February 2, 2015 – it took a little longer to get into work in the Tecumseh office this morning having to first dig out from about a foot of snow. But the beauty of small town living is that even with longer commute times everyone is in today and the longest commute I heard from anyone was an extra 20 minutes.
If the snow storm was the only bad news this week I would feel pretty good about the overall proposition of living in Canada. Unfortunately last month brought worsening economic news. Many of you will know that I am a pretty optimistic person when it comes to thinking about the future, so it is with some reluctance that I am writing to report the state of affairs for defined benefit pension plans just one month into 2015.
Coming off a good year in 2013 many of us had lots of optimism that interest rates had finally bottomed out. Then, just when I thought we were going to see the best news since we started Actuarial Solutions Inc. in 1998, we were hit with the massive decline in oil prices in 2014 and all the economic upheaval that has come with it.
The results for defined benefit pension plans in 2014 was slightly negative but not particularly terrible. Balanced pension funds generally earned 10% to 12% which was largely offset by the increases in liabilities due to falling interest rates during the year. During 2014, the initial interest rate used in calculating commuted values dropped about 0.5% with interest rates used to price annuities falling more than 1%. The net effect for most plan sponsor invested in a mix of stocks and bonds is likely a decline in funded status (transfer ratio) of 3% to 5%.
If the bad news ended there I really wouldn’t have much to write. But wait, before you breathe a sigh of relief let me tell you about January freeze – and this isn’t a story about the weather.
Although I think about economics, I don’t have a degree in the subject and would never suggest that I am anywhere close to an expert in how things work in the global economy. I barely understand the economy of my family other than the kids can spend fast enough to ensure that I have a reason to work for many years into the future. That isn’t a complaint though, because I like my job and if you have seen me golf you know that I don’t have a viable plan for activities in retirement.
Better than my getting into the nitty-gritty of bond yields – just click here to read Luke Kawa’s analysis that he posted last Thursday in the Globe and Mail. The bottom line? When no one was looking in January, the Bank of Canada dropped their lending rate by 25 basis points and now the bond market is telling us that Mr. Poloz may well cut the rate again in March if oil prices don’t stabilize. Oil was up Friday and again so far today so maybe we are out of the woods – but the overall sentiment isn’t nearly as rosy as any of us that hope for better days for defined benefit plans would like or need.
In the pension world, declining bond yields means that commuted value interest rates have fallen another 0.5% in just one month and the yields used to price annuities have fallen also. Without much headway in broad equity returns so far in 2015, plan sponsors may have slid another 3% to 5% which isn’t the direction we want to be going.
We continue to monitor plan solvency for our clients and if we suspect that a pension fund has fallen back 10% between actuarial valuations we let clients know so that they can decide to either prepare a financial update to file with the Financial Services Commission of Ontario or to defer a portion of the commuted value payout to terminated plan members for up to five years. I can’t promise better days ahead but we are doing what we can to keep clients informed.