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Happy New Year!  With 2023 behind us, and 2024 ahead of us, it’s time to look at what happened to defined benefit pension plans last year, and to prognosticate on what lies ahead for next year.

What Happened in 2023

As I look back at my commentary from last year, I had two main concerns for 2023: whether inflation could be tamed, and whether the succession of interest rate hikes would lead to a recession or if a ‘soft landing’ could be achieved.  A year later, it seems like we have some answers to these questions. 

First, inflation trended lower throughout most of 2023, and with a 12-month CPI figure of 3.1% in November 2023, this is down dramatically from the CPI figures of 6.8% in November 2022 (and the 8.1% peak figure in June 2022).  At these rates, inflation is just a touch outside of the Bank of Canada’s target range of 1% to 3%.  Secondly, while unemployment has inched upwards from 5.0% a year ago to 5.8% today, and consumer sentiment has softened in the past year, I do not believe these to be signals of an economy headed for a recession.  Rather, I believe these to be signals that the labour market is not as hot as it was a year ago, and that consumers are reacting to higher interest rates.  While it’s way too early to congratulate central bankers on a job well done, I am sure the champagne at this year’s New Years Eve party tasted sweeter than it did last year.

Financial Markets in 2023

Equity markets had a decent year in 2023.  Specifically, the TSX Composite Index returned close to 11% and the US S&P 500 equity index returned over 20% in 2023.  Furthermore, fixed income indices also posted positive returns in 2023 with universe bonds returning around 6%, and long-term bonds returning around 9%.  Finally, long-term government bond yields decreased by around 25 basis points from December 31, 2022 to December 31, 2023.

Implications for Pension Funding

In light of the investment returns and changes in bond yields noted above, 2023 will be a positive year for unhedged pension plans (i.e. those that have not adopted a ‘de-risked’ investment strategy).

In particular, the solvency position of unhedged pension plans will have improved by around 5% as investment returns slightly outpaced the increase in liabilities.  Furthermore, with the positive investment returns in the past year, the funded status on a going concern basis will likely improve for most pension plans in 2023.

This improvement will be welcome news for plan sponsors.  While most pensions are already well funded on a solvency and going concern basis, within our client base there are a few plans with small deficits that may now be able to reduce or even eliminate a special payment schedule as a result of the improved funded status in 2023.

Accounting Position at December 31, 2023

The yields on high-quality corporate bonds decreased by around 25 basis points from December 31, 2022 to December 31, 2023.  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 increase by around 4% if they have a December 31^st year-end.

But combined with the investment experience in 2023, unhedged pension plans should see an improvement in their accounting position – again by about 5% or so.

Looking Forward in 2024

Here is a list of items we will be watching for in 2024:

Surplus:  We increasingly see the emergence of surplus in many pension plans, and increasingly plan sponsors are actively exploring how it can be used.  For plan sponsors of closed and/or frozen pension plans, the issues of accessing surplus can be complicated, and increasingly they are exploring their options as to how best to utilize the surplus, and how this may impact their decision to wind-up their plan.

De-risking, Winding-up, and Transferring to JSPP’s:  As has been well documented, many entities have transitioned away from providing their employees with a defined benefit pension over the past few decades.  For entities with legacy closed or frozen defined benefit plans, the improvement in funded status over the past couple of years has made it less costly to adopt a de-risking investment strategy, purchase annuities, and/or formally wind-up their plan.

The decision to de-risk/wind-up a pension plan is never straightforward, and there are alternatives to winding-up – such as obtaining a discharge via an annuity purchase buy-out or merging into to a jointly sponsored pension plan like CAAT.  As such, we would encourage plan sponsors to discuss these options with their consultant prior to making any decision.

Speaking of CAAT, we are also seeing more employers considering this as the pension solution for their employees – and Joe’s recent blog on the autoworkers new collective agreement provides an excellent example of this.

Ontario Target Benefit Pension Plan Framework:  Of particular interest to trustees, employers, and members of multi-employer pension plans, and as noted in my blogs from last year, the Ontario government has made a lot of progress in developing its permanent framework for target benefit plans.  While the “temporary” SOMEPP funding rules were extended to January 1, 2025, we might be close to having a permanent framework in place by the end of this year.

The Alberta Pension Plan:  As you’ve probably heard, the Alberta government is exploring ways to exiting the Canada Pension and starting its own provincial plan.  Joe wrote an excellent blog on this initiative in the fall.  We will undoubtedly be watching to see how this evolves, with the next step an expected report from the Office of the Chief Actuary on how the assets of the CPP would actually be shared should Alberta choose to withdraw.

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As a reminder, we encourage plan sponsors to continuously monitor their plans, and to contemplate their long-term strategy for providing pension benefits.  At a minimum, this includes periodic reviews of their investment and funding policies.  As we begin a new year, now may be as good a time to review the design of your company’s pension plan(s) to ensure that they continue to meet the needs of the organization and its employees.

All the best to you in 2024!