Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Pension & Employee Benefits, November 2011
On November 15, 2011, the Canadian Association of Pension Supervisory Authorities (CAPSA) released CAPSA Guideline No. 6 Pension Plan Prudent Investment Practices Guideline (the Prudent Investment Practices Guideline), a companion Self-Assessment Questionnaire on Prudent Investment Practices (the Self-Assessment Questionnaire), and CAPSA Guideline No. 7 Pension Plan Funding Policy Guideline (the Funding Policy Guideline). The guidelines and the Self-Assessment Questionnaire are the final versions of the draft documents that CAPSA had initially released on March 1, 2011.
The release of the Prudent Investment Practices Guideline, the Self-Assessment Questionnaire, and the Funding Policy Guideline are intended to indicate the expectation of the various pension regulators respecting the adoption of prudent investment practices and funding policies.
In this bulletin, we will address the key features of the Prudent Investment Practices Guideline and its companion Self-Assessment Questionnaire, as well as those of the Funding Policy Guideline.
PRUDENT INVESTMENT PRACTICES GUIDELINE AND SELF-ASSESSMENT QUESTIONNAIRE
The Prudent Investment Practices Guideline is "intended to provide guidance to plan administrators on how to demonstrate the application of prudence to the investment of pension plan assets" while the Self-Assessment Questionnaire is designed to help administrators consider their investment practices by suggesting topics an administrator should consider when assessing its investment function and activities.
The Prudent Investment Practices Guideline is applicable to defined benefit (DB) plans, defined contribution (DC) plans and multi-employer pension plans (MEPPs). It is noteworthy, however, that CAPSA has encouraged administrators of DC plans to also refer to CAPSA Guideline No. 3 for Capital Accumulation Plans and any other CAPSA publications which deal with DC plans.
While the Prudent Investment Practices Guideline is a helpful tool for sponsors and administrators, we note that it does not amount to a shift from what we have previously understood to be viewed as good governance practices. The Prudent Investment Practices Guideline includes matters relating to prudent delegation, determination of investment objectives, risk management, creation of a statement of investment policies and procedures (SIP&P), creation of broader investment policies, considerations related to asset allocation, undertaking of due diligence, monitoring and the documentation of processes, policies and procedures. In addition to reviewing the Prudent Investment Practices Guideline, CAPSA has recommended that all administrators review the Self-Assessment Questionnaire and states that the questionnaire is intended to have broad application, and is intended to address all sizes and types of pension plans.
1. Role of Administrator/Role of Sponsor
In light of the Ontario Court of Appeal's decision in Re Indalex and its interpretation of the respective roles of a pension plan sponsor and the administrator in a single employer plan, it is encouraging that the Prudent Investment Practices Guideline summarizes the interpretation of the CAPSA parties about how these roles relate to investment. The guideline states that the plan administrator carries the responsibility for overall administration of the pension plan. This includes the management of the pension fund, the establishment of a written SIP&P or a Statement of Investment Policy and Goals (SIP&G), and investing fund assets accordingly. The administrator has a fiduciary responsibility in ensuring that assets of the pension fund are invested in a prudent fashion.
The guideline contrasts the role of the plan sponsor and describes that role as including plan design, setting benefit structures, plan establishment, plan amendment, plan termination, and determining the nature and level of pension benefits. While undertaking these activities, the guideline clearly states that the sponsor is not held to a fiduciary standard of care in relation to the pension plan and its beneficiaries.
The Prudent Investment Practices Guideline states that in the case of an employer which acts as both sponsor and administrator (for example, under a single employer plan), the fiduciary duty applies where the employer is acting in the role of plan administrator. This includes ensuring the pension fund is both administered and invested in accordance with the written SIP&P. However, according to the guideline, where acting in the role of plan sponsor, the employer is entitled to act in its own best interests, subject to any implied duty of good faith. The guideline provides that it is important for all parties to understand when plan administrator responsibilities are being carried out and when plan sponsor responsibilities are being carried out.
2. Prudent Person Rule
The Prudent Investment Practices Guideline provides a good reminder that it is the principle of prudence, and the underlying "prudent person rule" that should guide a plan administrator in the implementation of investment strategies. The guideline describes the prudent person rule as a rule of law that is intended to lead to balanced decision-making rather than any particular outcome. The focus is thus on an objective standard for behaviours and processes, with key elements being due diligence and proper documentation of the decision-making process. According to the guideline, a good governance structure is important for demonstrating the prudent person rule is satisfied.
FUNDING POLICY GUIDELINE
The Funding Policy Guideline outlines the general principles and objectives of pension plan funding, the purpose of establishing a funding policy for DB plans and the individual roles of the sponsor and administrator. The Funding Policy Guideline also addresses the dual role of the employer as plan sponsor and plan administrator under a single employer pension plan and identifies a number of reasons why the pension regulators regard the adoption of a funding policy to be "good practice and good governance".
Importantly, the Funding Policy Guideline recognizes that some of the considerations described in the guideline do not apply to all pension plans and that the adoption of a funding policy is not a requirement under current pension legislation.
The Funding Policy Guideline provides that "[t]he purpose of a funding policy is to establish a framework for funding a defined benefit pension plan taking into account relevant factors for the pension plan and the plan sponsor". Such factors include: benefit security; the stability and affordability of contributions; the financial position of the sponsor and competing demands for cash; the financial position of the plan; demographic characteristics; the terms of plan documents and related agreements; minimum legislative funding requirements; Income Tax Act limits; and plan and legislative provisions relating to funding excess.
The Funding Policy Guideline expressly states that in the course of activities related to establishing a funding policy, the plan sponsor is not held to a fiduciary standard of care. Additionally, the role of the administrator should be documented in the funding policy and the responsibilities for implementing the policy should be understood. The plan administrator has certain responsibilities if and when the funding policy is adopted. These responsibilities include ensuring that the investment policy is consistent with the funding policy.
The Funding Policy Guideline outlines some of the advantages (in the view of the CAPSA partners) to developing a funding policy, including: greater understanding of risk factors impacting variability of funding requirements and security of benefits; the potential for increasing sponsor discipline around funding decisions, leading to greater predictability in funding; helping to improve the transparency of funding decisions and increasing beneficiaries' understanding of pension funding; and providing guidance to the plan's actuary when selecting actuarial methods and assumptions.
According to the Funding Policy Guideline, the elements to be included in a funding policy include the following:
1. A Plan Overview: A plan overview, including features of the plan, related financial information and relevant characteristics of the plan sponsor.
2. Funding Objectives: How funding objectives integrate with the investment policy and sponsor or plan objectives, and consideration for inclusion of circumstances where funding beyond legislated minimums would be considered.
3. Key Risks: The key risks faced by the plan from the perspective of various stakeholders.
4. Funding Risk and Funding Volatility Tolerance: Documentation of the structure of the plan's liabilities as it affects funding risk and a description of the plan's tolerance for volatility in funding.
5. Funding Targets: A description of funding or contribution target levels.
6. Cost-Sharing Mechanisms: Considerations for cost-sharing mechanisms between beneficiaries and the employer.
7. Funding Excess: A description of the plan sponsor's policy on using funding excess, subject to plan documents and legislation. Where contribution holidays or benefit improvements may be undertaken, the policy should establish factors for determining how and when to use the excess. According to the Funding Policy Guideline, this would include a description of any desired margins that the plan sponsor wishes to keep before using the funding excess.
8. Guidance to Plan Actuary: Provision of guidance by the plan sponsor to the actuary when selecting actuarial methods and assumptions, which may include the going concern actuarial cost method, desired margins or provision for adverse deviations and acceptable asset valuation methods and ranges.
9. Frequency of Valuation: Subject to legislative requirements, provision by the plan sponsor of standards respecting the frequency of actuarial valuations.
10. Monitoring: Documentation of the roles and responsibilities, oversight, and frequency of review relating to the funding policy.
11. Communication Policy: Consideration of what, to whom, and when information regarding the funding policy will be shared, including provision to beneficiaries where appropriate. It is important to note that the Funding Policy Guideline recognizes that plan sponsors will not communicate information "that is counter to their commercial interests".
While the above elements are viewed as best practice, the Funding Policy Guideline recognizes that other issues may be relevant to some plans, and that avoidance of duplication with the investment policy is reasonable practice.
The Funding Policy Guideline also outlines special considerations for MEPPs, as volatility in such plans' financial positions can translate into fluctuating benefit levels rather than contribution levels. According to the guideline, in the case of a MEPP, the plan administrator would generally be responsible for the adoption of the funding policy. Nevertheless, in certain circumstances the responsibility may be shared between various stakeholders. While the various elements listed above apply to funding policies for MEPPs, additional considerations such as the approach to the setting and restructuring of benefit levels and the use of fixed contribution rates should be addressed. The issue of even-handed treatment between beneficiaries (both current and future) in various circumstances should also be discussed. The guideline also states that a MEPP should document the respective decision-making roles of trustees, employers and collective bargaining agents (as applicable).
By releasing the Prudent Investment Practices Guideline, the Self-Assessment Questionnaire, and the Funding Policy Guideline, CAPSA has provided useful reference tools for pension plan sponsors and administrators, particularly in the case of single employer pension plans. Plan sponsors and administrators of DB plans will need to consider when is the best time to formally adopt and communicate a funding policy and will need to carefully consider the contents of such a policy, taking into account not only the Funding Policy Guideline but also the description of any legal obligations or responsibilities before communicating the policy to plan members and other stakeholder groups.
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.