Defined Benefit plans in good health with opportunity to use surplus, but prepare for risks ahead


Image courtesy Mercer/Getty Images

By Jared Mickall, Mercer Canada

Special to Financial Independence Hub

Since the beginning of the year, Canadians saw the Bank of Canada maintain the overnight rate at 5.00% as inflation eased to be less than the upper end of the Bank of Canada’s inflation-control target of 3%.

Amidst this economic backdrop, Canadians who participate in defined benefit (DB) pension plans may be interested in the financial health of their DB plans.

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 March 29, 2024 the MPHP closed out the year at 118%, an improvement over the quarter from 116% as at December 31, 2023. The solvency ratio is one measure of the financial health of a pension plan.

Throughout Q1, most plans saw positive asset returns coupled with decreased DB liabilities, which resulted in an overall strengthening of solvency ratios. In addition, compared to the beginning of the year, there are more DB pension plans with solvency ratios above 100%.

In other words, Canadians who participate in DB plans are likely to have seen the financial health of their DB pension plans improve over Q1.

Inflation in Canada and interest rates

Canadian inflation eased to 2.9% in January, which is less than the upper end of the Bank of Canada’s inflation-control target of 3%. It is the Bank of Canada’s expectation for inflation to remain close to 3% during the first half of 2024 before gradually easing. On March 6, the Bank of Canada continued its policy of quantitative tightening by maintaining the overnight rate at 5.00%. On March 19, Canadian inflation for February 2024 came in at 2.8%, which ignited industry speculation on the timing and amount of a cut to the overnight rate.

In addition, on April 10, the Bank of Canada announced that it was maintaining the overnight rate at 5.00%. The next scheduled date for announcing the overnight rate target is June 5, 2024.

While the overnight rate remained unchanged during Q1, interest rates on Canadian bonds with longer terms finished the quarter at levels greater than they were at the start of the year. Due to the long-term nature of DB pension plans, long-term interest rates pose a significant risk for many DB pension plans. Monitoring long-term interest rates on Canadian bonds as well as the overnight rate, would be an ongoing focus for DB pension plan stakeholders.

A strategic opportunity arises

For DB pension plans in the enviable position of enjoying a surplus, having an effective strategy for its use should be on the agenda. Contribution holidays, improving benefits or retaining surplus are typical options and their financial impacts should be explored.

When examining the surplus options, it is necessary to review and understand the risks associated with interest rate changes, market volatility, increasing longevity, plan maturity and other risks specific to each DB plan in order for a DB plan to meet its long-term objectives.

On the horizon

In 2024, pension plans should expect the Canadian Association of Pension Supervisory Authorities (CAPSA) to release a new guideline on Pension Plan Risk Management. The most recent draft guideline underwent consultation in 2023. The draft guideline covers risk management frameworks for pensions and includes special considerations on specific topics such as: Third-party (outsourcing) risk, cyber security, Environmental, Social, Governance (ESG), use of leverage, target pension arrangements, and investment risk governance.

An effective surplus strategy would reflect current, and consider the anticipated, risk management guidelines from CAPSA and prepare for adverse financial experience. Applying appropriate governance and risk management processes should set a clear path forward.

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 sizes on all aspects of the management of their pension plans. 


Leave a Reply