For the first time in three years the solvency rate of defined benefit pension plans is declining, according to Aon Hewitt. On December 31, the rate was 90.6%, 2.7 points less than the previous year. 2014 started off well…
At the beginning of the summer, many observers promised rather healthy pension plans for 2014 in Canada. The stock markets were soaring and the interest rates were rising, to the extent that several pension plans were nearly capitalized. The rest of the year did not follow the same pattern. Experts agree that the decline in long-term interest rates during the second half of the year was astonishing and extremely rare. According to a memo from the Mercer office, "in mid-December they once again approached the lowest levels in the last 60 years, reached previously in mid-2012." This can be explained in part by the monetary stimulus in Europe and Japan during 2014.
Weakened pension plans
The solvency of defined benefit pension plans* has suffered the effects. The value of the plans' liabilities towards their active participants and pensioners rose much faster than the asset growth. On the last day of December, the solvency rate calculated by Aon Hewitt (from a sample of 449 public, semi-private and private defined benefit pension plans) was 90.6%, 2.7 points less than in December 2013.
This means that if the promoter of one of these plans were to go bankrupt, the annuity promised to the present or future pensioner would amount to 90.6% of its value, until the end of his/her life. "The implementation of defined benefit plans in Canada in 2014 shows how quickly the landscape of solvency can change in response to the volatility of financial markets," remarks Claude Lockhead, Executive Associate at Aon Hewitt. “The plans that remained exposed to interest rates took a real hit in 2014."
Rising amortization payments
Another sign of weakness gathered by Aon Hewitt is that only 18.5% of plans examined were more than fully capitalized at the end of the year, compared to 23% in the previous quarter and 26% at the end of 2013. With a weaker solvency level, a number of promoters will have to face much more significant amortization payments in 2015 to counter the deficit of their plan.
This deterioration in the health of the pension plans does not bode well, especially since the Canadian Institute of Actuaries is preparing to adopt a new mortality table which takes into account increasing life expectancy; an adoption that would bring about an increase in contributions to pension plans.
*Remember that for a defined benefit pension plan, the employer is responsible for the plan's solvency. The company commits to pay retired plan members an income calculated on the basis of the number of years of service and on a percentage of the salary. It differs from a defined contribution pension plan, for which the employer and the employee both pay contributions on a pre-determined basis, but the annuity amount is calculated according to the rate of return on the pension fund; it is not fixed in advance.