Canada's DB pension plans resilient but must prep for headwinds

Mercer report reveals strength but also highlights risk for pension plans, while Aon data highlights improved funded status

Canada's DB pension plans resilient but must prep for headwinds

Canadians relying on defined benefit (DB) pension plans to deliver the retirement income they need can be pretty confident in their resilience according to two new reports.

The latest Mercer Pension Health Pulse (MPHP) report shows that positive asset returns, and bond yield increases, further boosted the financial positions of DB plans in the second quarter of 2023 – up from 116% to 119% at June 30, 2023.

The improved position came despite challenges including the fall-out from the banking crisis and concern around the US debt ceiling and was buoyed by plans’ mostly positive investment returns. And 85% of plans in Mercer’s analysis are estimated to have been in a surplus position at the end of the quarter on a solvency basis.

“DB pension plans’ funded positions continue to benefit from higher interest rates, with many plans now in surplus positions,” said Ben Ukonga, Principal and leader of Mercer’s Wealth business in Calgary. “The question that should now be on plan sponsors’ minds is how best to manage this surplus, and potentially locking it in, in order not to re-experience the dark days of significant pension deficits.”

A separate report from Aon shows that the aggregate funded ratio for Canadian pension plans in the S&P/TSX Composite Index increased from 101.8% to 102.1% in the second quarter of 2023.

Among the key findings of the Aon Pension Risk Tracker:

  • Pension assets gained 1.2% over the second quarter of 2023.
  • The long-term Government of Canada bond yield increased 7 basis points (bps) during the quarter and credit spreads widened by 4 bps. This combination resulted in an increase in the interest rates used to value pension liabilities from 4.60% to 4.71%.

"The muted asset performance and the small increase in discount rates supported a small increase in funded status over the quarter amidst volatility," said Nathan LaPierre, partner, Wealth Solutions, Aon. "Pension plans treaded water at healthy funded positions over the last quarter, giving plan sponsors time to consider de-risking activities and shape better decisions."

Risks ahead

Despite the positive overall tone of the reports, the second half of the year is not without potential headwinds.

With inflation still not under control, and the likelihood of further interest rate hikes, the Mercer report notes these key risks along with the spectre of recession. Additionally, the US will be gearing-up for the presidential election which could lead to more uncertainty.

The report says that Canadian pension plans should ensure that they are positioned to mitigate these risks and that they can also withstand major economic impacts such as the pandemic including reviewing risk exposure, risk appetite, and their own governance processes.

“Despite the improved financial positions of most DB plans, DB plans sponsors need to remain vigilant given the level of uncertainty that still exists”, concluded Ukonga. “Plan sponsors should understand and be comfortable with the risks they are taking and hedge or transfer the risks they do not want to retain.