Funded Levels Rose for Canadian DB Plans in 2023, But Risks Remain

The solvency levels of Canadian defined benefit pension plans continued to increase in 2023 as more plans became fully funded; however, interest rates and market volatility will remain a major risk for many plans in 2024, analysts warn.

The aggregate funded ratio for Canadian pension plans in the S&P/TSX Composite Index rose to 101.8% at the end of 2023 from 100.7% at the end of 2022, according to the Aon Pension Risk Tracker. Meanwhile, the solvency ratio of Canadian defined benefit pension plans in Mercer’s pension database rose to 116% over the past 12 months from 113%. However, both gauges cooled off significantly during the fourth quarter, dropping from 105.6% and 125%, respectively, at the end of the third quarter.

“It is likely that members of DB pension plans should see improvement in the financial health of their plans,” said Jared Mickall, a principal in and leader of Mercer’s wealth practice in Winnipeg, Manitoba. “2023 saw strong equity performance amidst a volatile interest rate environment.”

Mercer noted that Canadian inflation declined during 2023 to near the higher end of the Bank of Canada’s inflation-control target of 3% and said that general views are that inflation will continue to decline in 2024 and reach 2% in 2025. However, Mercer cautioned that even with Canadian inflation falling, domestic pension plans are also exposed to global economies, which it said continue to see elevated levels of inflation and risks of recession.

“Given the risk of a further decline to Canadian interest rates and ever-present market volatility, a review of a pension plan’s risks to be retained or transferred (e.g. annuity purchase) continues to be prudent,” Mercer reported. “Pension plans with benefit payments going out that exceed the contributions coming in may need to have a heightened awareness of financial risks posed by the negative cashflow.”

Mercer also wrote that plan sponsors will need to consider the role of artificial intelligence as part of pension plan risk management in the coming year.

“Heightened geopolitical risk, inflation volatility, diverging global policies and transition risks all point to greater market instability, dispersion, and dislocation,” Venelina Arduini, a principal in Mercer Canada, said in a release. “Investors should engage with experienced partners and explore dynamic mandates. Agile managers across public and private asset classes can capitalize on opportunities created by these dispersions and risks.”

Meanwhile, Aon, which calculates the aggregate funded ratio for Canadian pension plans in the S&P/TSX Composite Index, reported that assets for the plans it tracks increased 12.4% during 2023, offset somewhat by the long-term Canadian government bond yield decreasing 26 basis points over the year.

“The past year was volatile for pension plans,” Nathan LaPierre, a wealth solutions partner in Aon, said in a release. “However, most pension plans in Canada will still end 2023 in good shape. Plan sponsors can continue to plan de-risking activities including annuity purchases and hibernation strategies such as liability-driven investing and smart use of diversified growth assets.”