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Announcement:

Moody's: Higher leverage due to low interest rate environment raises risk for Canadian pension funds

Global Credit Research - 03 Oct 2017

Toronto, October 03, 2017 -- The exceptional credit quality of Canadian public pension funds is based on several key factors including highly-rated sponsors, high stability and predictability of future cash flows, predictable national and provincial legal systems and strong coverage of obligations by high quality liquid assets, Moody's Investors Service says in a new report. However, high leverage and less-liquid investments raises risks for pension funds.

"As in many other countries, Canadian defined benefit pension plans are facing adverse demographic shifts thanks in part to an aging baby boomer population," Jason Mercer, a Moody's Assistant Vice President says. "The active-to-retired ratio, a measure of the relative proportion of contributing members to retirees collecting benefits, has fallen for all six pension managers in the past 10 years as growth in retirees outpaces contributors."

In the absence of strong investment returns, higher contributions or reduced benefits, a lower active-to-retired ratio reduces a pension plan's funding ratio and increases the liquidity requirements of the plan. Net contributions for most pension managers have shrunk in the past few years as the relative proportion of retirees increase.

"Weaker net cash flows make funds more dependent on market performance to maintain current funding levels, but low interest rates hinder the funds ability to make returns strong enough to offset the net cash flow pressures," says Mercer.

Moody's says funds that increase leverage and illiquid assets to ensure they can generate returns sufficiently high enough to mitigate the funding pressures from aging demographics and low interest rates also increase the pension fund's asset risk in the event of a market correction.

Pension managers facing cash flow pressures as a consequence of the low interest rate environment have adapted by combining scale, leverage and investment strategies. Through a mix of investment returns, increasing leverage and member contributions, Canadian pension funds have substantially increased their scale; and are among the largest pension managers globally.

Between 2011 and 2016, the combined assets of the six largest Canadian pension managers nearly doubled to almost CAD1.4 trillion. Investment income has been the largest contributor to this asset growth, with a combined earnings contribution of over CAD400 billion in the past five years.

The average leverage of the largest six funds has increased to 24% from 19% since 2009. This strategy entails higher risks for pension managers since leverage magnifies not only gains, but also losses.

The report "Canada - Public Pension Managers: Aging population, low interest rates drive higher investment risk, a credit negative," is available to Moody's subscribers at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1057573.

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NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: New York +1-212-553-0376, London +44-20-7772-5456, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Jason Mercer
Asst Vice President - Analyst
Financial Institutions Group
Moody's Canada Inc.
70 York Street
Suite 1400
Toronto, ON M5J 1S9
Canada
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Robert M. Callagy
Senior Vice President
Financial Institutions Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Canada Inc.
70 York Street
Suite 1400
Toronto, ON M5J 1S9
Canada
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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