Posted By 
By Jared Mickall, Mercer Canada
Special to Financial Independence Hub
Canadians have faced cost pressures in many facets of their daily lives, including housing costs, food and gas prices, and insurance premiums to name a few. At the same time, Canadians may be thinking about how inflation and volatile interest rates may have impacted their retirement savings over Q4.
Canadians that participate in defined benefit (DB) pension plans are likely to have seen the financial health of their DB pension plans weaken in Q4, but show an overall improvement over the whole of 2023. DB pension plans that used fixed income leverage may have experienced stable or improved solvency ratios over the quarter.
The Mercer Pension Health Pulse (MPHP) is a measure that tracks the median solvency ratio of the defined benefit (DB) pension plans in Mercer’s pension database. At December 31, 2023 the MPHP closed out the year at 116%, which is a decline over the quarter from 125% as at September 30, 2023, but an improvement from 113% at the beginning of the year. The solvency ratio is one measure of the financial health of a pension plan.
In the final quarter, plans saw positive asset returns, but these returns were not enough to offset an increase in DB liabilities due to a decline in bond yields. While we saw a decline in the financial health of DB pension plans over Q4, it improved over the whole of 2023. In addition, compared to the beginning of year, there are more DB pension plans with solvency ratios above 100%.
Canadian inflation and interest rates
Canadian inflation came down over 2023 and is approaching the upper end of the Bank of Canada’s inflation-control target of 3%. General views are that inflation will continue to decline in 2024 and reach the policy target of 2% in 2025. In 2023 the Bank of Canada increased the overnight rate to 5.00% from 4.25%, which was a continuation of increases that commenced in 2022, to mitigate inflation and to balance against the risk of a recession.
However, DB pension plan benefits are accumulated and paid over periods that are significantly longer than the overnight rate. Interest rates on Canadian bonds with longer terms were volatile throughout the year and finished at lower levels than at the start of the year. It’s unclear whether the interest rates that apply to DB pension plans will stabilize in 2024, and if so, at what level. As such, interest rates continue to pose a significant risk for many DB pension plans.
Outside of Canada
Canadian pension plans are also exposed to global economies which continue to see elevated levels of inflation and risks of recession. Central banks across the world are actively managing inflation with monetary policies. While governments, corporations and households in those regions may continue to adjust to their inflation and interest rate environments, the effect of interest rate changes to an economy is usually delayed. As such, central banks will need to monitor the effects of their policy changes to manage their economies and avoid recession.
Further, geopolitical tensions continue to be elevated which can impact global trade, fragment global supply chains, and disrupt the global economy.
The next steps of a long journey
The recent improvements in the solvency ratios of Canadian DB pension plans came after many years of declining interest rates, increases to contribution requirements and, in some cases, changes to benefits. Members of Canadian DB pension plans, and DB plan sponsors, will be keen to maintain solvency ratios above 100%. To achieve this, Canadian DB pension plans will need to continue to be vigilant in the financial management of their plans through appropriate governance and risk management processes. We expect that the role of artificial intelligence as part of pension plan risk management will be explored in 2024.
Jared Mickall is a pension actuary and is a Principal with Mercer Canada. He leads Mercer’s Wealth practice in Winnipeg and is working as client manager, strategic consultant and actuary for organizations of all size on all aspects of the management of their pension plans.
