Pension plans suffered less in the third quarter. The average yields were ultimately nil. We should rejoice.
The professional services companies Mercer Canada and Aon have published in turn their index on the financial health of pension plans. For the first, a typical balanced fund portfolio would have produced a positive return of 0.2% in the third quarter. For the second, pension plan assets lost 0.1% during the same quarter. This should be seen as a lull, after the average loss of 8.6% observed in the second quarter by RBC Investor and Treasury Services. This brought the cumulative annual return to -14.7% in the universe of the institution’s retirement plans, under the action of a correction affecting both the stock and bond markets.
For defined benefit (DB) plans, while the increase in bond yields has significantly eroded assets this year, this effect has been more than mitigated by the rise in interest rates used to value liabilities at passive. This mathematics linked to the discount rate has made it possible to significantly improve the state of health of this type of plan. Mercer’s Pension Financial Health Index, which measures the median solvency of DB pension plans in its database, was 108% as of September 30, down from 109% at June 30, after hovering around 100% last year.
Mercer explains that, unlike the first two quarters, the financial situation of most DB pension plans did not improve in the third, as many of them had to deal with both negative returns and a decline in long-term bond rates between the beginning and end of the quarter. Aon added that the yield on long-term Government of Canada bonds at the end of the quarter fell 5 basis points compared to the rate at the end of the previous quarter, while credit spreads tightened by 16 basis points. “This combination has led to a decrease in the interest rates used to [l’évaluation des] pension plan commitments, [qui sont passés] from 4.83% to 4.62%. »
At the end of the third quarter, 72% of the plans in Mercer’s database had surplus assets on a solvency basis; 17% showed a degree of solvency between 90% and 100%; 5%, a degree between 80% and 90%; and 6%, a degree less than 80%. For Aon, the Pension Risk Tracker calculates the overall funded status on an accounting basis for companies in the TSX S&P/TSX Composite Index that offer DB plans. This index has gone from 100.5% to 97.2% over the past three months. It was 96.9% at the start of 2022, specifies the firm.
Recurrence effect
Beyond this financial mathematics, Mercer is not without warning that due to the inflationary slippage, “sponsors of indexed-annuity DB plans will suffer cost increases in this regard, while sponsors of DB plans with a non-indexed pension could come under pressure from groups of retirees who wish to obtain a one-time adjustment according to the cost of living”. Not to mention that an increase in benefits on a discretionary basis would not be without creating tensions between stakeholders and plan members.
This pressure on the plans will be all the stronger as the erosion of purchasing power is pronounced. In an email exchange, Jean-Pierre Aubry, an independent economist, rightly shined the spotlight on this belief that once the shock passed and inflation returned to target, we would return to the situation that prevailed before the outbreak of inflationary fever. This would be true for the inflation rate, but not necessarily for the price level, he wishes to recall. This is effectively without taking into account the recurrence effect. This gap represents a loss of purchasing power for those whose incomes have not increased at the rate of the rise in the cost of living.
Yields at half mast
Meanwhile in the markets, according to statistics from Mercer, the S&P/TSX Bay Street Index fell 1.4% during the third quarter, while Canadian bonds totaled a positive return of 0.5% for the universe index and 1.5% for long-term bonds. For the first nine months, the decline in the benchmark equity index was increased to 11.1%, and that of bonds was reduced to 12% for the universe index and 21% for long-term bonds. Illustrating the impact of the rise in interest rates, the yield to maturity of the universal index fell from 1.9% at December 31 to 4.1% at the end of September, and from 2. 5% to 4.2% for long-term maturities.
On the stock market, after nine months, only the Energy (+19.6%) and Consumer Staples (+1.5%) components posted a positive return. The heaviest losses came from the Information Technology (-57.4%), Healthcare (-56.9%) and Real Estate (-26.7%) sectors.