BUSINESS

Higher long-term interest rates drive improvement in pension solvency in 2013

07/02/2013 02:50 EDT | Updated 09/01/2013 05:12 EDT
TORONTO - Consulting firm Mercer says the average solvency ratio of pension plans improved during the second quarter of 2013, thanks to an increase in long-term bond yields in the last two weeks.

Mercer's Pension Health Index stood at 94 per cent on June 30, up from 82 per cent at the start of the year.

Mercer says during the first five months of the year, pension funds also saw strong returns on equity, especially in foreign markets.

Although stock markets started to pull back in June, rising long-term interest rates helped pension plan solvency continue to improve.

Long-term interest rates are used to calculate the amount of money a pension plan needs to pay benefits. Low rates in recent years have forced many plans into a deficit position, while the recent rise has reduced that pressure.

"While interest rates have moved up dramatically in the last few weeks, it is not clear whether this is the start of a trend or a temporary blip," said Manuel Monteiro, partner in Mercer's financial strategy group.

The Mercer Pension Health Index shows the ratio of assets to liabilities for a model pension plan with valuations filed on a calendar-year basis.

A survey by consulting firm Aon Hewitt released Tuesday also found an improvement in the solvency of Canadian defined benefit pension plans.

The Aon Hewitt survey found that the median ratio of assets to pension liabilities at Canadian plans was three percentage points higher at the end of June compared to the end of March.

Aon Hewitt said the median solvency of plans surveyed was 77 per cent at the end of June, up from 74 per cent at the end of March.

"Normally, lacklustre market performance means bad news for pension plans but, in the latest quarter, the increase in interest rates helped improve the situation for plan sponsors," said Ian Struthers, a partner at the investment consulting division of Aon Hewitt Canada.

Monteiro said pension plans should consider decreasing their exposure to risk as they approach fully funded status.

"Most plan sponsors are taking significant interest rate and equity risk," said Monteiro.

"Continuing to take this risk may make sense for sponsors who are convinced that long-term interest rates will continue to surge upwards and that equity markets will perform. However, as pension plans approach a fully funded status, the sponsor's potential reward for continuing to take these risks diminishes."