SOURCE: Aon Hewitt

Aon Hewitt

July 02, 2015 16:10 ET

Global Uncertainty Drives Decline in Canadian Pension Health This Week, According to Aon Solvency Survey

Higher Bond Yields Increase Solvency Funded Ratio for Quarter, but Volatility and New Risks Weigh on Outlook

TORONTO, ON--(Marketwired - July 02, 2015) - Aon plc (NYSE: AON), the leading global provider of risk management and human resource consulting and outsourcing, today released results of its quarterly pension plan solvency survey, which found that the financial health of Canadian defined benefit (DB) pensions declined sharply this week after improving through most of the second quarter. Fears of the impact of Greece's default on debt payments to the International Monetary Fund (IMF), along with its inability to broker a deal with creditors, have created sharp declines in asset returns and increases in solvency liabilities for Canadian pensions in just a few days. While pension solvency still improved in the quarter overall, the recent downturn suggests that continuing interest rate and equity market volatility present risks to the outlook for plan solvency -- compounded by an expected change in the actuarial treatment of mortality later this year.

A total of 449 Aon Hewitt-administered DB pension plans from the public, semi-public and private sectors participated in the survey, which measures plans' assets over liabilities to calculate their solvency funded ratio. On June 30, 2015, the median solvency funded ratio stood at 92.9% -- a 4.0-percentage-point increase from the previous quarter -- and 26.5% of surveyed plans were more than fully funded at the end of Q2. Those results represent a reversal of the three-quarter trend of declining solvency, although the median ratio remains below the 96% level set in the second quarter of 2014.

However, before the events in Greece last weekend, the median solvency ratio for surveyed plans stood at 93.7%. This week, amid continuing global equity market uncertainty fuelled by Greece's debt crisis, the solvency ratio declined sharply before bouncing back up, and it remains unclear how large the impact of the Greek situation will be on plan solvency after Sunday's referendum.

"Pension plans must take a long-term view and not be overly reactive to short-term market moves, but the events of this past week show the need for a disciplined risk management process in volatile times," said Ian Struthers, Investment Consulting Practice Leader, Aon Hewitt. "In solvency terms, Canadian pension plans remain very healthy, so managing risk effectively is vital to protecting their gains and preparing for the future."

Recent instability in equity markets compounded already-disappointing returns in growth asset classes in the quarter. Canadian, U.S. and international equities saw negative returns of 1.6%, 1.2% and 0.8%, while Universe bond returns fell by 1.7% and global real estate investments declined by 8.0%. Offsetting those declines, however, were rising long-term yields -- the result of a global bond selloff that saw prices decline sharply -- which were responsible for the increase in plan solvency funded ratio, as higher yields raised the discount rates used to value pension liabilities.

The quarter also revealed some of the differences between traditional plans and so-called "de-risked" plans in times of volatility. With a typical 60/40 equity/universe bond asset mix, traditional plans benefited more from higher bond yields than did de-risked plans, whose sponsors have adopted strategies to mitigate interest rate and other risks through broader diversifications into assets that have lower correlations to equity markets. However, we would see de-risked plans perform better again should bond yields drop more as the Greek crisis unfolds. In fact, one expert's view is that we can expect a 50-70 basis points drop in bond yields should Greece exit the Euro.

Beyond the impact of global market uncertainty, other factors are weighing on the outlook for plan solvency. Among them are new mortality tables from the Canadian Institute of Actuaries, which will affect defined benefit plans solvency later this year. The new tables account for the increasing longevity of Canadians, and were they applied today, Aon estimates the impact would lower the median solvency ratio by one to four percentage points depending on the demographics of the plan.

As well, regulatory changes are expected to impact the rules for funding pension plans in jurisdictions across the country in 2016. These changes may require plan sponsors to adopt new investment and funding policies, as well as to revisit their risk management approaches.

"Recent events show that for pension plans, a lot can change in just a day," said William da Silva, Senior Partner and National Retirement Practice Leader, Aon Hewitt. "Yet the volatility we're seeing in the short term with regard to solvency is playing out amid deeper and longer-term changes in the pension industry. That means plan sponsors need to be nimble in both monitoring risk and responding to it, because the landscape can and is changing very quickly. We have been advising organizations for the better part of the last decade that applying the right tools in the context of a comprehensive risk management strategy is the new normal. While the events of the past week may be a surprise to plan sponsors, for those that have implemented the right strategies, this should not be a shock."

Aon recently introduced new tools to help pension plan sponsors better understand and mitigate risk. The Aon Hewitt Risk Analyzer provides an instantaneous and comprehensive view of plan risks, including interest rate risk. Meanwhile, the Aon Hewitt Longevity Model uses location-based data to give plan sponsors a clear mark-to-market view of the expected longevity of plan members and the corresponding impact on plan liabilities.

Aon's Median Solvency Ratio measures the financial health of a defined benefit 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.

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 69,000 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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