Canada: Under Review: Solvency Funding Reform For Ontario Sponsors Of Single Employer Pension Plans

On July 26, 2016, Ontario released a consultation paper, "Review of Ontario's Solvency Funding Framework for Defined Benefit Pension Plans" (Consultation Paper). The Consultation Paper is open for comment until September 30, 2016.

As noted in our November 2015 Blakes Bulletin: 2015 Ontario Economic Outlook and Fiscal Review Provisions Affecting the Retirement Income System, Ontario's 2015 Economic Statement provided that the Ontario government would initiate "on an expedited basis" a review of the current solvency framework for private sector single employer defined benefit pension plans (SEPPs) with a view to developing reforms. The Consultation Paper is the result of that review.

Temporary solvency relief was provided in Ontario in 2009, in 2012, and again earlier this year. The government is now acknowledging that as low interest rates have persisted, and the successive rounds of temporary solvency relief have been required, there is a problem to be addressed. Ontario has also flagged benefit security as an issue to be considered. The Consultation Paper indicates that the review's purpose is to "develop a balanced set of solvency funding reforms that would focus on plan sustainability, affordability and benefit security, and take into account the interest of pension stakeholders – including sponsors, unions, members and retirees."

The paper offers two main approaches to solvency funding reform for consideration — Approach A, which is a modification of the existing solvency funding rules, and Approach B, which is an elimination of current solvency funding rules and a strengthening of the going concern funding rules.

The Consultation Paper also raises the issue of the future role of the Pension Benefits Guarantee Fund (PBGF) including the level of benefit guarantee and how assessments supporting the operation of the fund would be determined.

Finally, the paper includes a section dealing with additional complimentary reform measures that are being discussed along with solvency funding reform.

We will briefly highlight the main issues set out in the Consultation Paper. We intend to provide written submissions to the Ontario government (due by September 30, 2016) and would be happy to discuss any comments you would like us to include.

APPROACH A: MODIFY SOLVENCY FUNDING RULES

Approach A does not eliminate solvency funding for SEPPs, but outlines modifications to the existing requirements to address issues such as persistent long-term low interest rates. (Under Approach A, it does not appear that the government is considering eliminating existing exclusions from solvency funding, for example indexation.)

Seven alternative options are set out under Approach A, which could be adopted either on their own or in combination. Those are:

Option 1: Averaging Solvency Ratios

This method would permit a pension plan sponsor to calculate the average solvency ratio over three years. The average solvency ratio and the solvency liabilities on the valuation date would then be used to calculate the solvency deficiency that will need to be funded over five years. A variation also being considered would permit the plan sponsor to fund using the lower of the average solvency ratio and the actual solvency ratio at the date of valuation.

Option 2: Lengthening the Amortization Period

Rather than requiring solvency funding deficiencies to be amortized over five years, the amortization period could be extended. The government does not indicate what extension it is considering but uses, as an example, 10 years.

Option 3: Consolidating Solvency Deficiencies

This would permit plan sponsors to have a fresh start solvency deficiency at each valuation date. This is seen both to make solvency funding more understandable and also to reduce the size of solvency funding payments.

Option 4: Funding a Percentage of the Solvency Liability

Under this approach, only a portion of the solvency funding liability would be required to be funded. This would, of course, reduce solvency payments. The government indicates that this would be coupled with an increase in the PBGF guarantee. Interestingly, the government seems to be proposing not only to increase PBGF assessments because of the additional risk related to lower solvency payments, but also to increase the level of benefits guaranteed under the PBGF to reflect larger deficit concerns.

Option 5: Solvency Funding for Certain Benefits Only

This option seems to go a long way towards the elimination of solvency funding altogether. The Consultation Paper states that "Under this option, normal retirement benefits would be funded on a going concern basis only." Again, the government proposes that the PBGF level of benefit be increased.

Option 6: Solvency Reserve Accounts

As already adopted in Alberta and B.C., this option would create a separate account within a pension fund to hold payments regarding a solvency deficiency with the intent that when the funding returned to a certain level, the employer may withdraw the excess amount irrespective of the plan provisions.

Option 7: Letters of Credit

In Ontario, letters of credit can be obtained from a financial institution in lieu of solvency funding payments for up to 15 per cent of the liabilities. The Consultation Paper proposes to permit an (unspecified) increased percentage of solvency liabilities to be funded by way of letters of credit. This is a good opportunity to provide comment on issues related to how the existing rules work.

APPROACH B: ELIMINATE CURRENT SOLVENCY FUNDING RULES AND STRENGTHEN GOING CONCERN FUNDING

Essentially, Approach B looks to abolish solvency funding requirements, maintain solvency reporting for information purposes, and rely on strengthened going concern funding requirements. To do this, a number of options are described that could be adopted either on their own or in combination to create the enhanced going concern funding. Those are:

Option 1: Requiring a Funding Cushion (Provision for Adverse Deviation or PfAD)

The Consultation Paper describes PfAD as "a required asset amount in excess of a plan's liabilities that must be funded before the plan may take action (e.g., benefit improvements) that could weaken the plan's funded position." We have recently seen PfADs used in Quebec.

The Consultation Paper notes that a number of factors could be used to calculate the PfAD (e.g., a plan's investment strategy in relation to its demographic profile, the sponsoring entity's financial strength (seen in the U.K.), plan design and interest rate assumptions).

Option 2: Shortening Amortization Period

Change from the current 15-year amortization period to a shorter period for ongoing funding valuations could be required.

Option 3: Restricting Return on Investment Assumptions

The Consultation Paper states that the interest rate selected by the actuary is typically the most significant assumption in determining a plan's liabilities and current service cost. This option would permit the Superintendent to set a maximum best estimate interest rate assumption that an actuary could not exceed, or require the use of the interest rate used for accounting purposes.

Option 4: Solvency Trigger for Enhanced Funding

This option would allow solvency funding to continue to play a role in determining when additional funding is needed, for example, where the plan fell below a certain funding threshold, or in order to take certain actions.

Option 5: Enhancing the PBGF

Under this option, the Consultation Paper notes that the PBGF assessments would likely be increased to reduce the risk to the PBGF if solvency funding were eliminated. No suggestion is made as to the magnitude of the change to the adjusted assessment. It also indicates that, as noted above, the current level of protection provided by the PBGF should be increased with additional PBGF assessments increased as required. Further, it notes that the PBGF assessment calculation could relate not only to the plan's funded status, but also to other factors such as to the extent to which a plan's investment strategy is consistent with its demographic profile.

ADDITIONAL COMPLEMENTARY REFORM MEASURES

As noted above, additional complementary reform measures are also discussed, which could be introduced along with either Approach A or B as follows:

  1. Requiring annual valuation reports irrespective of the plan's funding position.
  2. Requiring written governance and funding policies to be established and filed with the Financial Services Commission of Ontario.
  3. Modifying commuted value calculations to pay individuals electing to leave the plan an amount which is "more reflective of the underlying risk associated with the pension benefit" and that this could be accomplished by increasing the interest rate used to calculate the commuted value.
  4. Permitting contribution holidays only if a PfAD on a going concern or solvency basis is fully funded. Further, administrators would be required to file annual statements confirming their eligibility to continue the contribution holiday. It seems odd in the context of a government recognition that sponsors need assistance because of the funding levels caused by low interest to then impose an additional burden on plans which in fact are "overfunded".
  5. Requiring benefit improvements to be funded immediately if the plan is funded below a specified threshold, with any portion of the benefit improvement over the threshold being funded over a period of time shorter than the normal amortization period.
  6. Amending the Pension Benefits Act (Ontario) (PBA) to discharge plan administrators from their obligations under the PBA if the administrator purchases a buyout annuity from an insurance company where certain conditions are met.
  7. Changing PBGF coverage regardless of the approach for solvency reform chosen.

The Consultation Paper asks specific questions, but essentially is providing an opportunity for submissions to be made on or before September 30, 2016, regarding the advantages and the disadvantages of the various approaches, options, additional provisions and any restrictions that might be useful or other measures that should be considered. It will be opportune for plan sponsors to provide submissions to this Consultation Paper notwithstanding the relatively short period of time available, as these are clearly important changes and changes that have been long in coming.

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.

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