While Canadian DB plans are well-funded, volatile rate conditions could erode surplus positions faster than many plan sponsors expect, one expert warns
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're focusing on defined benefit (DB) plans.
Despite Canadian defined benefit pension plans operating from a position of rare strength, one expert suggests the interest rate environment threatens to erode that advantage faster than many plan sponsors may expect.
"The Canadian interest rate environment is very uncertain right now," said Zachary Barsky, director of institutional solutions at Toronto-based RPIA Capital Management. "Our economy had been perceived to be on weaker footing than our neighbours to the south."
Citing Mercer's Pension Health Pulse as of June 30, 2026, he noted that roughly 90 per cent of DB plans in Canada were running a surplus, with about 60 per cent of those at 120 per cent funded status or more.
How monetary policy impacts DB pension liabilities
That starting point, however, sits against a backdrop of monetary policy uncertainty that complicates the liability side of the ledger. Barsky explained that while inflation had been running close to the Bank of Canada's 2 per cent target, geopolitical pressures have disrupted that trajectory.
"With the conflict in the Middle East putting pressure on energy markets, we've seen that creep into the inflation numbers in Canada," he said.
Because a pension plan needs to determine how much it needs today to meet obligations that may not begin for decades, interest rates sit at the centre of that calculation, Barsky explained. When interest rates rise, liabilities shrink, and when they fall, liabilities grow.
Moreover, funded status depends on both sides of the balance sheet, meaning asset performance can amplify or offset whatever rates are doing to obligations, which is also where many Canadian plans have faced headwinds, he noted.
"[Plan sponsors] tend to take more of a value-based approach to the equity side of their book. They don't need to outperform the S&P 500 to achieve their objective, which is ultimately solvency ratios," Barsky said.
"When you talk about the Canadian equity market, for example, the view is that it's small, it's concentrated, and it's volatile because it's mostly in three sectors: financials, energy, and materials. Two of those sectors, energy and materials, are very much tied to the performance of the underlying commodity, which can be very volatile,” explained Barsky. "You don't necessarily want that volatility of return in your pension portfolio because it will perform differently than the liability side of your book."
In practice, that usually means plans are typically underweight energy, materials, and growth-heavy tech names in favour of sectors like financials, telecom, and staples, noted Barsky, particularly as these holdings can deliver steady single-digit returns year after year rather than 30 per cent one year and minus 20 per cent the next year, he said.
To that end, Barsky argued that pension boards and investment committees are built for strategic decision-making, not tactical calls, partly because many only convene once a quarter, and market conditions can shift considerably between meetings.
That reality puts the emphasis on asset mix design and stress testing rather than trying to predict the Bank of Canada's next move, he emphasized.
"The question is less about what happens if the Bank of Canada hikes or holds or cuts and more about acknowledging the range of scenarios that might occur in those instances," he said, pointing to the first quarter of 2020 as a stark example where equities fell sharply while rates were cut aggressively, hammering both sides of the ledger at once and dragging funded statuses from full funding down to roughly 85 per cent in a matter of weeks.
DB surplus breeds complacency for sponsors
He believes that episode underscores why today's surplus positions, however strong, should not breed false confidence for plan sponsors. After all, a plan sitting at 120 per cent funded status can see that cushion vanish in the wrong market environment, he said.
"Just because they have a surplus doesn't mean they have to do something, but it should inform them to at least have the conversation about whether they should do something," he said. "The emphasis for plan sponsors is what amount of that do we want to lock in? What are we willing to leave on the table at risk? It depends, of course, on their unique scenarios. Are they open or closed? Do they have a more mature plan or a less mature plan? That’s where the expertise of the committees can really come shine."
How to position funds for maximum liability impact
According to Barsky, the most common first step is increasing allocations to fixed income to align asset duration more closely with liabilities and preserving funded status regardless of which direction rates move. He suggests plans seeking greater precision can adopt liability-driven investing strategies.
In some cases, corporate sponsors with mature plans have gone further, annuitizing the retiree portion of their obligations to shrink the plan and concentrate on longer-duration demographics.
Beyond asset mix shifts, Barsky urged sponsors to rethink how they define success.
"Move more towards a liability benchmark, move more towards an absolute return benchmark, and away from more traditional equity index benchmarks," he said. "Is what you believed two or five years ago still what you believe today? Is your asset mix still applicable for where you are today? It's always easier to manoeuvre when you're beginning at a place of strength than a place of weakness."
