No marked improvement in solvency status despite decent market returns
TORONTO, April 11, 2012 – Despite the strong rally of equity markets in the first quarter of 2012 the financial status of pension plans has improved only slightly, according to Aon Hewitt, the global human resource solutions business of Aon plc (NYSE:AON). The median pension solvency funded ratio of a large sample of pension plans has increased from 68% at the end of 2011 to only 69% at the end of March, 2012. About 97% of pension plans in this sample had a solvency deficiency as at that date. The solvency funded ratio measures the financial health of a defined benefit pension plan by comparing the amount of assets to total pension liabilities in the event of a plan termination.
A typical pension fund earned an average return of 3.6% in this first quarter, made possible by good equity markets performance: 4.4% for the Canadian stock exchange, 10.5% (in Canadian dollars) for U.S. equities and 8.9% (in Canadian dollars) for international equities.
“The interest rates used in a March 31, 2012 solvency liability calculation are broadly comparable to the interest rates at the end of 2011,” reports Thomas Ault, an Associate Partner and actuary with Aon Hewitt in Vancouver. “Interest rates are still at historically low levels, which mean solvency liabilities remain very high”.
Impact of de-risking
“The results of the 1st quarter underscore the importance of assessing defined benefit pension plan performance in an asset-liability framework, as good asset performance was overshadowed by increased liabilities,” says Andr� Choquet, an investment consultant and actuary with Aon Hewitt in Toronto. “By thinking about plan assets as either liability-hedging or return seeking assets, plan sponsors can better manage the risk inherent in each component.
“For example, pension plans typically invest in universe bonds, with terms of mainly between five and ten years. Switching to long bonds, with maturities between 10 and 30 years will more closely match the plan’s liabilities cash flows and helps assets and liabilities behave in tandem when interest rates fluctuate.”
Aon Hewitt analyzed the performance of a plan employing a few simple de-risking strategies since the end of 2010 namely:
- Increased investment in bonds from 40 per cent to 60 per cent of portfolio
- Invested in long bonds instead of universe bonds.
This plan would have experienced a 78% solvency ratio as at March 31, 2012 as opposed to 69% for a typical plan.
Considerations in a low interest rate environment
Many pension plan sponsors are avoiding making the switch from Universe to Long Bonds, partly because of the prevailing low interest rates. This is because sponsors who are invested in shorter duration bonds may see a more dramatic improvement in their funded position (relative to sponsors who invest in longer duration bonds) if interest rates were to increase above their current levels.
For sponsors with this perspective, it is more important than ever to establish a formal risk strategy for the hedge fund portfolio, so that an appropriate and measured amount of risk is taken within their pension plan. This may mean introducing a strategy to switch from Universe to Long bonds if interest rates hit pre-determined levels.
“Given these first quarter results, we expect to see more clients moving towards de-risking strategies in the months ahead,” said Ault.
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About Aon Hewitt
Aon Hewitt is the global leader in human capital consulting and outsourcing solutions. The company partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. For more information on Aon Hewitt, please visit www.aonhewitt.com/canada
Aon plc (NYSE: AON) is the leading global provider of risk management, insurance and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 61,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative and effective risk and people solutions and through industry-leading global resources and technical expertise. Aon has been named repeatedly as the world’s best broker, best insurance intermediary, reinsurance intermediary, captives manager and best employee benefits consulting firm by multiple industry sources. Visit www.aon.com for more information on Aon and www.aon.com/manchesterunited to learn about Aon’s global partnership and shirt sponsorship with Manchester United.