How commuted-value calculation changes will impact lump-sum DB pension payments

The value of a typical Canadian defined benefit pension plan’s assets declined in June, according to LifeWorks Inc.’s latest monthly report.

An investment portfolio designed to mimic typical Canadian DB portfolios saw its assets decline by 5.4 per cent over the month. The benchmark portfolio is composed of 50 per cent equities and 50 per cent fixed income.

Equities performed particularly poorly during the month, with domestic stocks experiencing the most significant declines. The S&P/TSX composite index dipping 8.7 per cent. Foreign stocks experienced somewhat milder losses, with the MSCI ACWI index finishing the month down 6.6 per cent.

Read: Average solvency position of Canadian DB pension plans improved in May: report

Returns for Canadian bond indices were negative, with yields increasing by 0.29 per cent over the month. Corporate credit spreads also increased.

As a result of portfolio performance, LifeWork’s solvency index, which provides an indication of changes in the solvency funding, saw its fastest decline in 2022. It dipped by 3.3 per cent, from 103.2 per cent to 99.9 per cent.

While the value of assets may have fallen, pension costs have also dropped. The pension expense index, which provides an indication of changes in the following year’s pension expense since the start of the year, dipped to 47 per cent, down five per cent from the previous month. The decline in expenses is the result of rising inflation expectations, though the report also revealed that expectations for long-term inflation appear relatively conservative.

Read: Pensions in position to off load risks: expert

At the beginning of the month, expectations for 30-year inflation in Canada reached 1.78 per cent, according to a calculation made by comparing the prices of indexed and non-indexed bonds. On July 13, 2022, after the Bank of Canada announced it would raise interest rates, it fell from 1.8 per cent to 1.7 per cent, says Murray Wright, associate partner in LifeWorks’ retirement and financial solutions team.

“Yesterday’s hike was, essentially, priced in. Unless we get a real surprise, the needle generally doesn’t move much on a day-to-day basis. The Bank of Canada tries to avoid to shocking or surprising markets. The only surprise, here, was that it wasn’t raised 75 basis point, but by 100. It isn’t an enormous difference.”

While higher interest rates could help lower plan liabilities, Wright notes the expectation of increasing rates was also already taken into account. In Canada, however, inflation expectations aren’t based on as solid a foundation of data as in the U.S., he adds. “The Bank of Canada doesn’t issue many real return bonds, so it isn’t a very reliable measure in Canada. It’s an indication of what the market expects, but if you look back in history, it isn’t very accurate.”

According to figures released by the U.S. Bureau of Labor Statistics, year-over-year inflation reached 9.1 per cent in the U.S. mid-year. Wright says inflation expectations for the Canadian economy could shift significantly when Canada’s mid-year consumer price index figures are revealed.

“The June numbers were on the high side in the U.S. The next inflation release from Statistics Canada is on July 20. If there are surprises in them, that’s where things could change.”

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