Pension Finance Watch – Third Quarter 2023

Results for Canadian defined benefit pension plans

The WTW Pension Index has increased in the third quarter, as a decrease in accounting liability measures was partially offset by negative asset returns. The net effect on our benchmark plan was an increase of 2.9% in the WTW Pension Index (from 96.6 to 99.4) for the quarter.

Canadian Interest Rates

The Bank of Canada increased its overnight lending rate by 0.25% in early July bringing the policy rate to 5.0%. It maintained the rate at this level through the quarter while continuing its policy of quantitative tightening. However, the yield on 30-year Canada treasuries increased during the quarter to finish 72 bps higher than it started, as concerns have increased that interest rates might remain higher for longer than anticipated. Credit spreads stayed relatively flat during the quarter, contracting by only 4 bps. The benchmark discount rate determined under the RATE:Link methodology used to determine defined benefit obligations increased by 75 bps, which combined with the effect of interest accumulation led to a decrease in accounting liability measures over the quarter.

Canadian Bond Yields (End of Period)

Investment Returns

Global equity markets started the quarter on a positive note in July but took a negative turn in August and had a typically difficult September with a sharp rise in yields and oil prices and related concerns about economic growth. Most major global equity markets saw low single digit negative returns for the quarter. Similarly, Canadian equities saw low single digit negative returns (-2.2%), led by the communication sector which posted -12.6% returns. However, with oil prices increasing materially and due to Canada’s high concentration in energy markets (one of the best performing sectors of the quarter, +10.3%), it overperformed against US equities (-3.3%) but still underperformed against international equities (-1.3%), in local currency terms.

The CAD continued to strengthen relative to major global currencies, other than to the USD, leading unhedged Canadian investors to see CAD returns improved on US equity investments but dampened on international equity investments during Q3.

The mid and long parts of the yield curve saw sharp increases during the quarter, leading to negative returns in major Canadian bond indices. With the increase in yields, long term bonds were most negatively impacted over the quarter.

While all bonds saw negative returns for the quarter, due to their higher yields and shorter duration corporate bonds outperformed relative to government bonds, in a stable credit spreads and rising yield environment.

Asset Class Returns

The benchmark plan’s 50% equity / 50% fixed income portfolio decreased 5.5% for the quarter. The more conservative 30% equity portfolio decreased 7.1% for the quarter, and the more aggressive 70% equity portfolio decreased 3.9% for the third quarter.

Pension plan liabilities under Canadian, International and U.S. accounting standards are measured using a discount rate based on yields available on high-quality corporate bonds as of the measurement date. Using the same RATE:Link methodology as we use for the WTW Pension Index in other countries, the discount rate for our benchmark plan increased over the quarter by 75 basis points to 5.63% at September 30, 2023. Among other factors, the selected discount rate depends on projected plan cash flows, the bond data and the methodology utilized for constructing the yield curve. The RATE:Link approach represents one possible methodology; other acceptable methodologies may result in higher or lower discount rates, and consequently lower or higher plan liabilities.

WTW tracks the monthly change in its Pension Index in a series that dates to December 31, 2000. Like bond prices, pension liability values move in the opposite direction to interest rates. The WTW Pension Liability Index decreased by 8.2% for the quarter, reflecting the combined effect of interest accumulation and the benchmark discount rate change.

The decrease in accounting liability measures were partially offset by negative investment returns resulting in a net increase in the WTW Pension Index over the quarter, from 96.6 to 99.4 as at September 30, 2023. The change in the WTW Pension Index does not reflect any contributions made to reduce the size of any deficit or any contribution holiday taken on account of any surplus.

Canadian Pension Index Results

A Note to our Readers

This publication tracks the asset/liability performance of a hypothetical Canadian benchmark pension plan, based on a 50/50 asset mix and a typical liability profile. The index is not intended to represent an average funded ratio. Rather, the intent is to provide plan sponsors with a consistent and relevant measure to serve as a general indicator of the effects of capital market events on pension plan financing.

Definition of terms

Bond yields

• The 30-year Canada semi-annual bond yield reflects the yield on the actively-traded Government of Canada bond maturing in 30 years.
• The 10-year Canada semi-annual bond yield reflects the yield on the actively-traded Government of Canada bond maturing in 10 years.
• The 91-day T-Bill semi-annual yield refers to the yield on Government of Canada treasury bills which mature in 91 days.
• The FTSE Corporate semi-annual bond yield reflects the yield on the FTSE Corporate Bond Index composed of corporate bonds with varying maturity.

Asset class returns

• Total return incorporates the combined effect of price changes and interest or dividend income. This will typically differ from the daily results published in financial journals, which are based only on price changes.
• S&P/TSX Composite refers to the “S&P/TSX Composite Index”, which tracks larger companies in the Canadian market.
• S&P 500 refers to the “S&P 500 Index”, which tracks the largest 500 companies in the U.S. based on the market value of their equity. Total return is reported in terms of the Canadian dollar and therefore includes the effect of currency changes.
• MSCI EAFE refers to the “Morgan Stanley Capital International Europe, Australasia, Far East Index” of equity securities. Total return is reported in terms of the Canadian dollar and therefore includes the effect of currency changes.
• 91-Day T-bill returns are based on the “FTSE 91-day Treasury Bill Index”.
• FTSE Universe Bonds refers to the “FTSE Universe Bond Total Return Index” for government and corporate bonds of all maturities in excess of one year.
• FTSE Long Bonds refers to the “FTSE Long Term Bond Total Return Index” for government and corporate bonds with maturities in excess of 10 years.

Portfolio returns

• The WTW Pension Index 50% / 50% portfolio return is based on a diversified portfolio of 50% equity (10% Canadian, 20% U.S. and 20% MSCI EAFE) and 50% fixed income (FTSE Long Bonds).
• The 30% and 70% equity portfolios are constructed with similar composition within their equity and fixed income components.

Benchmark discount rate

• The discount rate is determined each month for this benchmark pension plan based on observed yields for high-quality corporate bonds and the benchmark plan's projected cash flows. Higher or lower discount rates may be more appropriate for other plans with different expected cash flows.⁵ Furthermore, a variety of methodologies may be used to interpret the data available on long-term Canadian corporate bonds. This calculation uses the same RATE:Link methodology as we use for the WTW Pension Index in other countries. Other acceptable methodologies may result in higher or lower discount rates, depending on market conditions.

WTW Pension Liability Index

• The Pension Liability Index tracks the change in the benchmark plan’s obligations due to the accumulation of interest and changes in financial assumptions. For this purpose, the obligations are measured based on the requirements of U.S. and International accounting standards.⁵
• Contributions are set equal to the level of benefit payments for the benchmark plan.

WTW Pension Index

• The WTW Pension Index is the ratio of market value of assets to accounting obligations for the benchmark plan. Assets change from month to month based on the investment performance of the 50% / 50% portfolio, assumed contributions and benefit payments. Liabilities change from month to month due to accumulated service cost and interest, benefit payments and the effects of any other changes in the WTW Pension Liability Index. The WTW Pension Index is an accounting measure, not a funding measure. As such, it is not appropriate to consider this as a measure of a pension plan’s funding, which is based on statutory requirements.

About This Report

This report reviews how capital market performance affected Canadian defined benefit pension plans, with a focus on linked asset/liability results. Specific plan results depend on liability characteristics, portfolio composition and actual investment results, among other factors.

¹ Regulations on COVID-19 vaccine and testing requirements issuedInformation prior to June 2015 and FTSE Corporate bond yield provided by FTSE Global Debt Capital Markets Inc. Copyright © FTSE Global Debt Capital Markets Inc. All rights reserved. The information contained herein may not be redistributed, sold or modified or used to create any derivative work without the prior written consent of FTSE Global Debt Capital Markets Inc. Effective June 2015, Canada 10 and 30 year yield were obtained from the Bank of Canada; the 91-day T-bill yield was obtained from Scotiabank.

² Source: Bloomberg LP. All S&P/TSX Composite indices are registered trademarks of The Toronto Stock Exchange Inc. and Standard & Poor’s Corporation.

³ Source: Bloomberg LP. All S&P indices are registered trademarks of Standard & Poor’s Corporation.

⁴ Bloomberg LP. All MSCI indices are registered trademarks of Morgan Stanley Capital International Inc..

⁵ The discount rate assumption is adjusted to reflect changes in market interest rates. Our benchmark plan is a traditional final-pay pension plan with approximately half of the liabilities in respect of active employees and half of the liabilities in respect of terminated vested and retired employees. Plans with different designs or demographic characteristics will see different results in terms of both the level of appropriate discount rate and the plan’s response to changes in financial assumptions.

Authors

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Vladimir Rnjak

Director, Retirement

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Kevin Tighe

Senior Director, Retirement

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