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Article | Canada Pension Finance Watch

Pension Finance Watch – Second Quarter 2020

Investments|Retirement
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By Vladimir Rnjak and Kevin Tighe | July 27, 2020

Results for Canadian Defined Benefit Pension Plans.

Updates to the Pension Index

The asset mix underlying the Willis Towers Watson Pension Index was changed to be more representative of the typical asset mixes of pension plans in Canada. A comparison of the two mixes was included in the Pension Finance Watch for Q1 2020.

Results for Canadian Defined Benefit Pension Plans

The Willis Towers Watson Pension Index has decreased in the second quarter as falling discount rates were offset somewhat by positive investment returns. The net effect on our benchmark plan was a decrease of 5.3% in the Willis Towers Watson Pension Index (from 76.0 to 72.0) for the quarter.

Willis Towers Watson Pension Index

Willis Towers Watson Pension Index chart showing from 2000 to present.
Willis Towers Watson Pension Index chart showing from 2000 to present

Canadian Interest Rates

The Bank of Canada has maintained its benchmark interest rate steady at 0.25% throughout Q2 after cutting the rate twice in Q1 in an effort to combat the economic impact of COVID-19. The yield on 30-year Canada treasuries started the quarter with small fluctuations before starting its steady decline in Mid-April and ended the quarter at 0.99%. Similarly, the 91-day T-bill rate saw a decrease during the quarter, falling by 5 bps. With the easing of COVID-19 lockdowns and optimism about an economic recovery we saw a decrease in credit spreads. As a result, the benchmark discount rate determined under the RATE:Link methodology used to determine defined benefit obligations decreased by 103 bps, leading to a significant increase in accounting liability measures over the quarter.

Key Bond Yields (at end of month)

Key bond yields chart showing from 2000 to present.
Key bond yields chart showing from 2000 to present

Canadian Bond Yields (End of Period)
Bond yields for end of June 2020, end of March 2020 and end of June 2019

1) Information 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.

Jun. 2020 Mar. 2020 Jun. 2019
Canada Treasuries(1)
30-year 0.99 1.32 1.68
10-year 0.52 0.71 1.46
91-day T-bill 0.20 0.25 1.66
Corporate Bonds(1)
FTSE 2.12 3.24 2.69
Benchmark Discount Rate 2.51 3.54 2.96

Investment Returns

During Q1 the world was surprised by a global pandemic which resulted in unprecedent declines in equity markets across the globe. This forced countries to take drastic lockdown measures and implement social distancing rules which seems to have flattened the infection curve for now. The negative impact on the economy from lockdowns led many countries, including the US Federal Reserve, European Central Bank, Bank of Canada and others, to implement asset purchase programs to support the economy and financial system. Governments fiscal and monetary stimulus measures and optimism from investors of a turnaround spurred a sharp reversal during Q2 with most major equity markets, lead by the US, posting double digit returns for the quarter. With the rebound in oil prices we saw a strengthening in the CAD which, for unhedged Canadian investors, deceased CAD returns on US and international equity investments.

Corporate and government bonds saw positive returns over the quarter due to decreasing yields on government bonds and narrowing of credit spreads.

Asset Class Returns
Return rates for the last quarter, year-to-date and the last 12 months

2) Bloomberg LP. All S&P/TSX Composite indices are registered trademarks of The Toronto Stock Exchange Inc. and Standard & Poor’s Corporation.
3) 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

Q2 2020 YTD Last 12 months
Stock Returns
Canadian Equities – S&P/TSX Composite (2) 17.0% -7.5% -2.2%
U.S. Equities – S&P 500 (Canadian dollars) (3) 15.7% 1.7% 11.8%
Non-North American Equities – MSCI EAFE (Canadian dollars) (4) 10.3% -7.0% -1.3%
Canadian Fixed Income Returns
91-day T-Bills 0.1% 0.8% 1.6%
FTSE Universe Bonds 5.9% 7.5% 7.9%
FTSE Long Bonds 11.2% 11.4% 12.0%

The benchmark plan’s 50% equity / 50% fixed income portfolio increased 12.5% for the quarter. The more conservative 30% equity portfolio increased 12.0% for the quarter, and the more aggressive 70% equity portfolio increased 13.0% for the 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 Willis Towers Watson Pension Index in other countries, the discount rate for our benchmark plan decreased over the quarter by 103 basis points to 2.51% at June 30, 2020. 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.

Willis Towers Watson 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 Willis Towers Watson Pension Liability Index increased by 18.8% for the quarter, reflecting the combined effect of interest accumulation and the discount rate change.

The impact of the decrease in the liability discount rate together with the positive investment returns resulted in a net decrease in the Willis Towers Watson Pension Index over the quarter, from 76.0 to 72.0 as at June 30, 2020. The change in the Willis Towers Watson 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
Results for the last quarter, year-to-date and the last 12 months
Q2 2020 YTD Last 12 Months
Portfolio Returns
30% Stocks/70% Fixed Income 12.0% 6.8% 9.6%
50% Stocks/50% Fixed Income 12.5% 3.8% 8.0%
70% Stocks/30% Fixed Income 13.0% 0.8% 6.3%
Benchmark Plan Liability Results
Change in Pension Liability Index 18.8% 10.7% 10.8%
Percentage Change in Pension Index -5.3% -6.3% -2.5%

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 Willis Towers Watson 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 Willis Towers Watson Pension Index in other countries. Other acceptable methodologies may result in higher or lower discount rates, depending on market conditions.

Willis Towers Watson 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.

Willis Towers Watson Pension Index

  • The Willis Towers Watson 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 Willis Towers Watson Pension Liability Index. The Willis Towers Watson 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.
  • 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.

    About this report

    This report reviews how capital and equity 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.

    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.

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Authors

Director, Retirement

Senior Director, Retirement

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