Canadian pension plans’ solvency improved slightly in the second quarter of 2014.
The Mercer Pension Health Index stands at 105%, down from 106% at the start of the year, but up from 104% as of March 31.
There has been a tug-of-war between long-term interest rates and equity markets. Long-term interest rates have declined, pushing pension liabilities higher. However, pension assets have grown almost as much as pension liabilities due to strong equity returns and the positive impact of falling interest rates on bond portfolios.
Many plan sponsors were expecting interest rates to continue moving upwards in 2014, further improving the funded position of pension plans. In fact, the reverse has happened with long-term interest rates falling by more than 40 basis points during the year. Once again, it shows that pension plans remain largely exposed to significant and unpredictable volatility of interest rates.
“The financial position of pension plans remains healthy and it continues to be a good opportunity for plan sponsors to measure and, if necessary, adjust their risk exposure to their desired level. For many, this means reducing their risk exposure by increasing fixed income allocations or by offloading portions of their liabilities to an insurance company through an annuity transaction” said Manuel Monteiro, partner in Mercer’s Financial Strategy Group. “We expect annuity market activity to ramp up significantly in the 3rd and 4th quarters of 2014.”
The current positive pension situation could deteriorate quickly, particularly if equity markets falter or there is continued downward pressure on long-term interest rates. Consequently, there could be a significant early mover advantage for plan sponsors who are able to act quickly.
A typical balanced pension portfolio returned 2.8% in the second quarter and 7.2% in the first half of 2014.