SOURCE: Aon Hewitt

Aon Hewitt

September 29, 2016 15:17 ET

Canadian Pension Health Declines Modestly in Third Quarter as More Volatility Lies Ahead

As Solvency Stabilizes, Canadian Pensions Should Look Towards Managing Future Risks, Says Aon Survey

TORONTO, ON--(Marketwired - September 29, 2016) - The health of Canadian defined benefit (DB) pension plans slightly declined in the third quarter of 2016, according to the latest quarterly pension plan solvency survey from Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON). Amid relatively robust equity markets and continued decline in bond yields (a consequence of the UK vote to leave the European Union), overall pension solvency declined by 0.8 percentage points in the three months ending September 29. However, solvency remains relatively stable, and a growing proportion of surveyed pension plans ended the quarter fully funded. Whether well-funded or not, all plans should consider ways to address risk, as the end of 2016 seems likely to be marked by heightened volatility, uncertainty in fixed income and equity markets, and potential decisions that will impact funding in the coming years.

The Aon survey measures plans' assets over liabilities to calculate their solvency funded ratio, is based on results from a total of 438 Aon Hewitt-administered DB pensions from the public, semi-public and private sectors; the data has been recalibrated to reflect surveyed plans' recent experience. Median solvency on September 29, 2016 was 84.6%, down from 85.4% on June 30, 2016. However, more than 12% of plans were fully funded at quarter's end.

"With the immediate impact of Brexit muted and relative stability in monetary policy, the summer proved to be relatively calm for pension plans," said Ian Struthers, Partner, and Investment Consulting Practice Director at Aon Hewitt. "However, when we look more closely at the quarter, we see that there has been volatility on both the asset and liability sides of the ledger."

According to the survey, pension solvency in the quarter was supported by strong returns in all major equity markets, including Canada (4.1% in Q3, for a 14.4% year-to-date (YTD) return), the U.S. (5.6% in Q3, for 2.5% YTD), Europe, Australasia and the Far East (8.3% in Q3, for -3.2% YTD) and emerging markets (12.2% in Q3, 11.6% YTD). Alternative asset classes also performed well: global real estate returned 4.4% through Q3, for a 6.8% YTD return, while global infrastructure returned 3.3% in Q3, for a 10.9% YTD return. The devaluation of the Canadian dollar against some currencies contributed to higher Canadian-denominated returns, by an average of 2.0% over the quarter.

Meanwhile, long bond yields declined through the quarter as did credit spreads, continuing the trend towards lower yield. That, coupled with other factors like longevity-created headwinds for most pension plans, muted the impacts of fairly robust asset markets.

Although solvency ended the quarter relatively stable, there may be limited opportunity for pension plans to continue to see positive gains in risk-seeking asset classes. Strength in global equities has made valuations increasingly unattractive, particularly in the U.S., and there remain significant risks to earnings as economic growth is still weak. In fixed income, credit markets have performed well, but weaker economic conditions highlight risks; government bonds offer even less value as they continue to trade at historic highs.

"The question is, what now?" adds Struthers. "The global economy and monetary policy seem to have entered a period of renewed uncertainty, and we see heightened volatility in fixed income and equity markets through the end of the year. As well, there are few attractive asset classes left, as prices have risen across the board, and low yields will continue to put pressure on plan solvency. With pensions in a position of strength, a strong focus on optimizing risk is crucial. Smart diversification -- potentially including exposure to alternative asset classes -- is vital in this environment, and hedging strategies, including currency hedging where plans have large non-U.S. exposures, need to at least be considered."

Heightened volatility, especially at a time when plan solvency has improved, provides an ideal opportunity for pension plan sponsors to revisit their broader risk management plans.

"As we head into Q4, many sponsors should be reassessing where they are in the risk plan and taking advantage of opportunities that may exist in the pension landscape," said William da Silva, Senior Partner and National Retirement Practice Leader, Aon Hewitt. "Not only should sponsors focus on capital market risk, including interest rate risk, and evaluate trade-offs in hedging these risks, but they should also be focused on their funding strategies. This will be even more important for sponsors of Quebec-registered plans as the impact of new funding legislation becomes reality. For many sponsors of plans registered in other jurisdictions, the next couple of quarters are pivotal in their funding strategy as many plans look to reset their contribution levels for the coming years. There are many options available to these sponsors, and their varying impacts should be evaluated within the sponsor's broader risk management framework."

Aon's Median Solvency Index measures the financial health of a DB plan by comparing total assets to total pension liabilities in the event of plan termination. It is the most accurate and timely representation of the financial condition of Canadian DB plans because it draws on a large database and reflects each plan's specific features, investment policy, contributions and solvency relief steps taken by the plan sponsor. The analysis of the plans in the database takes into account the index performance of various asset classes, as well as the applicable interest rates to value liabilities on a solvency basis. Actuarial valuation data is refreshed on an annual basis as new valuations are filed keeping the database always up to date.

About Aon

Aon plc (NYSE: AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 72,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit: http://aon.mediaroom.com.

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