The solvency position of Canadian pension plans dipped in the third quarter of 2014.

The Mercer Pension Health Index stands at 99% on September 30, down from 106% at the start of the year and 105% as of June 30. The largest factor for the decline was a significant increase in the estimated cost of purchasing annuities – a critical input in the solvency valuation of pension plans.

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So far, the pension story in 2014 has been a tug-of-war between long-term interest rates and equity markets. Long-term interest rates have declined by 60 basis points, pushing pension liabilities higher. However, pension assets had grown almost as much as pension liabilities due to strong equity returns, the positive impact of falling interest rates on bond portfolios, weakness in the Canadian dollar, and in some cases, payments to fund previous deficits. The new element in the third quarter was the increased cost of purchasing annuities, which pushed solvency ratios markedly lower. With the recent volatility in equity markets over the past few weeks, pension plans are vulnerable to further declines in their financial health.

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Of the 6% drop in the Mercer Pension Health Index in the Q3, 2% was attributable to the further general decline in long-term interest rates and 4% to tightening in the annuity market above and beyond the impact of declining interest rates. Asset returns were slightly positive over the quarter, which had a small offsetting impact.

“Despite the deterioration in the third quarter, the financial position of pension plans remains healthy,” said Manuel Monteiro, partner in Mercer’s Financial Strategy Group.

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“2014 has not been the banner year for group annuity transactions that many were expecting, partly because plan sponsors were not ready to act quickly early in the year and more recently because annuity pricing has not been as favourable,” Monteiro adds. “However, we have begun to see a turnaround in the annuity market with a number of significant transactions late in the 3rd quarter. Similar to 2013, we may witness a very significant increase in annuity transactions in the 4th quarter.”

A typical balanced pension portfolio returned 1% in the third quarter and 8.3% year to date.

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