It is again that time of year, when pension plan sponsors take stock of their experience in 2019 and make plans for 2020.
What happened in 2019
With 2019 generating great investment returns, Canadian pension plan sponsors may be expecting significant improvements in the funded status of their plans – however, expectations should be tempered.
To be clear, the equity markets had a great year in 2019. The TSX Composite Index generated a return of about 23%, and US and international equity indices also generated double digit returns. Furthermore, fixed income indices have posted decent returns with short-term bonds indices generating a return of about 3%, and long-term fixed income indices generating a return of about 7%.
However, in 2019, the yields on long-term government bonds decreased by about 40 basis points, and the non-indexed commuted value interest rate assumptions decreased by around 80 basis points. Combined, these factors will cause the solvency liabilities to increase by about 5% to 8% (depending on the characteristics of the plan) due to these changes alone.
As a result, when looking at a pension plan as a whole, it is our expectation that unhedged pension plans (i.e. those that have not de-risked) will generally see an improvement of between 4% to 8% in their solvency position in 2019.
Accounting Position at December 31, 2019
2019 also saw a fairly dramatic decrease in the yields on high-quality corporate bonds, with such yields decreasing by about 75 basis points from December 31, 2018 to December 31, 2019. Many plan sponsors use these yields to develop the discount rate assumption for the benefit obligations used in their financial statement accounting entries. As such, plan sponsors with December 31st financial reporting dates can expect the benefit obligations for their pension and OPEB plans to increase by as much 7% to 12% due to the change in the discount rate alone. As such, it is our expectation than unhedged pension plans may not see any material change in their accounting position, despite the significant investment returns generated in 2019.
What we are watching for in 2020
The continued decline in the yields of fixed income assets will present challenges for plan sponsors looking to achieve their funding targets. Irrespective of the positive equity performance achieved in recent years, the impact of the low interest rate environment will be a major factor for consideration for plan sponsors preparing funding valuations in 2020.
For instance, the low interest rate environment may result in the need to lower going-concern discount rates; and for Ontario registered plans, the potential need to reflect the impact of the ‘Benchmark Discount Rate’ component in the Provision for Adverse Deviations. The net impact of which would lead to an increase in the going-concern funding targets. Fortunately, many of the plans we work with are reasonably well funded on a going-concern basis, so the impact of increasing the going-concern funding target may not be overly burdensome. Furthermore, Ontario and other jurisdictions have softened their rules on solvency funding, and thus many plan sponsors are no longer beholden to the strict ‘mark-to-market’ approach of solvency pension funding.
As our readers will know, a low interest rate environment tends to favour borrowers at the expense of lenders and savers (i.e. plan sponsors). To this end, we always encourage plan sponsors to consider balancing the various risks inherent in their plans, and to frequently review their long-term strategy for providing pension benefits, as well as to review their investment and funding policies. Also, with the improvement in the solvency position for pension plans experienced over the past year, we expect some plan sponsors will want to explore various de-risking strategies (including annuity purchases).
We also expect a revision to the actuarial standards of practice for pension commuted values in 2020. This was discussed in our blog from last year, and it is our understanding that the Actuarial Standards Board is in the process of finalizing their updates to the actuarial standards for commuted value calculations. Again, proposed changes include updating the manner in which the interest rate assumption is established, special provisions for plans with risk sharing provisions, and updating the pension commencement assumption. We will be sure to elaborate more on these changes once the standard is finalized.
Wishing you all the best for 2020!