Canada: Pension Risk Management: Financial Risks

Last Updated: June 1 2016
Article by Andrew Harrison and Sonia T. Mak

Most Read Contributor in Canada, September 2016

Risk management relating to pension plans has been a much-discussed topic among plan sponsors and administrators in recent years, particularly after the market crash in 2008.

Our Pension and Benefits Group has been assisting our clients in addressing different risks regarding their pension plans. The Group will issue a series of Pension Alerts to discuss the key risks, the strategies to reduce or eliminate such risks and the considerations that an employer needs to take into account in adopting a particular strategy.

This Pension Alert discusses financial risks and the upcoming Pension Alerts will cover the following:

  • Investment Risks
  • Administration Risks
  • Litigation Risks
  • Plan Restructuring or Termination Risks

Most of these risks are relevant to both defined contribution and defined benefit pension plans although some of them are more important to one type of plan than the other.

Financial Risks

Financial risks relate to the costs in maintaining a pension plan. There are two key costs: costs for funding benefits and costs in administering a pension plan. This Pension Alert focuses on the costs of funding benefits as their related risks are much more significant than those relating to administrative costs.

By the nature of a defined benefit (DB) pension plan, risks associated with funding benefits are more relevant to this type of plan than defined contribution (DC) pension plans. Funding risks can be caused by different factors: market fluctuations, low interest rates, increasing longevity of plan members and increase in annuity costs.

General Considerations

There is a broad range of options to address funding risks. The appropriateness of an option for a plan depends on the specific circumstances of the plan and the employer. Some of the risk management strategies discussed below (i.e., plan termination, plan closure or freeze, plan type changes, changes in benefit and/or contribution formula, plan merger or use of letters of credit) are a plan sponsor's options while the strategies of annuity purchases, longevity risk hedging contracts and liability-driven investments are a plan administrator's options. In most circumstances, the employer is both the plan sponsor and plan administrator.

The employer, as plan administrator, is subject to fiduciary duties and a duty of care in selecting and implementing the appropriate strategy. The employer, as plan sponsor, has considerable flexibility in adopting a risk management strategy. However, the employer needs to bear in mind its fiduciary duties as plan administrator to ensure that if there is a conflict of interest between the "sponsor" role and the "administrator" role, such conflict is not ignored but is appropriately addressed in the circumstances (e.g., by giving notice to members).

Proper due diligence needs to be done in determining the strategy to be adopted and in implementing the strategy. The relevance and significance of a particular consideration varies among the options. Below are some key considerations:

  • The pension standards legislation prohibits the reduction of accrued pension benefits. The strategy must not result in a reduction of accrued pension benefits and the plan amendments to implement a strategy need to be carefully drafted to avoid an unintentional reduction of accrued pension benefits rendering the amendments void.
  • The pension standards legislation prescribes requirements which are applicable to some of the strategies. Sometimes it is difficult to comply with the requirements because of the specific circumstances of a plan.
  • Employment agreements and/or collective agreements may contain constraints.
  • There may be risk of constructive dismissal claims if the strategy involves changes to plan design, closing the plan or terminating the plan as the employer, by adopting such strategy, is unilaterally changing a term of employment.
  • Employee communications are crucial to the successful implementation of most strategies and to minimizing the risk of employee claims.


1. Plan Termination

A drastic measure to remove the funding or contribution risk is to terminate the pension plan. This step will remove the risk of funding further accrual of benefits under the plan (be it DB or DC) in the future.

However, for a DB plan, if the assets are not sufficient to pay the accrued benefits, the employer is required to fund the deficit over a period of time. Additional benefits are triggered on plan termination in some jurisdictions (e.g., "grow-in" benefits in Ontario), resulting in additional required funding. If there is a surplus, the surplus is required to be dealt with. Surplus distribution to the employer requires regulatory approval. It can be a lengthy and costly process.

There is also an immediate administrative cost associated with plan termination.

2. Plan Closure or Freeze

This option has been quite popular among employers as a risk management option in recent years.

A plan closure (for DB or DC) means that new members are not permitted to join the pension plan. There are variations of this option. If the change affects only new hires, the change can be made by simple prospective plan amendments. Some pension plans include a membership eligibility period or provide for voluntary participation. If the plan closure applies to current employees who have not joined the plan (i.e., they can no longer join the plan as a result of the plan closure), the process will be more complicated. Considerations like appropriate grandfathering need to be taken into account.

A plan freeze means that further pension accrual ceases from a prospective effective date. This option is relevant for a DB plan. It can be a "soft" freeze (i.e., cessation of the accrual of pensionable service only) or a "hard" freeze (i.e., no further accrual of pensionable service and future increase in earnings will not be taken into account in the benefit formula). Case law has cast doubt on the legality of a "hard" freeze in some jurisdictions and its availability can depend on the plan language used in the benefit formula. Extra care is therefore required if a "hard" freeze is contemplated. A plan freeze is implemented by plan amendments which are considered as "adverse" amendments under the pension standards legislation in some jurisdictions (e.g., Ontario) and prior notice to members is required under such legislation. This legislative requirement needs to be taken into account in determining appropriate employee communications.

3. Plan Type Changes

This option involves the employer changing the DB plan design to a different type of plan such as a hybrid DB/DC plan, a DC pension plan, a jointly-sponsored pension plan, a target benefit pension plan or a shared-risk pension plan. These plan designs result in either the shifting of risks to plan members (e.g., a DC pension plan where members bear the investment risk) or sharing the funding risks with plan members (e.g., a jointly-sponsored pension plan requires members to contribute towards unfunded liability and solvency deficiency; a target benefit plan permits the reduction of accrued pension if the pension fund is insufficient to pay the accrued pension).

There are complex and detailed statutory and regulatory requirements associated with these options and members' buy-in is required in some jurisdictions. In addition, some of these plan designs are not yet available in all jurisdictions (e.g., shared-risk pension plans are available only in New Brunswick).

4. Changes in Benefit and/or Contribution Formula

Funding or contribution risks may also be reduced by removing costly ancillary benefits (such as indexation or subsidized early retirement benefits), introducing a reduction in the benefit formula (for a DB plan), imposing required contributions on members, increasing the member contribution rate, or reducing employer contribution rates (this is more relevant to a DC plan), on a prospective basis.

Some pension standards legislation may have restrictions on the ability to modify a benefit or contribution formula (e.g., restrictions on removing indexation; 50% rule in respect of a DB plan).

5. Risk Transference

Another option is to transfer the funding risk away from the employer. This option has been gaining popularity in recent years, first in the U.K. and the U.S. and, recently, also in Canada.

Risk can typically be "transferred" to an insurance company through the purchase of "buy-in" annuities or "buy-out" annuities or entering into longevity risk hedging contracts by the plan administrator.

A "buy-in" annuity is an insurance policy held as an investment of the pension fund by a single premium payment. Once the premium is paid, the insurance company is contractually responsible for funding the benefits. However, under this option, the plan remains responsible for benefit payments and the employer is not discharged from funding the benefits under the pension standards legislation. In other words, if the insurance company becomes insolvent, the employer remains on the hook for funding benefits. Since it is an investment, it needs to be permitted by the plan's statement of investment policies and procedures and to comply with the applicable pension investment rules. As an investment, the plan administrator needs to assess the investment risk of the "buy-in" annuity.

A "buy-out" annuity is an insurance policy pursuant to which the liability to pay benefits is "transferred" to the insurance company upon payment of a single premium. This is typically used in connection with a pension plan wind-up. A "buy-out" annuity does not necessarily discharge the employer from funding benefits in all Canadian jurisdictions.

Longevity risk hedging contracts are designed to reduce the risks to pension plans of increased costs associated with unfavourable longevity experience. Pursuant to this arrangement, the plan administrator pays regular pre-determined periodic payments to the counterparty in exchange for the counterparty agreeing to provide the pension plan with regular floating payments. As a result, the pension plan has more predictable outflows during the term of the hedging contract. However, the plan retains the ultimate responsibility for paying the benefits. In other words, the employer remains on the hook for funding the benefits.

Risk transference options are expected to gain increased popularity in the pension world. Some pension regulators have issued guidelines and policies on the plan administrator's responsibilities in entering into agreements for these options in anticipation of their increased popularity.

6. Other Possible Options

There are other options which have been used by some employers.

Plan Merger. When an employer has a DB pension plan with a significant surplus and a DB pension plan with a funding deficit or a solvency deficiency or has a DC pension plan, an employer merges the DB plan (with surplus) with the other DB plan (with funding problem) or the DC plan to form one pension plan so that the surplus can be used to fund the merged plan as the predecessor plans become different components of one single plan with one pension fund after the plan merger. A plan merger requires the approval of the pension regulator. The process can be complicated and lengthy, particularly if the plans are registered, or have members, in different provinces. Before embarking on this process, the plan documents (current and historical) need to be reviewed to determine whether there are provisions which prohibit the "merger" of the pension funds into a single fund or limit the ability of cross-subsidization.

Liability Driven Investment. This strategy involves the plan administrator aligning pension fund investments to manage plan liabilities. This is one of the most popular traditional pension risk management strategies.

Letters of Credit. Most pension standards legislation in Canada permits the employer to use letters of credit to fund the solvency deficiency of a pension plan. The legislation sets out a statutory scheme which the employer needs to comply with for using a letter of credit. This strategy does not remove or reduce funding risk but it is a strategy to avoid trapping money in the pension plan, as it is anticipated that the solvency deficiency does not reflect the long term funding needs of the plan.

About BLG

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.