2021 is Over… What Happened and What’s Next?
It is that time of year, when pension plan sponsors take stock of the past year — and plan for the year ahead.
What Happened in 2021
2021 was an excellent year for plan sponsors of unhedged pension plans (i.e. those that have not already adopted a ‘de-risked’ investment strategy).
The TSX Composite and US S&P 500 equity indexes both generated returns of about 25%. Fixed income indices posted slight negative returns with the universe fixed income index down about 2%, and the long-term fixed income index down about 4%. All told, unhedged pension plans could see their investment returns for 2021 be in the range of 10% to 14%.
In addition to the good news for investment returns in 2021, the yields on long-term government bonds increased by about 60 basis points from December 31, 2020 to December 31, 2021. Furthermore, the initial non-indexed commuted value interest rate assumptions increased by 90 basis points, and the ultimate non-indexed commuted value interest rate assumption increased by 50 basis points. As a result, and depending on the characteristics of the plan, I estimate that the solvency liabilities for pension plans will decrease by about 5% to 8%.
Thus, when looking at a pension plan as a whole, it is our expectation that unhedged pension plans will see that their solvency position improved significantly in 2021 – potentially by as much as 15% or more in some cases.
Accounting Position at December 31, 2021
In addition, the yields on high-quality corporate bonds increased by about 50 to 60 basis points from December 31, 2020 to December 31, 2021. Thus, plan sponsors who use these yields to develop their discount rate assumption for the benefit obligations used in their financial statement accounting entries should also see that the benefit obligations for their pension and other post-retirement benefit plans decrease by 5% to 8% at December 31st.
When combined with the investment experience for 2021, unhedged pension plans should see a significant improvement in their accounting position – again by as much as 15% or more.
Looking Forward in 2022
With the significant improvement in the funded status of pension plans that occurred in 2021, ASI saw an increase in the number of plan sponsors reaching out to continue the discussion surrounding their strategy for their defined benefit pension plans. In some circumstances – typically where a plan sponsor had previously decided to transition away from providing a defined benefit pension to their employees – these discussions were straight forward and resulted in a plan sponsor simply adopting a ‘de-risked’ investment strategy or deciding to formally wind-up their plan.
However, more often than not, these discussions are not straightforward, and plan sponsors have more options to consider today than they have in the past. To this end, in 2021, we saw our clients adopt a number of unique solutions: from joining the CAAT Pension Plan to purchasing annuities and obtaining a discharge. Also, in 2021, we saw the emergence of a significant amount of surplus is some pension plans. While this is a pleasant development, the emergence of surplus may require the plan sponsor to reconsider their long-term strategy for their pension plan.
If I learned anything in 2021, it is that there is no ‘one size fits all’ solution for plan sponsors. The key takeaway for plan sponsors is to explore all options, be open minded to new solutions, and allow themselves to be flexible as circumstances change.
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As a reminder, 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. At a minimum, this includes a periodic review of their investment and funding policies. With the significant improvement in the funded status of pension plans in 2021, now may be a good time to review your company’s pension plan(s).
Wishing you all the best for 2022!