Canada: Alberta/British Columbia Joint Expert Panel On Pension Standards Report - Part 2

III. FUNDING AND BENEFIT SECURITY

Defined Benefit Funding Rules

Recommendation 8.1.1-A Pension standards should continue to require both solvency and going-concern valuations, with reasonable requirements that protect benefit security while not being overly onerous for sponsors, as further described below:

Going-concern funding requirements

Recommendation 8.1.1-B Current going-concern funding rules should continue to apply and be determined by the plan actuary and the plan sponsor, based on the plan's funding policy (see also Section 7.1 "Governance standards" above), actuarial standards of practice and regulatory requirements.

Solvency funding requirements

Recommendation 8.1.1-C Solvency funding rules should be developed on the following bases:

• Asset valuations should be based on pure market measures (with no smoothing of assets).

• Liability valuations should be prepared on a pure wind-up basis, assuming annuity purchases for persons receiving or eligible for immediate pensions and termination (commuted) values otherwise. Benefits provided at the discretion of the administrator/trustee/plan sponsor should not be included in the valuation.

• Assumptions should be based on the actuarial standards for calculating commuted values that would be adopted in the legislation. (See also Recommendation 6.1-G above.) No additional margins or provisions for adverse deviation (PfADs) should be required, other than those already implicit in the commuted value.

• Amortization of any solvency deficiency should continue to be over five years; however, assets to satisfy the deficiency could include letters of credit or assets in a PSF. (See Recommendations 8.1.2-A and 8.1.2-C below.)

• Solvency valuations should be required annually unless, at any valuation, plan solvency was 110 percent or greater, in which case the next valuation would not be required for three years.

Ownership and Use of Surplus

Pension Security Funds

Recommendation 8.1.2-A Pension standards legislation should permit the establishment of a "pension security fund" (PSF) that would be separate from but complementary to the regular pension fund, on the following bases:

• Contributions required to meet going-concern funding
• obligations should be forwarded to the regular pension fund as under current practice.

• Contributions required to meet solvency obligations over and above the going-concern obligations could be forwarded to the PSF.

• The PSF could also hold voluntary sponsor contributions greater than those required to meet solvency obligations, to assist in managing contribution volatility.

• The PSF could be structured as a trust, insurance contract or other financial funding medium acceptable under the federal Income Tax Act. (See Section 10.1 "Income tax rules" below.)

• The governments should consult with the CIA regarding detailed rules on PSFs (including certification requirements and frequency of valuations).

Contribution holidays/surplus withdrawals – regular fund

Recommendation 8.1.2-B Contribution holidays in relation to, and surplus withdrawals from the regular pension fund would be permitted, on the following bases:

• Contribution holidays should be permitted unless explicitly prohibited in the plan terms.

• Surplus withdrawal from the regular fund should continue to be permitted subject to regulator consent and only if the plan permits it or the members consent.

• Contribution holidays and surplus withdrawals should be restricted to ensure that they do not reduce surplus assets to less than five percent of the value of the liabilities as of the most recent review date.

• The financial position of the plan should be required to be updated (based on changes in interest rates and actual investment returns) before the withdrawal can be made or the contribution holiday can commence.

• Both contribution holidays and surplus withdrawals should be required to be spread over five years (20 percent of the excess per year).

• For the holiday or the withdrawal to continue after the first year, the financial position of the plan, the calculation of the five percent buffer and the amount of the surplus available should be required to be updated annually in a similar manner.

• Where a PSF had been established, a contribution holiday should be permitted in the regular pension fund:

• to the extent that funds are in excess of going-concern requirements; and

• as long as the sum of the regular pension fund plus the PSF (after the contribution holiday) exceeds the funds needed under the solvency valuation based on a 105 percent threshold.

See Section 10.1 for recommendations relating to income tax limits on surplus assets.

Letters of credit

Recommendation 8.1.2-C Letters of credit should continue to be permitted for use in securing solvency deficiency obligations.

Legacy surplus issues

Recommendation 8.1.2-D Plans with "legacy" surplus issues should be permitted to "ring-fence" such issues by allowing the older plans to be frozen and new plans to be established with clear contractual provisions relating to surplus issues to "wrap around" the frozen plan, on the following bases:

• The terms and conditions of the new plan with respect to surplus use and withdrawal should be subject to contract law.

• The existing plans, whose surplus use and withdrawal rules were governed by trust law, should be permitted to be closed to new entrants and frozen with respect to accruals of further service and recognition of salary increases.

• Recognition of vesting and other entitlements in the old plan should be required for the purpose of establishing benefit entitlements in the new plan, and vice versa.

• Benefits in the new plan should include recognition of salary increases with respect to service accrued in the frozen plan.

• There should be no requirement to wind up the "legacy" plan, but rather it would continue and form part of the members' ultimate benefits from the two combined plans, continuing to pay out benefits until all liabilities are discharged.

Utilization o fPlan Assets

General rules

Recommendation 8.1.3-A The governments should adopt the following principles in the legislation for asset utilization:

• Established property rights to surplus that is in a plan at termination should not be tampered with.

• At all times if a pension plan sponsor and members want to define their "deal" regarding surplus ownership and utilization in some other fashion, they should not be precluded from doing so.

• Surplus in an ongoing plan should be available to the plan sponsor for contribution holidays unless the plan explicitly prohibits it.

• Withdrawal of surplus by the plan sponsor should take place only if the plan permits it or the employees agree; the withdrawal should be subject to regulator approval.

• Surplus in new "wrap-around" plans and in PSFs should be dealt with as described in the Recommendations under Section 8.1.2 above.

The governments should build upon these principles as the body of common law evolves with subsequent court decisions.

Partial plan terminations

Recommendation 8.1.3-B The following rules should apply with respect to surplus use and distribution on partial plan terminations:

• Vesting of benefits should be automatic for all members affected by a partial termination but vesting should not include a right to surplus assets unless the plan specifically provides for it.

• Partial terminations should continue to be required, subject to the criteria in the current legislation (termination of an identifiable group, etc.).

• Administrators should be required to notify the regulator of a plan termination rather than being required to file a special report; the actuary of a DB plan should also report the event on a subsequent regular valuation.

Plan mergers and divisions

Recommendation 8.1.3-C The following rules should apply to plan mergers and divisions:

• A plan should be permitted, but not required, to transfer a proportion of the surplus equal to the ratio of the liabilities for the transferred members to the total of the plan's liabilities.

• The money transferred into the transferee plan should be allowed to be used according to the terms of the new plan.

Plan expenses

Recommendation 8.1.3-D Plan expenses should be payable from the plan fund unless the plan text specifically provides otherwise. This default rule would supplement the current standard requiring all plan texts to contain a provision indicating how plan expenses will be paid. It would address problems in old plans with unclear or nonexistent wording.

DB/DC contribution holidays

Recommendation 8.1.3-F Where a plan has been converted from DB to DC leaving a legacy DB provision in place within the plan, surplus arising with respect to the DB provision should be available for employer contribution holidays in the DC portion of the plan as long as the DB and DC segments are part of the same trust (to the extent that the plan assets are subject to a trust).

Specified Contribution Target Benefit Plans (SCTB)

Funding rules for SCTBs

Recommendation 8.2.1-A A new category should be created in the pension legislation for funding and disclosure for single and multi-employer plans with similar characteristics, called specified contribution target benefit plans. The essential characteristics of such a plan are:

• Contributions are limited to specified employer and employee contributions ("specified" by the parties to the deal, whether through a collective bargaining agreement or another method).

• Employer(s) are limited in their liability to providing the specified contributions.

• There is a formula benefit set out in the plan document but it is subject to reduction if funding is not sufficient and can therefore be considered a target benefit.

Recommendation 8.2.1-B There should be a single funding test for the purpose of setting minimum funding standards. It should be a "going-concern plus" test:

• Going-concern liabilities should be estimated using "best estimates" of long-term going-concern assumptions, following generally accepted actuarial practice.

• The actuary should have to demonstrate that the plan has an appropriate PfAD. The variables at issue could include, but not necessarily be limited to:

• distribution of liabilities between active and deferred/retired members,

• degree of mismatch between assets and liabilities, and

• variability of hours worked

The greater the volatility of the above variables, the greater the PfAD needed. The result would be a target going-concern funded ratio of 100 percent at minimum, rising with the degree of PfAD.

• The funding rules should either specify the magnitude of the PfAD or incorporate actuarial standards addressing the same issue. As actuarial standards are yet to be developed in this area, the CIA should be asked to develop such standards or at least to advise legislators on appropriate PfAD standards.

Recommendation 8.2.1-C To determine the size of the PfAD and the prescription for remediating problems, the funding rules should require that stress testing be performed as part of the actuarial valuation:

• The standards should require the actuary to perform all appropriate scenario tests which must include both stochastic tests, and specified deterministic scenarios.

• Standards for stochastic testing should have to state what level of statistical confidence would be required.

• Where the plan would be vulnerable to the failure or withdrawal of one or more employers, that scenario should be included in the stress testing. Proportionate and appropriate protection should be factored in when there is an apparent significant chance of wind-up.

• It is important that the actuarial profession be engaged to develop stress testing metrics. Actuarial standards do not currently exist in this area; therefore, the CIA should be asked to create such standards. If the profession declines to create such standards, the legislation should impose them based on advice from actuarial consultants.

Recommendation 8.2.1-D If going-concern liabilities plus any necessary PfAD are greater than assets, deficiencies should be required to be eliminated by increasing contributions and/or reducing benefits so as to restore the plan to the target funded ratio. The remediation should be required to be achieved with regular, consistent and timely treatment:

• The plan should have to demonstrate that contributions would be sufficient to amortize unfunded liabilities over 15 years or the "expected average remaining service life", whichever is less. The other rules relating to unfunded liabilities would continue to apply:

• Once identified, an unfunded liability should be required to be amortized in that length of time or less and should not be allowed to be combined with more recently established unfunded liabilities so as to extend the amortization period beyond the original maximum period.

• Gains should be required to be applied to the oldest-established unfunded liability first, with the result that either the payments would be lowered or eliminated, or the same payments would continue but the unfunded liability would be amortized more quickly.

• If funding levels indicated above are not met, the " plan's funding status should be required to be adjusted immediately by contribution increases, changes in plan design (e.g. benefit reductions or increased eligibility requirements) or a combination of those. The trustees should have the primary responsibility to exercise even-handedness in making any changes in plan design.

Benefit improvements for SCTBs

Recommendation 8.2.2-A The legislation should also require that a reasonable method be used for costing benefit improvements: benefit improvements should be valued on the same going-concern-plus basis as required for the minimum funding standards.

Recommendation 8.2.2-B No benefit improvement should be permitted unless there is at least a 100 percent going-concern-plus funded ratio and no benefit improvement should be allowed that would reduce the plan's funded status below the fund's target ratio.

Recommendation 8.2.2-C To provide more flexibility in plan design, temporary benefit improvements should be permitted, subject to the general limitation that there must be a going-concern-plus surplus. These improvements must be accompanied by full disclosure to plan members of the temporary nature of the benefit and who is entitled to receive it. Such improvements should be subject to Recommendation 8.2.2-B limiting benefit improvements.

Valuations for SCTBs

Recommendation 8.2.3-A The current standards for frequency of valuations should be retained. The regulator should continue to have discretion to require more rigourous and/or more frequent valuations and/or additional stress testing as part of risk-based monitoring.

Recommendation 8.2.3-B In any SCTB plan where the probability of wind-up is higher, the actuary should be required to take into account the wind-up scenario in setting the going-concern-plus assumptions. The more probable the windup scenario the closer the going-concern-plus valuation should be to a wind-up valuation.

Recommendation 8.2.3-C The valuation filed with the regulator should state the target funded ratio and how it was calculated, including making the PfAD explicit.

Recommendation 8.2.3-D The valuation should be required to include an estimate of the amount that would be required to settle all liabilities at that point in time (settlement valuation), and state the settlement ratio.

Transfer values

Recommendation 8.2.5-A An individual's termination benefit should be valued using the same assumptions as were used in the most recent valuation, that is, on a going-concern-plus basis.

Recommendation 8.2.5-B The maximum termination benefit any individual may receive should be 100 percent of the going-concern liability. Even if the current funded ratio is over 100 percent to meet the plan's target funded ratio, the maximum payment should be 100 percent. If the ratio is less than 100 percent, terminating members who elect to remove their funds should receive a pro-rated amount, based on the funded ratio at that time. There should be no later "catch-up" payment to bring their payment to 100 percent of the target benefit.

SCTB governance

Recommendation 8.2.6-A Our recommendations relating to governance standards in Section 7.1, and trustee/fiduciary education in Section 7.1.1, should be adopted to complement these funding rules. We do not endorse any single governance structure as the most suitable.

Recommendation 8.2.6-B As indicated in Recommendation 7.1-C, a funding policy should be a mandatory element of the governance policy for these plans. Some of the special requirements related to funding policies for SCTBs should include:

• There should be a policy on benefit increases.

• The legislation should require that the actuary, in the actuarial report, opine that there is nothing in the funding policy that is inconsistent with sound actuarial practice for the particular plan.

Recommendation 8.2.6-C The governing fiduciary should be required to certify that the plan has been managed in accordance with its governance policy, funding policy and investment policy.

Recommendation 8.2.6-D There should be a requirement for an annual assessment by the governing fiduciary of the plan's administration, its compliance with legislated minimum standards, governance, funding and investment policies, and the performance of the trustees, administrative staff and significant external professionals. The assessment should be in writing and available to the regulator upon request, but should not be required to be filed.

Recommendation 8.2.6-E Governing fiduciaries should be required to obtain the education and training required in order to properly meet their responsibilities. (See also Recommendation 7.1.1-B.)

Recommendation 8.2.6-F Governing fiduciaries should be required to ensure that those with administrative responsibilities with respect to the plan are appropriately trained.

IV. SPECIFIC PENSION STANDARDS

Locking In

Recommendation 9.1-A Unlocking of funds subject to pension standards legislation in Alberta and British Columbia should only be permitted on the following bases:

• Pension funds should remain locked in so long as the individual is still an active member of the plan.

• SCTBs should retain the ability to set rules regarding when an individual is or is not a terminated member.

• It should be optional whether a plan permits unlocking.

• If a plan permits unlocking, individuals who are at least age 50 should be permitted to unlock either 25 percent or 50 percent of their entitlements, on a one-time basis, at or after termination of employment. The unlocked amount could be transferred to a non-locked in RRSP, while the locked in portion could be transferred to a LIRA or locked-in RRSP.

• If the plan is silent on unlocking, then 50 percent unlocking at age 50 or over at the member's election should be the default.

• There should be no change to the existing rule that plans may disallow portability within 10 years before normal retirement.

• For transition purposes, individuals subject to the current Alberta legislation who are age 50 or over at the time the new legislation is enacted should be "grandfathered" under that rule regardless of the option selected for the plan going forward.

• There should be no change to the existing unlocking rules (subject to harmonization) with respect to:

• shortened life expectancy;

• non-residency in Canada; and

• small amounts.

• Financial hardship unlocking should be applicable in both provinces using the Alberta model.

V. RELATED LEGAL AND OTHER FRAMEWORKS

Income Tax Rules

Recommendation 10.1-A The governments should actively advocate that the federal government change various tax rules that impact the pension system, including:

• raising the maximum contribution/benefit limits (to be more competitive with other major industrialized economies with which we compete for human resource talent)

• raising the maximum funding limits for DB plans to encourage more generous funding of such plans and improve benefit security, by allowing surpluses of up to 25 percent, except for Individual Pension Plans, where the current ten percent maximum excess would remain

• advocating any changes required to federal tax and bankruptcy and insolvency laws to support establishment of the Pension Security Fund

• updating the rules applicable to the maximum transfer values for DB to DC plans to allow larger amounts to be transferred tax-free

• making the tax rules flexible enough to accommodate new plan designs that meet the principles of general application under next-generation pension standards legislation

• allowing contributions by employees to broad-based plans to be deductible where their employer opts not to participate (See Sections 6.3 and 11)

• allowing self-employed individuals to make contributions to a registered pension plan

Bankruptcy and Insolvency Issues

Recommendation 10.4-A There should not be a pension benefit guarantee fund established in Alberta and British Columbia.

Recommendation 10.4-B The governments should encourage the federal government to extend the "super priority" secured creditor status to all due but unpaid contributions, including solvency deficiency or unfunded liability special payments, but not to extend such status to such amounts that are unamortized but not yet due.

Recommendation 10.4-C The governments should encourage the federal government to provide the PSF with the same treatment under federal bankruptcy and insolvency legislation as applies to the regular pension fund of a pension plan. (See also Section 8.1.1 "DB funding rules" above.)

Recommendation 10.4-D The deemed trust rules in pension standards legislation need to be clarified to ensure that monies held for pension contributions are treated in the same manner as earned but unpaid wages under provincial employment standards legislation and, in situations other than bankruptcy, are not available to satisfy other creditors.

VI. THE "ABC PLAN"

Recommendation 11-A The governments should establish a Steering Committee made up of experts in pension plan administration, governance and investment to examine the feasibility of establishing a multi-employer pension plan available to all employers and employees working in our provinces. The Steering Committee should have a mandate not only to make specific plan design recommendations but also to suggest the means by which key participants (especially employers and employees) in the ABC Plan operation would work together to ensure their buy-in to the ABC Plan's purposes and objectives. We also encourage the Steering Committee to consult with other provinces who may be considering similar plans.

Recommendation 11-B The ABC Plan design should be based on a simple DC formula with, generally, matching employer and employee contribution rates. Although the Panel recommends an entry level participation rate of a minimum of three percent of employee's earnings, the Plan design should be flexible enough to allow both employers and employees to make contributions without matching contributions from each other in order to encourage increased savings by all ABC Plan participants.

Recommendation 11-C All employers and workers, including self-employed individuals earning employment or self-employment income in either Alberta or British Columbia, should be eligible to participate in the Plan. All employers and employees should be automatically enrolled in the ABC Plan but the employer and/or their employees should be allowed to opt out of participation if they so choose. Employees whose employer has opted out should still be automatically enrolled without employer contributions unless they choose to opt out. Self-employed individuals in our provinces should also be encouraged to participate in the Plan. Auto-enrolment is not recommended – rather, participation by self-employed individuals should be on an opt-in basis.

Recommendation 11-F Governance of the ABC Plan should be at arm's length from government. There are several models of pension governance that the governments could consider.

Recommendation 11-H Administration of the Plan should be at arm's length from government. The board of governors would ultimately be responsible for deciding how best to structure the administration of the Plan.

Recommendation 11-I The Panel does not recommend that employers or employees contributing to the ABC Plan have any investment choice. Rather, the Panel recommends investment of the Plan assets would be subject to the policy direction of the board of governors.

Recommendation 11-J The Plan's design could include auto-annuitization, spreading out annuity purchases over time to minimize longevity risk and retirement end-date sensitivities which would help mitigate risks of market volatility.

Recommendation 11-L Contributions to the ABC Plan should be locked in similar to the locking-in rules applicable to any registered pension plan in our provinces.

Recommendation 11-M Vesting of employer contributions to the ABC Plan should be immediate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.