SOURCE: Aon Hewitt

Aon Hewitt

December 31, 2014 11:20 ET

Canadian Pension Plan Solvency Declines in 2014, Aon Hewitt Survey Finds

Aon Hewitt's Key Measure of Defined Benefit Pension Plan Health Shows First Annual Decline in Three Years, While Plans Following a De-Risking Strategy Show Solvency Improvement

TORONTO, ON--(Marketwired - December 31, 2014) - The solvency of Canadian defined benefit (DB) plans declined through 2014, according to the latest pension plan solvency ratio survey by Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE: AON). The nearly three-percentage-point decline in plan solvency in 2014 was driven by a decrease in long-term interest rates, and represents the first annual decrease in Aon Hewitt's key measure of defined benefit pension plan health since 2011. The solvency ratio also declined in the fourth quarter from the third, by 0.5 percentage points. However, compared with traditional pension plans, plans that had a de- risking strategy in place for 2014 continued to be more resistant to interest rate declines; as a result, their solvency ratio saw more moderate declines year-over-year, and actually improved in the fourth quarter.

A total of 449 Aon Hewitt administered pension plans from the public, semi-public and private sectors participated in the survey, and their median solvency funded ratio -- the market value of plan assets over plan liabilities -- stood at 90.6% at December 31, 2014. That represents a decline of 0.5 percentage points over the previous quarter ended September 30, 2014, and a 2.7 percentage-point drop from plan solvency at December 31, 2013. Since peaking at 96.6% in April 2014, overall plan solvency has declined by 5.9 percentage points, continuing the trend towards worsening plan solvency that began in the third quarter of 2014 (when the solvency ratio dropped to 91.1% from 96.2% in the previous quarter). As well, approximately 18.5% of the surveyed plans were more than fully funded at the end of the year, compared with 23% in the previous quarter and 26% at the end of 2013. Plan sponsors that must file valuations as at December 31, 2014 could see the amount of their deficiency contributions double in 2015 as a result of the lower solvency ratio.

Long-term interest rates experienced significant volatility in 2014, with an overall decline of nearly a percentage point. Overall, the year demonstrated that amid market volatility, pension plans that have adopted a de-risking strategy which partly mitigates interest rate risk perform better than pension plans that continue to take interest rate risk. By way of example, a traditional plan (with a 60% equity/40% bond asset mix) that began the year with a 90% solvency ratio would have finished 2014 with a ratio of 88.5 %. In contrast, according to the Aon Hewitt survey, a typical delegated plan with a solvency ratio of 90% on January 1 would have ended 2014 with a ratio of 91.5%. Delegated pension plans typically have adopted a de-risking strategy, implemented by a professional third party that optimizes the risk of the plan within an asset-liability context. For many this means greater portfolio diversification in their return-seeking assets and a higher interest rate hedge ratio. The result: better protection against equity market volatility.

"If nothing else, the performance of Canadian DB plans in 2014 shows how quickly the solvency landscape can change in response to capital market volatility. Plans that stayed exposed to interest rates really took a beating in 2014," said William da Silva, Senior Partner, Retirement Practice, Aon Hewitt. "Those plan sponsors who have implemented or fine-tuned their risk management strategies performed much better than traditional plans amid interest rate declines. Looking ahead to 2015, the only certainty is uncertainty. This should inspire all plan sponsors to evaluate their funding and investment strategies, with a view to better managing risk."

The imperative for plan sponsors to re-evaluate their approach to risk management is even more crucial in 2015, adds da Silva, with the pending introduction of new mortality tables for the Canadian market, which when implemented may have a significant impact on plan solvency. Pensioners are living longer, which may increase liabilities for many plans; in fact, according to Aon Hewitt, the new mortality tables from the Canadian Institute of Actuaries could result in a decline in median plan solvency of more than four percentage points.

The main driver for the drop in solvency ratios during 2014 was the decrease in discount rates used to value plan liabilities. This was primarily driven by the decrease in prevailing rates on the longer end of the yield curve, which had a positive impact on fixed-income assets (8.4% and 16.7% return on Universe and Long Bonds, respectively), but a negative impact on transfer values and the cost of purchasing annuities. The adverse impact of lower interest rates was in part offset by equity performance, led by U.S. Equities (26.3%), World Equities (16.3%) and Canadian Equities (10.8%). Plans invested in alternative asset classes like Global Real Estate and Infrastructure were rewarded with 2014 returns of 28.2% and 26.9%, respectively. (The above returns are in Canadian dollars, and include the 8.5% gain from the depreciation in the Canadian dollar over 2014.)

"2014 represents an inflection point in plan performance, and should serve as a wake-up call for defined benefit plan sponsors. The negative pressure on interest rates was unexpected," said Ian Struthers, Partner, Investment Consulting Practice, Aon Hewitt. "With strength in the US economy offset by weakness in Europe and Asia, and with volatility in commodity prices, we can continue to expect interest-rate instability and weakness in some equity markets, notably Europe. With the added impact of new longevity estimates coming soon, plan sponsors need to carefully consider their investing and governance approach. For example, plans that not only mitigate interest rate risk, but also include a robust governance process that locks in market gains, will be best positioned to manage within this volatility -- a fact well worth considering in what looks likely to be a continuing difficult landscape in 2015."

The solvency funded ratio measures the financial health of a defined benefit plan by comparing total assets to total pension liabilities in the event of plan termination. Aon Hewitt's median pension solvency ratio 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.

About Aon Hewitt's Median Solvency Ratio

Aon Hewitt's Median Solvency Ratio is developed using a database of 449 pension plans from all sectors (public, semi-public and private) and from most Canadian provinces. Each plan's characteristics and data are used to project their solvency ratio on a monthly basis. These projections take into account the increase in financial indices for various asset classes, as well as the applicable interest rates to value liabilities on a solvency basis.

About Aon Hewitt

Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit www.aonhewitt.com.

About Aon

Aon plc (NYSE: AON) is the leading global provider of risk management, insurance and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 66,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative and effective risk and people solutions and through industry-leading global resources and technical expertise. Aon has been named repeatedly as the world's best broker, best insurance intermediary, best reinsurance intermediary, best captives manager, and best employee benefits consulting firm by multiple industry sources. Visit aon.com for more information on Aon and aon.com/manchesterunited to learn about Aon's global partnership with Manchester United.

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