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February 05, 2014
Hot equity markets mean improved pension funding

The robust equity results of 2013 have helped reduce the sizable deficits of many of the largest defined benefit pension plans in Canada and the United States.  

According to the Milliman 100 Pension Funding Index, pension liabilities in the United States decreased in 2013 by $190 billion while plan assets increased by $128 billion, a net gain of $318 billion.  This was the first time since 2007 that deficits declined and assets increased.

Milliman principal and actuary John Ehrhardt says the improvements reported in 2013 have almost wiped out the $337 billion loss recorded during the 2008-09 market crash.

Similar trends were recorded in Canada, with the Mercer pension index of 607 public and private sector pension funds reporting an average funding level of 99.9 per cent.  A year ago, 60 per cent of pension funds in that index had funding levels of less than 80 per cent.  An Aon Hewitt pension index of 275 pension plans reported an average funding level of 93.4 per cent at the end of 2013, an increase of almost 25 per cent from the previous year.

The rally in pension funding follows a strong year in world equity markets.  The United States market led the way with a 41 per cent improvement over 2012.  Canada’s equity gains were a far more modest but still very respectable 12.7 per cent.  Worldwide, equity markets generated average returns of 35.5 per cent, the strongest since the 2008-09 market crash.

Also supporting pension investment funding was the modest growth in government bond yields.  The Government of Canada bond yield rose from a low of 2.37 per cent to 3.28 per cent in 2013.

For many pension plan sponsors, the return to equity market growth is a welcome relief from years of record low interest rates and near-stagnant markets which saw many pension plans slip well below their minimum funding requirements.  As late as July 2013, the Dominion Bond Rating Service warned that aggregate funding levels of the 461 defined benefit pension plans that it reviews had fallen into a “danger zone” below the 80 per cent level.  (See the October 2013 edition of the Coughlin Courier for background.)

With the equity storm of 2008-09 apparently over, the big question for pension plan managers and plan sponsors will be “Where do we go from here?”  Do they continue to build funding ratios to levels exceeding the 100 per cent mark to cushion their plans against the next market downturn?  Or, will they yield to the inevitable temptation that comes with pension surpluses and reduce or take a holiday from their pension contributions?

During the market bubble prior to the 2008-09 crash, many plan sponsors excused themselves from making further pension contributions, leaving their organizations with significant pension funding liabilities when the downturn occurred.

The next year will see if pension funding history repeats itself.

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