Higher long-term interest rates drive improvement in pension solvency in 2013

TORONTO – Consulting firm Mercer says the average solvency ratio of pension plans improved during the second quarter of 2013, thanks to an increase in long-term bond yields in the last two weeks.

Mercer’s Pension Health Index stood at 94 per cent on June 30, up from 82 per cent at the start of the year.

Mercer says during the first five months of the year, pension funds also saw strong returns on equity, especially in foreign markets.

Although stock markets started to pull back in June, rising long-term interest rates helped pension plan solvency continue to improve.

Long-term interest rates are used to calculate the amount of money a pension plan needs to pay benefits. Low rates in recent years have forced many plans into a deficit position, while the recent rise has reduced that pressure.

“While interest rates have moved up dramatically in the last few weeks, it is not clear whether this is the start of a trend or a temporary blip,” said Manuel Monteiro, partner in Mercer’s financial strategy group.

The Mercer Pension Health Index shows the ratio of assets to liabilities for a model pension plan with valuations filed on a calendar-year basis.

Pension plans should consider decreasing their exposure to risk, said Monteiro.

“Most plan sponsors are taking significant interest rate and equity risk,” said Monteiro.

“Continuing to take this risk may make sense for sponsors who are convinced that long-term interest rates will continue to surge upwards and that equity markets will perform. However, as pension plans approach a fully funded status, the sponsor’s potential reward for continuing to take these risks diminishes.”