At the end of 2003, Canada’s larger corporate defined benefit pension plans were 87% funded, on average, up slightly from an 85% funded ratio at the start of the year, according to Watson Wyatt Canada. While a survey from Mercer Investment Consulting finds that Canadian pension plans achieved their best investment returns since 1997.

The Watson Wyatt Pension Barometer, released today by Watson Wyatt Canada, also shows that plan funded ratios dropped to as low as 81% in May 2003, due to the effects of various changing economic conditions, before rising again to the 87% level at the end of the year.

While the 87% figure represents the funded level of the average plan, Watson Wyatt explains that a plan’s its expected funded ratio at the end of 2003 could actually have ranged from 81% to 90%, depending on the asset mix of the plan and the proportion of liabilities relating to pensioners. Going into 2003, the average 85% funded ratio lay in the middle of a wide range, with 7% having a ratio in excess of 125% and 30% with a ratio below 75%.

Many plans will have enjoyed investment returns in 2003 that exceeded the rate of return assumed in their actuarial valuations, leading to hopes of at least a partial recovery from deficits. However, according to Watson Wyatt, for many this will prove to be a false hope.

Based on the annual changes reported in published indices, conservatively invested portfolios (with 30% invested in equities, for example) would have had returns of roughly 10% in 2003, while aggressively invested portfolios (with 70% invested in equities, for example) would return closer to 15%.

However, the discount rate used in determining pension liabilities for financial statement purposes, is based on yields on long-term bonds. By the end of 2003, interest rates on long bonds were lower than they were as of Dec. 31, 2002, resulting in potentially little or no improvement in the funded ratio.

According to Ian Markham, senior actuary with Watson Wyatt Canada, there’s still a ways to go for pensions to reach a 100% funded level.

“Looking forward, if bond yields remain at their Dec. 31, 2003 level, equities will have to return a whopping 35% in 2004 to get the 87% funded ratio up to 100%, barring extra contributions,” said Markham. “If bond yields were to increase by 1%, the typical plan could achieve a 100% funded ratio with a 25% equity return in 2004 — still far above the predictions of the most optimistic of economists.”

A survey released today by Mercer Investment Consulting found that Canadian pension plans achieved their best investment return since 1997.

Mercer notes that positive returns in all the main asset classes during 2003 improved the outlook for Canadian pension plans.

“Although the first quarter of 2003 was very challenging, the major equity markets posted very solid returns by the end of the year. Managers of discretionary balanced pooled funds, buoyed mainly by the strong Canadian equity market, posted a median return of 13.9% for 2003, the best median return since 1997,” said Marcel Larochelle, practice leader for Mercer Investment Consulting in Canada.

Thanks to those favourable results, Mercer’s Canadian Pension Health Index, a measure of the impact of capital markets on the financial position of Canadian pension plans, increased to 89% at year end, up 3% from the beginning of 2003, ending a three-year decline in the Index.

In most asset classes, investment managers underperformed the leading index.

Canadian small cap equities were the top performing asset class returning an impressive 42.7% over the year as measured by the BMO Nesbitt Burns Small Cap Index. Investment managers underperformed the index with a median return of 38.6%

With a median return of 25.8% in 2003, Canadian equity managers slightly underperformed the S&P/TSX Composite which posted a return of 26.7% for 2003, led by strong performance in the metals/minerals, real estate/construction, and industrial sectors.