Pension solvency improves in Q3 despite negative returns

Rising bond yields boosted the solvency of Canadian defined-benefit pension plans in the third quarter despite negative asset returns.

The median solvency ratio of DB pension plans finished the quarter at 125%, according to consulting firm Mercer, up from 119% at the end of Q2.

After a strong first half of 2023, global equity markets delivered moderately negative returns in Q3, and bond returns were generally negative as yields rose.

But those conditions led to a “somewhat counterintuitive” strengthening of DB pensions, Mercer said, as higher bond yields decrease pension liabilities.

“This decrease, along with a decrease in the estimated cost of purchasing annuities, more than offset the effect of negative asset returns, leading to stronger overall funded positions,” the consulting firm said Tuesday.

Mercer estimated that 88% of the plans in its database were in a surplus position at the end of the third quarter, up from 85% in Q2. The percentage of plans estimated to have solvency ratios of less than 80% remained the same at 5%.

Aon PLC reported Tuesday that the funded ratio for defined-benefit pension plans at firms that belong to the S&P/TSX Composite index edged up to 105.4% from 101.7% in the second quarter.

The solvency ratio improved even though pension assets lost 5% in Q3, Aon said.

The yield on long-term Government of Canada bonds increased 77 basis points in the quarter and credit spreads widened by two basis points, it said, resulting in the interest rate used to value pension liabilities rising from 4.62% to 5.41%.

“Although pension assets experienced negative returns over the quarter, yields have continued to increase, which lowered liabilities and increased funded positions amid volatility,” said Nathan LaPierre, partner, wealth solutions with Aon, in a release.

“The continued upward trend of pension plan funded positions will likely lead to further de-risking opportunities, including increased interest in liability-driven investment solutions and annuity buy-in and buy-outs.”

Mercer noted several headwinds for the fourth quarter, including stubbornly high inflation, geopolitical tension, a U.S. auto strike, and the possibility of a recession despite a strong labour market.

“Looking ahead, with interest rates expected to remain high in the short to medium term, plan sponsors should be reviewing their risk tolerances, the risks they are exposed to, and taking steps to hedge or transfer the risks they do not want,” said Ben Ukonga, principal and leader of Mercer’s wealth practice in Calgary, in a release.

“Or else, they will be kicking themselves when the Goldilocks environment DB plans are experiencing comes to an end.”

Mark Burgess

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Mark was the managing editor of Advisor.ca from 2017 to 2024.