The new year starts off with defined benefit data that is a cautionary tale for advisors for the year ahead.
New defined benefit data from Aon Hewitt should serve as a wake-up call for advisors and plan sponsors.
For the first time in three years, Aon Hewitt's key measure of defined benefit pension plan health showed an annual decline.
The nearly three-percentage-point decline in plan solvency in 2014 was driven by a decrease in long-term interest rates. The solvency ratio also declined in the fourth quarter from the third, by 0.5 percentage points.
"2014 represents an inflection point in plan performance, and should serve as a wake-up call for defined benefit plan sponsors. The negative pressure on interest rates was unexpected," said Ian Struthers, Partner, Investment Consulting Practice, Aon Hewitt. "With strength in the US economy offset by weakness in Europe and Asia, and with volatility in commodity prices, we can continue to expect interest-rate instability and weakness in some equity markets. With the added impact of new longevity estimates coming soon, plan sponsors need to carefully consider their investing and governance approach.”
However, compared with traditional pension plans, plans that had a de-risking strategy in place for 2014 continued to be more resistant to interest rate declines. As a result, their solvency ratio saw more moderate declines year-over-year, and actually improved in the fourth quarter.
"If nothing else, the performance of Canadian DB plans in 2014 shows how quickly the solvency landscape can change in response to capital market volatility. Plans that stayed exposed to interest rates really took a beating in 2014," said William da Silva, Senior Partner, Retirement Practice, Aon Hewitt.
"Those plan sponsors who have implemented or fine-tuned their risk management strategies performed much better than traditional plans amid interest rate declines. Looking ahead to 2015, the only certainty is uncertainty. This should inspire all plan sponsors to evaluate their funding and investment strategies, with a view to better managing risk."
Long-term interest rates experienced significant volatility in 2014, with an overall decline of nearly a percentage point. Overall, the year demonstrated that amid market volatility, pension plans that have adopted a de-risking strategy which partly mitigates interest rate risk perform better than pension plans that continue to take interest rate risk.
For example, a traditional plan with a 60 per cent equity/40 per cent bond asset mix that began the year with a 90 per cent solvency ratio would have finished 2014 with a ratio of 88.5 per cent. In contrast, according to the Aon Hewitt survey, a typical delegated plan with a solvency ratio of 90 per cent on January 1 would have ended 2014 with a ratio of 91.5 per cent.
Delegated pension plans typically have adopted a de-risking strategy, implemented by a professional third party that optimizes the risk of the plan within an asset-liability context. For many this means greater portfolio diversification in their return-seeking assets and a higher interest rate hedge ratio. The result: better protection against equity market volatility.
The imperative for plan sponsors to re-evaluate their approach to risk management is even more crucial in 2015, added da Silva, with the pending introduction of new mortality tables for the Canadian market, which when implemented may have a significant impact on plan solvency.
For the first time in three years, Aon Hewitt's key measure of defined benefit pension plan health showed an annual decline.
The nearly three-percentage-point decline in plan solvency in 2014 was driven by a decrease in long-term interest rates. The solvency ratio also declined in the fourth quarter from the third, by 0.5 percentage points.
"2014 represents an inflection point in plan performance, and should serve as a wake-up call for defined benefit plan sponsors. The negative pressure on interest rates was unexpected," said Ian Struthers, Partner, Investment Consulting Practice, Aon Hewitt. "With strength in the US economy offset by weakness in Europe and Asia, and with volatility in commodity prices, we can continue to expect interest-rate instability and weakness in some equity markets. With the added impact of new longevity estimates coming soon, plan sponsors need to carefully consider their investing and governance approach.”
However, compared with traditional pension plans, plans that had a de-risking strategy in place for 2014 continued to be more resistant to interest rate declines. As a result, their solvency ratio saw more moderate declines year-over-year, and actually improved in the fourth quarter.
"If nothing else, the performance of Canadian DB plans in 2014 shows how quickly the solvency landscape can change in response to capital market volatility. Plans that stayed exposed to interest rates really took a beating in 2014," said William da Silva, Senior Partner, Retirement Practice, Aon Hewitt.
"Those plan sponsors who have implemented or fine-tuned their risk management strategies performed much better than traditional plans amid interest rate declines. Looking ahead to 2015, the only certainty is uncertainty. This should inspire all plan sponsors to evaluate their funding and investment strategies, with a view to better managing risk."
Long-term interest rates experienced significant volatility in 2014, with an overall decline of nearly a percentage point. Overall, the year demonstrated that amid market volatility, pension plans that have adopted a de-risking strategy which partly mitigates interest rate risk perform better than pension plans that continue to take interest rate risk.
For example, a traditional plan with a 60 per cent equity/40 per cent bond asset mix that began the year with a 90 per cent solvency ratio would have finished 2014 with a ratio of 88.5 per cent. In contrast, according to the Aon Hewitt survey, a typical delegated plan with a solvency ratio of 90 per cent on January 1 would have ended 2014 with a ratio of 91.5 per cent.
Delegated pension plans typically have adopted a de-risking strategy, implemented by a professional third party that optimizes the risk of the plan within an asset-liability context. For many this means greater portfolio diversification in their return-seeking assets and a higher interest rate hedge ratio. The result: better protection against equity market volatility.
The imperative for plan sponsors to re-evaluate their approach to risk management is even more crucial in 2015, added da Silva, with the pending introduction of new mortality tables for the Canadian market, which when implemented may have a significant impact on plan solvency.
