Q3 saw a recovery but choppy waters lie ahead and risk profiles should be adjusted, according to index
Driven by equities, Canadian pension plans’ funded position continued to recover in Q3 but major risks await, according to the Mercer Pension Health Index (MPHI).
A second wave of the coronavirus, as well as the possibility of a disputed election in the United States, cloud what has been an encouraging quarter.
The index, which represents the solvency ratio of a hypothetical defined benefit (DB) pension plan, increased from 101 per cent at the end of June to 107 per cent at the end of September, but was still down from 112 per cent at the start of 2020. The median solvency ratio of the pension plans of Mercer clients was at 93 per cent on September 30, up from 91 per cent on June 30th, but down from 98 per cent at the beginning of the year.
During the third quarter, funded positions of DB plans continued to claw back some of the losses incurred in the first quarter. The improvement was driven by equities, which delivered solid returns across most markets. Despite a mid-quarter rise, bond yields fell in September to end the quarter roughly unchanged from the end of June.
Manuel Monteiro, Partner and Leader of Mercer Canada’s Financial Strategy Group, said: “Most defined benefit plans have proved resilient to the tremendous challenges that the first nine months of 2020 have delivered.” He added that plans remain very well funded by historical standards, even with liabilities measured at today’s ultra-low interest rates.
“The level of uncertainty we face today is unprecedented. Plan sponsors should evaluate the impact of alternative scenarios, and adjust their risk profile accordingly.”
Unlike in previous crises, pension plan sponsors are not facing a looming increase in pension contributions, thanks to recent changes to funding rules. However, sponsors in industries most affected by the pandemic may be facing challenges to meet their ongoing obligations, including pension contributions.
Some jurisdictions, including Ontario, have offered relief to these sponsors in the form of temporary contribution deferrals, subject to meeting certain conditions, including restrictions on dividend payments and executive compensation. The conditions attached to these relief measures make them unattractive except for plan sponsors hardest hit by the pandemic.
While pension plans have held up well so far, many large risks lurk in the fourth quarter, including the U.S. election outcome and potential for protracted disputes and unrest, the impact of the resurgence of the virus on economic activity, and the timing and effectiveness of a vaccine. All these factors could trigger significant volatility in the fourth quarter of 2020 and beyond.
From an investment standpoint, a typical balanced pension portfolio would have posted a return of 3 per cent during the third quarter of 2020, as equity markets trended upwards and bond yields remained roughly unchanged from the second quarter of the year.
“The rally in risk assets continued throughout the first half of the third quarter over supportive monetary policies and signs of a global economic recovery” said Todd Nelson, Partner at Mercer Canada. “However, the recent spike in global COVID-19 cases and the uncertainty around the upcoming U.S. election has unnerved investors, leading to losses in global equity markets in September. Concerns have also resurfaced regarding the possibility of an increase in medium to long-term inflation following the unprecedented monetary and fiscal policy actions in response to the crisis”.
