SOURCE: Aon Hewitt

Aon Hewitt

September 28, 2015 11:46 ET

Third Quarter Takes a Bite out of Pension Plan Health, According to Aon's Latest Solvency Survey

Declining Bond Yields and Market Volatility Lead to Sharp Decline in Pension Solvency

TORONTO, ON--(Marketwired - September 28, 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 health of Canadian defined benefit (DB) pensions declined sharply in the third quarter, driven by global uncertainty and volatility in long-term interest rates and in equities. With monetary policy in Canada and the United States in flux, and continuing weakness in commodities, particularly oil, the outlook remains clouded, as heightened volatility is likely to impact plan solvency going forward. Plans better positioned to weather market fluctuations, however, should fare better in this still-risky climate.

The Aon survey, which measures plans' assets over liabilities to calculate their solvency funded ratio, is based on quarterly results of a total of 449 Aon Hewitt-administered DB pensions from the public, semi-public and private sectors. The median solvency ratio on September 24, 2015 was 87.6% -- a 5.3 percentage point decrease from the previous quarter. Only 13.6% of surveyed plans were more than fully funded for the quarter, down 12.9 percentage points from Q2. With those results, Canadian DB plans resume a trend of declining solvency, which was reversed briefly last quarter (+4.8%). Pension health has now declined in four of the last five quarters, resulting in a median solvency that is considerably lower than it was a year ago (91.1%).

Driven by the Bank of Canada's 25 basis point cut to the overnight rate in July, and the U.S. Federal Reserve's decision to hold its target rate near zero in mid-September, long-term bond yields declined during the quarter. Long-term Canada bond yields fell by 5 basis points from July 1, lowering the discount rate used to value pension liabilities. Declining yields also pushed up the value of fixed income holdings, but for traditional plans, with lower interest rate hedge ratios, the benefit was not enough to counter the adverse impact on liabilities.

Compounding the impact of declining yields was heightened volatility and poor performance in growth asset classes. Canada's S&P/TSX composite fell by more than 7.7% over the quarter, while emerging markets declined by 12.9%. Stronger performance was turned in by the U.S. S&P 500 (+0.7%) and global real estate (+4.5%), although those returns were amplified by the Canadian dollar's decline against the U.S. greenback and other currencies. Just as Canada's plunging currency is benefiting the export and manufacturing sectors of the economy, it also has a positive impact on plan solvency: Aon estimates the median solvency ratio would have been 1.6 percentage points worse had the loonie remained stable over the quarter.

Meanwhile, across bonds, equities and other asset classes, uncertainty over global growth and monetary policy is fuelling heightened volatility. Equity market volatility rose sharply through the quarter -- for example, by more than 80% as measured by the S&P/TSX 60 VIX index. Not surprisingly, so-called "de-risked" plans, whose sponsors follow strategies that diversify assets broadly to achieve lower correlations with equity markets and mitigate their exposure to interest rate fluctuations, fared better than more traditional plans. De-risked plans -- for example, those that have adopted an Outsourced Chief Investment Officer strategy -- saw solvency in Q3 decline by only about two percentage points, in part because they had taken advantage of the earlier higher solvency to manage their asset mixes and reduce equity exposure and increase debt exposure. This allowed them to be less impacted by the decline in equity markets and pick up additional gains from bonds.

"There has been a lot of attention paid to stumbling Canadian markets and uncertainty over the economic picture, but the truth is that heightened volatility presents at least as big a risk to pension health as poor equity returns," said Ian Struthers, Partner, Investment Consulting Practice, Aon Hewitt. "Well-diversified plans -- even those with majority exposure to Canadian assets -- can better weather the downdraft in Canada's economy because they are less exposed to market fluctuations, and therefore can achieve more stable returns over the long term."

The outlook in Canada is particularly difficult because of two factors. One is the domestic equity market's high exposure to oil prices. Benchmark West Texas Intermediate (WTI) crude prices declined by about 25% from July 1, but volatility has increased by more than 40% as measured by the CBOE/NYMEX crude oil volatility index. The rapid fluctuations in oil prices have led to more volatility for Canada's resource-heavy equity indexes, and highlight the need for plan sponsors to consider strategies that hedge exposure to market risk.

Another factor is the introduction, expected on October 1, of new mortality tables from the Canadian Institute of Actuaries. By accounting for Canadians' increasing longevity, the new mortality tables are likely to lower median solvency by raising plan liabilities. Aon estimates the median DB plan solvency ratio would be 3.1 percentage points lower had the mortality impact been included.

"It's clear that heightened volatility in equity and fixed income markets coupled with the continued low interest rate environment are likely to be challenges to plan sponsors for some time to come," said William da Silva, Senior Partner and National Retirement Practice Leader, Aon Hewitt. "It's vitally important for sponsors to respond now, while solvency is still relatively strong. Develop an overall risk management strategy incorporating benefit, funding and investment policy, if you haven't already. And even if you have one in place, there are smaller, more tactical actions you can take now to potentially take advantage of certain market opportunities that may exist on both the asset and liability sides of the plan's balance sheet. This is a good time to put those things in place so that when conditions finally improve, you are ready to take action. Finally, don't forget about governance: too often, we see a good strategy fail during execution due to bad governance."

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:

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