SOURCE: Aon Hewitt

Aon Hewitt

September 30, 2014 15:55 ET

Canadian Pension Plan Solvency Declines in the Third Quarter, Aon Hewitt Survey Finds

Aon Hewitt's Key Measure of Defined Benefit Pension Plan Health Shows First Decline in Nine Quarters; More Challenges to Traditional Plans Emerging

TORONTO, ON--(Marketwired - September 30, 2014) - Lower long-term interest rates drove down the solvency of Canadian defined benefit (DB) plans from July to September, according to the latest pension plan solvency ratio survey by Aon Hewitt, the global human resources solutions business of Aon plc (NYSE: AON). Decent equity market returns and pension plan contributions helped offset some of the declines, but overall plan solvency ratio dropped in the third quarter by more than four percentage points from the second quarter -- the first decline in plan solvency since June 2012. Plans that had put in place a de-risking strategy, however, proved less sensitive to rate declines and their solvency ratio did not suffer as much.

More than 275 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 91.1% at September 26, 2014. That represents a decline of 4.9 percentage points over the previous quarter ended June 30, 2014, a 5.5% drop from the peak of 96.6% reached in April 2014, and a 3.1% increase over the same quarter in 2013. With the decline, this quarter's survey results reverse a trend throughout 2013 and 2014 of improving solvency positions for the surveyed plans. As well, approximately 23% of the surveyed plans in Q3 were more than fully funded at the end of the third quarter this year, compared with 37% in the previous quarter and 15% in Q3 2013.

The impact of lower long-term rates on plan performance made it even clearer that pension plans that continue to take interest rate risk and those that have adopted a de-risking strategy -- which partly mitigates interest rate risk -- perform very differently amid market volatility. Overall, equities performed well in Q3, but with long-term interest rates continuing their decline, the average pension plan had weaker performance than plans that have instituted a de-risking plan. Pension plans that have adopted a de-risking strategy have deliberately employed an optimized approach to managing the risk budget of the plan within an asset-liability context. Often, this leads to a portfolio that seeks greater diversification in its allocations to return-seeking assets and a higher hedge ratio through fixed income instruments with longer durations in their liability- hedging assets (hedge ratio is a measure of sensitivity of assets to changes in liabilities due to interest rates; the higher the hedge ratio, the better the protection against dropping rates).

"Canadian DB plans have strung together a nice run of winning quarters, but as we have been saying for some time now, market volatility continues to present significant risks and plan sponsors should be implementing or fine-tuning their de-risking strategies in order to stay current and optimized in the face of ever-changing capital market conditions," said William da Silva, Senior Partner, Retirement Practice, Aon Hewitt. "Now that we have seen plan solvency decline for the first time in over a year and a half, hopefully this will serve as a wake-up call to all plan sponsors to consider their funding and investment strategies with risk management as their key objective. Overall Canadian plan solvency is still relatively strong compared to where things stood just a few years ago, so there is still time to act. But with new mortality tables coming into effect, we expect material increases in liabilities for many plans. Clearly, that is another signal that the time to act is now."

Aon Hewitt expects that actuarial standards for solvency valuations to be released in 2015 will take into account the new mortality tables released earlier this year. That will have a real impact on the solvency liabilities of DB plans. The Canadian Institute of Actuaries' mortality tables project longer life-spans for Canadian pensioners than the previously used U.S. mortality tables. If the new CIA tables were applied to the Q3 survey, we would expect the solvency ratio of the median plan to be even lower (86.9% compared with 91.1%).

Aon Hewitt has seen more and more plan sponsors explore de-risking strategies to mitigate long-term risk. There are a number of strategies available to them. Beyond analyzing plans' risk profiles as capital markets continue to change, other risk management strategies are becoming more prevalent and will undoubtedly become more mainstream as plan sponsors begin to seek out other creative solutions for managing their pension risk.

The main driver for the drop in solvency ratios during Q3 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, 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 stronger returns on equities, led by the quarter's best performer, U.S. equities (4.9% return in Q3), followed by emerging markets (2.5%) and global equities (2.1%). Canadian equity assets returned -1.1% on the quarter, while returns for long-term and universe bonds were 2.3% and 1.1%, respectively.

"Clearly the good times we've seen for plan performance up until this quarter have created some complacency among plan sponsors," said Ian Struthers, Partner, Investment Consulting Practice, Aon Hewitt. "The volatility we have forecast in previous quarters began to have a real effect on the downside this quarter, and really the only thing that didn't make plan performance worse were strong equity markets in the United States and internationally. If there is a market correction this winter, we could see a continuing decline in plans' solvency ratio. Couple this with the impact of new mortality tables, and some plans could find themselves caught in a perfect storm of lower returns and increasing liabilities, erasing the tremendous gains many plans have experienced over the last 18 months or so."

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 more than 275 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 65,000 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, reinsurance intermediary, captives manager and best employee benefits consulting firm by multiple industry sources. Visit www.aon.com for more information on Aon and www.aon.com/manchesterunited to learn about Aon's global partnership and shirt sponsorship with Manchester United.

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