The solvency of defined-benefit (DB) pension plans remained steady in the first quarter (Q1) of 2017, according to Mercer LLC’s quarterly pension health index.
Although DB pension assets saw strong performance in the equities markets in Q1, the Mercer report finds, an eight-point drop in long-term interest rates coupled with an increase in the projected cost of purchasing annuities neutralized those gains.
Mercer’s index, which represents the solvency ratio of a model DB pension plan, registered no change from the 102% solvency position at the beginning of the year. In addition, the median solvency ratio is still fixed in its spot at 93%.
The health of DB pension plans saw a marked improvement in the last quarter of 2016, bolstered by the rise in long-term interest rates and positive equities markets.
“[DB] Pension plans have largely held on to the significant gains that occurred in the fourth quarter of 2016, particularly after the U.S. election,” says Manuel Monteiro, leader of Mercer Canada’s financial strategy group, in a statement.
Still, the report notes, concern among DB plan sponsors lingers about how much the equity markets will continue to tumble as the post-election market “euphoria” wanes.
The health-care bill in the U.S. put forth by a Republican-led Congress, which failed to win enough support, has also dampened expectations that the new administration’s agenda for a tax overhaul, fewer regulations and a hefty stimulus package can easily pass the hurdles ahead.
Worries about global geopolitical developments, along with sweeping anti-globalization sentiment, are also at the forefront of DB pension plan sponsors’ concerns.
Against this geopolitical and economic climate, Monteiro anticipates that a shift in approach to mitigating risk among DB pension plan sponsors may be underway.
“We expect that many pension plan sponsors will bank their recent gains and reduce risk exposure by moving away from equities into bonds and alternative assets,” he says. “We also expect 2017 to be a breakout year in the group annuity market with many sponsors choosing to transfer risk through annuity transactions.”
In addition, the report illustrates the success of a typical balanced portfolio, which would have returned 3.7% during Q1.
Canadian equities started the year with a positive return of 2.6% through Q1, although the health-care and energy sectors, which posted negative returns of -10.1% and -5.7%, respectively, dragged down the S&P/TSX composite index. Utilities and consumer discretionary both produced the highest returns, at 7.3%.
U.S. equity returns started the year strong in both U.S. dollars, with a return of 6%, and Canadian dollars (C$), with a return of 5.1%.
Although the loonie may have appreciated slightly against the U.S., it depreciated against both the British pound sterling and the euro during Q1. This means that international equities, which posted a 5.1% return in the MSCI EAFE index, performed much better for Canadian investors.
Emerging markets had quite a strong showing during the quarter, posting a return of 8.5% in local currency terms and 11.8% in C$.
Earlier in March, the U.S. Federal Reserve Board hiked interest rates south of the border by 25 basis points to a range of 0.75%–1%, meeting expectations, with two more increases still projected to come this year. Meanwhile, the Bank of Canada continues to hold the benchmark interest rate steady at 0.5%.