The solvency position of Canadian pension plans dipped in the third quarter of 2014, according to Mercer.
Its Pension Health Index stood at 99% on Sept. 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.
So far, the pension story in 2014 has been a tug-of-war between long-term interest rates and equity markets, says Mercer. 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.
Of the six-percentage-point drop in the index in the third quarter, two percentage points were attributable to the further general decline in long-term interest rates and four percentage points 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 when viewed against the backdrop of the last decade,” says Manuel Monteiro, a partner in Mercer’s financial strategy group.
The current favourable position of pension plans continues to provide a good opportunity for plan sponsors to measure and, if necessary, adjust their risk exposure to their desired level. Plan sponsors that wish to reduce their risk exposure could do so by increasing fixed income allocations or offloading portions of their liabilities to an insurance company through an annuity transaction.
Monteiro notes that 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.
“However, we have begun to see a turnaround in the annuity market with a number of significant transactions late in the third quarter,” he adds. “Similar to 2013, we may witness a very significant increase in annuity transactions in the fourth quarter, particularly if insurers sharpen their pencils in order to meet their sales targets.”
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