Canadian Plan Solvency Ratio Slips in Q3

Benefits Canada reports, OFSI pension estimates down, global pensions up:

The global funded status of pension plans increased in Q3, but results from OFSI show different results.

The Office of the Superintendent of Financial Institutions (OSFI) has released the results of its semi-annual solvency testing for 400 federally regulated, defined benefit (DB), private pension plans.

The average solvency ratio at the end of June 2010 is estimated at 87%, three points lower than the December 2009 estimate of 90%. Judy Cameron, managing director of OSFI's private pension plans division, attributes this decrease to market volatility in the earlier part of the early.

"Since June 30th, market conditions have remained volatile. Although pension fund returns have improved, there has been a substantial decline in long-term interest rates," said Cameron.

"The modest decline in the average estimated solvency ratio in June suggests that plans will continue to face elevated funding demands in the coming months,” she said. “OSFI encourages administrators to adopt robust risk-management practices regardless of market conditions. In particular, scenario testing can be used to assess and prepare for the impact of possible changes in investment returns and interest rates on plan solvency and funding requirements."

However, two recent reports—one from Aon Hewitt and the other from RBC Dexia—say that globally, pension funds are up slightly from where they were last quarter despite ongoing market fluctuations.

The Aon Hewitt report indicates that strong asset performances in July and September helped boost the overall funded status of global pension plans. The consulting firm found that the funded status of global pension plans was 80% in the third quarter of 2010, up slightly from 79% in the previous quarter.

"While the quarter closed with modest gains, market volatility continues to run at very high levels. Managing this risk remains the focus of pension plan sponsors as we head into year-end," said Ari Jacobs, Aon Hewitt's North American retirement solutions leader. "Plan sponsors that have taken steps to systematically de-risk their plans are benefiting from those decisions, while others continue to look for opportunities to gain control over their pension finances, including funding strategy, liability settlement and investment policy options."

Regional analysis

In Canada, strong asset returns led by domestic equities contributed to total assets increasing by 7.3%, according to a RBC Dexia Investor Services report.

Domestic stocks were the best performing asset class for Canadian pensions, the report states, increasing by 10.2% in the quarter and 6.7% year-to-date. “Most sectors posted double-digit returns with advances fairly wide spread but uneven during the quarter,” said Don McDougall, director of advisory services for RBC Dexia. “Pension plans nearly kept pace with the TSX Composite during the quarter but trail the index by 0.7% year-to-date.”

The Aon Hewitt report indicated that the gains were offset by a significant decrease in corporate bond yields, which resulted in a 6% increase in liabilities.

The net impact was that average funded ratios increased only incrementally, from 87% at the start of the quarter to 88% at quarter's end.

"Many organizations have been holding off on implementing liability driven investments or risk management strategies, thinking that interest rates were due to increase," said Rob Vandersanden, a principal in Aon Hewitt's Calgary office. "However, yields have continued to trend downwards, effectively wiping out the strong investment returns of the past quarter."

In the U.S., the funded status of pensions showed a marginal improvement in the third quarter, increasing from 80% to 82%. Strong equity markets also helped pension plans regain losses they experienced in the second quarter. However, the corporate bond rates used for measuring pension liabilities plummeted to less than 5% in August. Even after a slight uptick in September, these rates fell by 0.3% to 0.5% from levels seen in the prior quarter. As a result, pension liabilities increased by 4% to 6%, negating much of the benefit from strong equity performance.

Canadian pension plans did rally in the third quarter. But pensions are all about managing assets and liabilities. What typically happens after a financial crisis is that asset values decline and interest rates fall, exacerbating pension deficits. It took more than four years after the tech meltdown in 2000 before pension solvency ratios were boosted back to appropriate levels (even after stock markets bounced back, interest rates remained low, so pension deficits got worse). It will take even longer this time around. What pensions need are asset values to go up and interest rates to increase. Hence the response to reflate and inflate their way out of the pension mess.