Pension Finance Watch – Third Quarter 2024

Results for Canadian defined benefit pension plans

The WTW Pension Index has slightly increased in the third quarter due to positive asset returns, partially offset by an increase in accounting liability measures. The net effect on our benchmark plan was an increase of 0.6% in the WTW Pension Index (from 102.0 to 102.7) for the quarter.

Canadian interest rates

The Bank of Canada lowered its overnight lending rate by 25 bps in July and by a further 25 bps in September, bringing the policy rate down to 4.25% at the end of the quarter. This continues the shift in the central bank’s monetary policy from tightening to easing. The Bank is also continuing its policy of balance sheet normalization. Core inflation, the Bank’s preferred measure, which has been below 3% for several months now averaged around 2 ½%. However, shelter costs is still the biggest contributor to total inflation, though beginning to decelerate. The Consumer Price Index dropped to the Bank’s target of 2% in August and dropped further to 1.6% in September. The US Federal Reserve, for its part, has cut its benchmark interest rate in September for the first time in over 4 years by 50 bps. The Bank’s decision on further rate adjustments will likely depend on the evolution of price pressures in various economic sectors but it would appear as though a quantitative easing cycle is underway in both the US and Canada.

The yield on 30-year Canada treasuries finished the quarter 26 bps lower than it started. Credit spreads decreased slightly during the quarter by 3 bps. The benchmark discount rate determined under the RATE:Link methodology used to determine defined benefit obligations decreased by 30 bps, which combined with the effect of interest accumulation led to an increase in accounting liability measures over the quarter.

Canadian Bond Yields (End of Period)

Investment returns

The third quarter of 2024 saw increase volatility in global equity markets as a brief selloff was followed by a robust recovery. This was primarily driven by a soft-landing sentiment, despite weaker economic activity, as easing inflation and falling interest rates—fuelled by significant accommodative monetary policies from central banks—spurred a strong rally in stocks. The Canadian equity market led the way with a double-digit positive return as it benefited from global sentiment, with a particular uplift in sectors like Real Estate, Financials, Health Care and Utilities, which led the TSX gains. The US equities market had solid mid-single digit gains over the quarter. The S&P 500, led by sectors outside the tech-heavyweights, saw gains as investor confidence was bolstered by lower borrowing costs. The "Magnificent 7" continued to perform well, but there was a noticeable broadening of market gains, with value stocks and smaller companies beginning to catch up. International developed markets, proxied by the MSCI EAFE index, which excludes both the US and Canada, posted a more modest gain (0.8% in local currency terms).

The Canadian dollar strengthened against the US dollar but depreciated against other major currencies, which impacted unhedged Canadian investors differently across their foreign equity investments. While returns on US equities were relatively tempered, investments in international equities saw improved returns during the quarter.

In the Canadian bond market during Q3, the short end of the yield curve saw significant declines (~100 bps). following the Bank of Canada's rate cuts, whereas the longer end experienced a smaller, but still substantial, decrease (~30 to 60 bps). This led to positive returns across all bond segments, with longer-term government bonds gaining more than shorter-term government bonds due to their heightened sensitivity to yield changes. Corporate bonds still managed to gather return notably similar to government bonds for the quarter, benefitting from higher yields but relatively stable credit spreads and shorter duration in a decreasing yield environment.

Asset class returns

The benchmark plan’s 50% equity / 50% fixed income portfolio increased 6.1% for the quarter. The more conservative 30% equity portfolio increased 6.0% for the quarter, and the more aggressive 70% equity portfolio increased 6.2% 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 WTW Pension Index in other countries, the discount rate for our Canadian benchmark plan decreased over the quarter by 30 basis points to 4.66% at September 30, 2024. 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 increased by 5.4% for the quarter, reflecting the combined effect of interest accumulation and the benchmark discount rate change.

The net impact of the increase in accounting liability measures and positive investment returns resulted in a net increase in the WTW Pension Index over the quarter, from 102.0 to 102.7 as at September 30, 2024. 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.

Sources

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. Return to article undo
2. Bloomberg LP. All S&P/TSX Composite indices are registered trademarks of The Toronto Stock Exchange Inc. and Standard & Poor’s Corporation. Return to article undo
3. Bloomberg LP. All S&P indices are registered trademarks of Standard & Poor’s Corporation. Return to article undo
4. Bloomberg LP. All MSCI indices are registered trademarks of Morgan Stanley Capital International Inc. Return to article undo
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. Return to article undo

Authors

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Vladimir Rnjak

Director, Retirement

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Kevin Tighe

Senior Director, Retirement

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