Equity markets saved DB pensions from disaster in 2019

Mercer says that low interest rates continue to challenge financial statements

Equity markets saved DB pensions from disaster in 2019
Steve Randall

As the low interest rate environment endures along with a flat yield curve, Canada’s defined benefit (DB) pension funds with large equity allocations avoided disaster in 2019.

According to Mercer Canada, he solvency position of DB funds improved in the fourth quarter of 2019; the Mercer Pension Health Index, representing the solvency ratio of a hypothetical plan, increased to 112% on December 31st from 105% at the end of the third quarter and from 102% at the beginning of 2019.

“DB plans with substantial equity allocations owe the markets once again for saving them from what could have been a disastrous year,” said Andrew Whale, Principal in Mercer Canada’s Financial Strategy Group.

But the overall improvement for DB pension plans’ solvency funded positions belies the increased obligations for sponsors: “A one year increase of 15% on the balance sheet may cause CFOs and investors alike to take notice of legacy DB liabilities that they may have otherwise glossed over,” said Whale.

He added that transferring the obligation to an insurer has become more attractive for some plan sponsors as the difference between the cost to settle the DB obligations via annuity purchase and the DB obligations held on the balance has reduced.

“We have seen their appetite for annuities increase tremendously,” said Whale.

How funds fared in Q4 2019
A typical balanced pension portfolio would have risen by 2.3% during the fourth quarter of 2019.

Equity markets advanced in all regions while Canadian bonds fell modestly. 

Canadian equities saw the best performance in the IT sector, leading 7 of the 11 main sector groups; but healthcare lagged. The overall return for the S&P/TSX Composite Index was 3.2%.

Canadian fixed income markets fell amidst higher yields with real return bonds detracting the most value (-2.0%), while long-term bonds (-1.9%) underperformed universe bonds (-0.9%).

US equities returned 9.1% in US dollar terms (6.8% in Canadian dollar terms).

Developed market equities were also up, with the MSCI World returning 7.6% in local currency terms (6.4% Canadian dollar).

Emerging markets returned 9.6% in both local currency terms and Canadian dollar terms.

“Investors breathed a cautious sigh of relief to close out 2019,” said Todd Nelson, Partner at Mercer Canada. “While major stock indices reached record highs over the year, concerns about geopolitical risks, slowing economic growth and uncertain monetary policy persist into 2020.”