By Joel Kranc

Markets and the overall economy in 2022 were volatile at best, hampered by declines, generationally high inflation, a tight labor market and supply chain issues. But despite that uncertainty, Defined Benefit (DB) pension plans in Canada ended the year on a high note and entered 2023 on the same path.

Two separate reports point to this fact. The Mercer Pension Health Pulse, says that DB plans finished the year 113%, up from 108% at September 2022 and up from 103% at the beginning of last year. Separately, AON says the aggregate funded ratio for Canadian pension plans in the S&P/TSX Composite Index increased from 96.9% to 100.8% during the past 12 months, according to their Aon Pension Risk Tracker. It was at 98.7% at the end of Q3.

“The significant increase in interest rates is the biggest story because it offset the losses in terms of the equity and some of the alternatives markets,” says Nathan LaPierre, partner, Wealth Solutions at Aon. “So the increase in interest rates has either helped keep the funds really healthy or, for a lot of organizations, improved ratios.”

He adds that, many plan sponsors would not have gone to full interest rate hedging not because they were anticipating increases in 2022 as a single event, but anticipating more of a possibility of an increase as opposed to a decrease.

While Ben Ukonga, principal and leader of Mercer’s Wealth business in Calgary, agrees that 2023 is off to a promising start, the actual situation is more complex.  “The financial positions of most DB plans, when measured on a solvency basis, will be higher at the beginning of 2023 than they were at the beginning of 2022,” he says. “However, when measured on a going-concern basis, the story may be different. In addition, for plans that use leverage on the fixed income component of their asset mix and also invest in equities, the financial positions of those plans would have likely decreased.”

In 2023, LaPierre says DB plan sponsors will likely take advantage of their positions and gains. “They’ be thinking, ‘should they be looking at revisiting their strategies to lock in some of those gains?’ In other words, de-risk the assets, hedge out more interest rate risk; remove risks from equities so that they can try to perhaps prepare for a recession if it’s coming – by safeguarding their funding ratios.

De-risking could mean moving more assets into fixed income or longer duration investments, says LaPierre. “If they want to remove some of the liabilities from their books it would be annuity purchases from insurance companies.”

Inflation, despite being down somewhat at the beginning of 2023, is still very high by conventional standards.

“With continued high inflation, capital market headwinds, and geopolitical tensions, 2023 could turn out just as volatile as 2022,” explains Ukonga. “As such, plan sponsors should ensure they understand and are comfortable with the risks their plans are exposed to, and if they are not, should take steps now to manage these risks.”

Employers will need to manage it in terms of wage expectations and borrowing costs. However, it is no longer the unknown it was in 2022. “There’s the past story of 2022, which is the inflation story, which the [Ukraine] war exacerbated, but going into the future [investment strategy] is more about the uncertainty,” says LaPierre.

And while inflation, and its interest rate increase after effect, have helped DB plans’ funding ratios, it can be difficult for plans with no automatic cost of living adjustments, who now see pressures to change and provide those cost of living adjustments. “I think plan sponsors will be hearing from their retiree groups asking about some sort of inflation adjustment,” adds LaPierre.

It should be noted that similar events are occurring in the U.S. pension market as well. MetLife Investment Management says the average U.S. corporate pension funded status rose to 106.3%, the highest level in the last 10 years. How this plays out on both sides of the border will mainly depend on the rate of inflation throughout the year and if markets will settle from the uncertainties of 2022.