1 per cent, while the FTSE TMX universe index was up by one per cent.
According to Mercer, DB plans would have to increase their current service funding contributions by close to 20 per cent based on lower expectations of future long-term returns on the asset mix. It also noted positive equity market performance throughout 2019 and a rebound in long-term rates in September prevented a potential 14 per cent decline in the index at the end of August, driven by the lowest yields on long-term bonds in more than 60 years.
Read: Canadian DB pensions benefit from higher asset returns in November: Aon
“Most DB pension plans in Canada weathered the storm over the summer and some came out stronger, but there are worrisome signs on the horizon,” said Andrew Whale, principal in Mercer Canada’s financial strategy group. “The good news is that many plan sponsors have maintained the strong position that they started with in 2019,” he added. “They should use this as an opportunity to embrace new strategies for the road that lies ahead.”