Canadian DB Plans Flat in Q2 Despite Strong Returns

Falling bond yields prove too much for robust asset gains.

The solvency positions of Canada’s defined benefit pension plans declined slightly in the second quarter of 2019 despite relatively strong asset returns during the period, according to professional services firm Aon’s quarterly Median Solvency Ratio survey.

Aon said the median solvency remains high by historical standards but cautioned that falling bond yields suggest pension plan sponsors should prepare for volatility ahead.

“Despite the slight solvency ratio decline in the second quarter, the fact remains that the funded status of DB plans in Canada is still high, while many plans are at or getting close to a strategic end state,” said Aon’s William da Silva in a statement. “Given the volatility we have seen over the past few months, it’s arguably more important than ever that plan sponsors review and, where necessary, revise their end-game strategy.”

Aon’s median solvency ratio measures the financial health of a defined benefit plan by comparing total assets to total pension liabilities on a solvency basis. The analysis takes into account the index performance of various asset classes, as well as the applicable interest rates to value liabilities on a solvency basis.

In the most recent survey, the solvency ratio increased by 0.8 of a percentage point in the second quarter of 2019 to 99.3% from 98.5% the previous quarter. The survey also found that 48.2% of the plans were fully funded as of July 1, up 1.2 percentage points since the end of the first quarter.

Canadian bond yields fell in the second quarter as they have the two previous quarters, with Canada 10-year yields down 24 basis points and Canada long bond yields down 29 basis points. Aon noted that lower yields increase pension plan liabilities and adversely impact plan solvency.

The survey also found that pension assets returned 2.7% in the quarter, compared with an 8.5% return in the first quarter. And in Canadian dollar terms, most equity indices had positive returns, led by the Canadian S&P/TSX composite, which rose 2.6%, the U.S. S&P 500 (+2.0%), global MSCI World (+1.7%) and international MSCI EAFE (+1.4%) indices. However, the MSCI Emerging Markets index declined 1.6%.

Real asset returns diverged in the second quarter as global infrastructure rose 1.4% in Canadian dollar terms, while global real estate declined by 2.3%. In fixed income, falling bond yields drove prices higher as the FTSE TMX Long Term Bond Index rose 4.8%, while the FTSE TMX Universe index increased 2.5%.

“Sentiment is changing direction on a dime,” said Erwan Pirou, chief investment officer for Aon’s Delegated Investment Solutions (Canada). “In six months, we have gone from a rising-yield environment, which lowered pension fund liability, to a falling-yield environment, which is increasing liability.”

Pirou added that “traditionally structured pension plans will struggle to keep up, and sponsors could well miss opportunities to de-risk before it’s too late. The past six months have put the need for speedy and efficient decision-making into a real-world context.”

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