Canadian Defined Benefit Pension Plans' Solvency Improves Slightly in 2012,
According to Aon Hewitt
TORONTO, Jan. 3, 2013 /CNW/ - Defined benefit (DB) pension plans' solvency in
Canada improved slightly in2012 thanks to company contributions and a strong
equity market, according to Aon Hewitt, the global human resource solutions
business of Aon plc (NYSE:AON). The median pension solvency funded ratio -
orthe ratio of the market value of plan assets to liabilities — is
approximately 1 percent higher this year than at the start of 2012.
According to Aon Hewitt, opposing factors had an overall positive impact on
the financial status of defined benefit pension plans this year. On the one
hand, interest rates continued their decline pushing up the value of
liabilities of pension plans. The discount rate used to calculate the
liabilities to be settled by annuity purchases in case of a plan termination
went down from 3.31percent at the beginning of the year to2.96percent at
the end of 2012.
On the other hand, equities performed well, with Emerging Markets leading the
pack at 16.0 percent, followedby International Equities (15.3 percent), US
Equities (13.4 percent) and Canadian Equities (7.2percent). Pension plans
invested in alternative asset classes such as Global Real Estate and
Infrastructure were rewarded with returns of 25.8 percent and 11.7 percent
respectively. Finally, most plan sponsors had to contribute towards their
deficits due to minimum solvency funding requirements.
The combination of all these factors led to a slight rise in Aon Hewitt's
median solvency funded ratio ofalargesample ofpension plans from 68
percent at the end of 2011 to 69 percent at the end of 2012.
About97percent of pension plans in that sample had a solvency deficiency
as at December 31, 2012. Thesolvency funded ratio measures the financial
health of a defined benefit pension plan by comparing theamount ofassets
to total pension liabilities in the event of a plan termination.
"There are mainly three ways that plan sponsors will see themselves out of
this solvency conundrum," said Thomas Ault, an associate partner in Aon
Hewitt's Retirement Consulting practice. "Through an increase ininterest
rates, favorable equity and alternative markets returns, or through higher
employer contributions. We had two out of three this year."
The following graph depicts the movement of assets, liabilities and funded
ratios for this median pension plan since January 1, 2010.
The graph shows that assets have only increased by 20 percent over the
three-year period since January 1, 2010 whileliabilities, driven by a
continuous drop in long term interest rates, have increased by 50 percent over
Impact of de-risking
In addition to the performance of the typical plan, Aon Hewitt has also
tracked the performance of a plan that has employed a few simple de-risking
strategies since January 1, 2011, such as:
-- Increased investment in bonds from 40 percent to 60 percent of
-- Investment in long bonds instead of universe bonds to better
The de-risked plan experienced a 79 percent solvency ratio as at December 31,
2012 as opposed to69 percent for the median plan.
Looking Ahead to 2013
According to Aon Hewitt, there was, again, downward pressure on yields in
2012, and it is likely to continue in2013. "The demand on long bonds by
pension funds and insurance companies to better hedge their liabilities,
foreign investors looking for a safe haven and the level of public debt are
all contributing factors tothis trend," said André Choquet, a senior
consultant in Aon Hewitt's Investment Consulting Practice. "Plansponsors may
want to review not only their investment policy but their benefit design and
funding policies if they believe we're in this low rate environment for the
Aon Hewitt believes the following trends are likely to continue in 2013:
-- Mega risk transfer deals: 2012 saw two large scale North
American annuity buy-outs with GM and Verizon settling $26
billion and $7.5 billion of their retiree liabilities
respectively both with the same insurer, Prudential. Some plan
sponsors that believe low interest rates are here to stay may
opt to remove pension risk from their balance sheet as it
negatively affects their stock price. Canadian insurers hope to
see the first $1 billion buy-in or buy-out deal this year.
-- Diversification out of equities: Plan sponsors who do not
envision an early exit from their defined benefit plans, may
opt to continue diversifying the growth component of their
pension fund into alternatives and hedge funds mainly to reduce
market risk while preserving their return expectation. Many
alternative asset classes are now available to smaller
investors through pooled funds.
-- Delegation of responsibilities: Some sponsors concerned about
the level of oversight and governance needed to effectively
manage their defined benefit plans especially as they approach
their endgame may choose to delegate some or most of their
responsibilities to a third party who will then implement
a de-risking and an eventual annuity settlement strategy.
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Media Contact: Alexandre Daudelin │ +1.514.982.4910
Image with caption: "Aon Hewitt Survey of Median Solvency Ratio 2010-2012 (CNW
Group/AON Hewitt)". Image available at:
SOURCE: AON Hewitt
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