Volatility and liability simmer beneath modestly positive solvency numbers last quarter, according to Mercer report
The latest Mercer Pension Health Pulse (MPHP) found that the median solvency ratio for Canadian defined benefit (DB) pension plans had increased from 121 per cent to 122 per cent between June 28th and September 30th of this year. Positive returns offset the increase in DB liabilities caused by falling rates, while the number of plans with solvency ratios above 100 per cent increased through Q3. On the surface, it’s a positive report that shows a healthy DB environment in Canada.
Jared Mickall, however, believes there are causes for some concern and reassessment underneath those topline numbers. Mickall is the principal and leader of Mercer’s wealth practice in Winnipeg, and he spoke with BPM highlighting the degree of volatility that strong asset performance at the end of Q3 covered up. He notes, as well, that new CAP guidelines — while aimed at the defined contribution space — may hold lessons about risk management for DB plans. He believes there is a moment now for plan sponsors to assess how their plans are being managed while solvency remains strong.
“You see a slight improvement, and this seems to illustrate stability, however there was volatility,” Mickall says. “We saw interest rates decrease and markets reacted. As interest rates at longer durations decrease, liabilities for pension plans go up. We would have expected that would be a pull down on solvency ratios, but what also happened was a positive asset returns in general for most asset classes.”
Canadian and global equities led those positive asset returns. US currency conversions as well as the appreciation on bond prices as rates fell also contributed to total returns. While positive, many of those equity returns were themselves highly volatile within the quarter. A big uptick in the last few weeks of September helped cover that volatility — however — and meant the line between the ends of Q2 and Q3 appears deceptively smooth.
Mickall sees in the underlying volatility a note of caution for DB plan sponsors. The quarter should serve to remind them that liabilities can rise in a falling rate cycle and if we don’t see an equity pickup in these falling rate periods, there could be a significant impact to plan solvency.
Mickall argues, too, that plan sponsors need to take a close look at the risks for their DB plans going forward. He highlights the new guideline number 10 in the recently released CAPSA guidelines. That guideline emphasizes the important of identifying, evaluating, and actively managing risks related to governance, administration, investments, funding and benefit adequacy.
“If your plan is in a financially healthy state, it's a bit of a comfortable time to realize we're not under massive financial pressure and we can think think about anticipating more,” Mickall says. “Now you can sit back and strategically take the time to understand, Okay, what if these risks happen? How exposed are we, and is this an opportunity for a for, maybe for us to recalibrate.”
Within those risk categories are somewhat more novel areas such as cybersecurity risks, which could have a severe outcome for DB plans if managed poorly. There are also the traditional risk areas like financial risk, investment risk, and the potential for an asset-liability mismatch. DB plans indexed to a metric like inflation may need to assess how to manage that risk as well.
Longevity continues to be a rising source of risk for DB and DC plans. Guideline number 10 even outlines the likelihood that in a DC plan, if a member doesn’t purchase an annuity they may very well live beyond their savings from the plan. While DB plans exist in a different context, the risks associated with longevity continue to pose issues for plan sponsors to manage.
Looking at the broad positivity of the report and the risks identified in underlying numbers, Mickall emphasizes the importance of individual plans assessing and making strategic decisions based on their particular circumstances. He drives home the point that proactivity is key to success, especially in times when things still look relatively strong.
“Monitoring the funding for your plan specifically is really key to understanding how this goes forward and whether the decisions that you made three months ago or a year ago are still valid,” Mickall says. “You should proactively take a look at that to make sure you are still comfortable today with those decisions. And you may still come with the same conclusion, or you may decide differently based upon some analysis as things that things evolve.”
