Canada: Ontario Pension Funding Reform And Administrator Discharge Upon Annuity Purchase

On December 14, 2017, the Ontario government posted descriptions of two proposed regulations to the Ontario Pension Benefits Act (PBA) regarding the funding rules for defined benefit pension plans and the availability of an administrator's discharge upon purchase of an annuity (together, the "Proposed Regulations").

The Proposed Regulations relate to some of the changes to the PBA announced by the Ontario government in May 2017 (as discussed in our May 2017 Blakes Alert: Ontario Government Announces New Funding Framework for Defined Benefit Pension Plans) and set out in Bill 177 (as discussed in our November 2017 Blakes Bulletin: Bill 177, Stronger, Fairer Ontario Act (Budget Measures), 2017: Pension Issues). Bill 177 received royal assent on December 14, 2017. Regulations in connection with the other changes to the PBA set out in Bill 177 are expected to be released in the near future.

This bulletin provides a summary of the Proposed Regulations.

FUNDING REFORM

Changes to the Solvency Funding Rules

  • Determination of Solvency Special Payments: Currently, special payments are required to be made where a plan is less than 100 per cent funded on a solvency basis. Under the new rules governing the funding of defined benefit pension plans (Funding Framework), special payments would only be required where a plan is less than 85 per cent funded on a solvency basis. The period over which a solvency funding deficiency must be amortized will remain at five years.
  • Solvency Excess and Transition: If a plan has a solvency excess (i.e., the sum of the solvency assets and the solvency asset adjustment exceeds the sum of the prior year credit balance, 85 per cent of the solvency liabilities and 85 per cent of the solvency liability adjustment), the new rules will continue to allow the length of the amortization period in respect of any existing solvency special payment schedule to be reduced and will prohibit a reduction in the monthly payment amounts. However, in order to facilitate the transition to the new Funding Framework, in the first valuation report filed under the new Funding Framework, a solvency excess may be used to either reduce the monthly payment amount or the amortization period for a previously established solvency special payment schedule (provided such schedule has less than six years remaining).
  • Previous Solvency Funding Relief: Under the new Funding Framework, new elections to use one or more solvency relief measures introduced in 2016 will not be permitted. Further, consequential amendments will be made to the rules for determining the solvency asset adjustment for plans that previously elected certain solvency funding relief measures.
  • Temporary Solvency Funding Relief for Public Sector Plans: New rules will be established to facilitate the transition to the new Funding Framework for the 25 public sector pension plans that currently receive temporary solvency funding relief under Regulation 178/11 to the PBA.
  • Letters of Credit: In order to recognize the new requirement to fund only 85 per cent of solvency liabilities, the new Funding Framework will permit the value of a letter of credit to be reduced to fund 85 per cent of solvency liabilities, rather than 100 per cent. For example, if a plan is 70 per cent funded on a solvency basis, letters of credit could be used to fund solvency special payments for 15 per cent of solvency liabilities, and no other payments determined on a solvency basis would be required.

Changes to Going Concern Funding Rules

  • Going Concern Funding Deficiencies: Under the new Funding Framework, the amortization period for funding a going concern deficit is being shortened to 10 years from the current 15 years. Further, special payments for going concern unfunded liabilities established in different valuation reports will be consolidated into one 10-year schedule that begins one year after the plan's valuation date. Special payments set out in a valuation report would apply to the period starting one year after the effective date of the report until one year after the effective date of the next report. Nonetheless, separate schedules may need to be maintained in certain circumstances, including when required to fund benefit improvements (as discussed below).
  • Funding for Indexation: Under the new Funding Framework, funding pre- and post-retirement indexation will be required on the same basis as for other benefits. However, contributions regarding the Provision for Adverse Deviations (PfAD) will not be required for either the going concern liabilities or the normal cost of future indexation.

PfAD and Related Contribution Requirements

A PfAD is a percentage that will be used to calculate additional contributions in respect of a plan's normal cost and its going concern liabilities. Under the new Funding Framework, contributions for the PfAD for the normal cost would be paid by the employer together with normal cost contributions (although members of certain jointly sponsored pension plans may share in making these contributions) and would be determined by multiplying the PfAD by the normal cost, which does not include costs for future indexation. The PfAD for accrued liabilities would be determined by multiplying the PfAD by the plan's going concern liabilities, excluding liabilities for future indexation. Any unfunded portion would be included in the plan's going concern unfunded liability and amortized over 10 years.

The amount of a plan's PfAD will depend on whether the plan's defined benefit provision is "open" or "closed" to new members. A plan's PfAD would also depend on the proportion of non-fixed income assets in the target asset mix that will be required to be set out in the plan's Statement of Investment Policies and Procedures. For the purposes of the PfAD, non-fixed income assets include all equities and employer issued securities, as well as 50 per cent of specified alternative investments (e.g., real estate), whereas fixed-income assets would normally include bonds, cash, term deposits, short-term notes and treasury bills. Mutual funds will be treated as either fixed income or non-fixed income assets depending on the nature of their underlying holdings.

The PfAD will be calculated as the sum of three components:

  1. A fixed component of five per cent for closed plans and four per cent for open plans.
  2. A component dependant on the plan's asset mix, determined in accordance with the below table:

    Percent of non-fixed income assets PfAD for closed plans PfAD for open plans
    0% 0% 0%
    20% 2% 1%
    40% 4% 2%
    50% 5% 3%
    60% 7% 4%
    70% 11% 6%
    80% 15% 8%
    100% 23% 12%

Adjusted Going Concern Special Payment Schedules

Under the new Funding Framework, most going concern special payment schedules will be consolidated at each valuation, but special payments to fund benefit improvements and for past service unfunded actuarial liabilities established for a new plan would be maintained and have fixed schedules.

Benefit Improvements

Under the new Funding Framework, benefits under a plan may be improved only if, after the improvement, the plan's solvency ratio is at least 85 per cent and the going concern funded ratio is at least 90 per cent. The employer will be allowed to make a lump sum contribution to the plan if necessary to satisfy these funding thresholds. The increase in going concern liabilities and the PfAD resulting from the benefit improvements need to be funded over five years on a going concern basis. Special payment schedules to fund benefit improvements would not be consolidated with other going concern special payment schedules.

Contribution Holidays

Once the new rules are in effect, surplus will be available for contribution holidays only if the following criteria are satisfied:

  • The plan's PfAD is fully funded on a going concern basis
  • The plan's transfer ratio is at least 1.05 after reducing the solvency assets by the amount of surplus used to lower contribution requirements
  • A cost certificate is filed with the Superintendent of Financial Services (Superintendent) within the first 90 days of each year in which a contribution holiday is taken
  • Notice is given to plan participants and, where applicable, unions representing members and any advisory committee.

Further, the value of assets that could be used to take contribution holidays in a year will be limited to 20 per cent of the plan's available actuarial surplus. The cost certificate referred to above would set out the estimated available actuarial surplus. The amount of available actuarial surplus that may be used to reduce contributions for normal cost and PfAD on the normal cost would be the lesser of:

  • The amount of available actuarial surplus for the particular fiscal year, as set out in the last filed report; and
  • The amount of estimated available actuarial surplus as set in the cost certificate for the particular year.

However, the rules for the cost certificate will be modified for the fiscal year in which a valuation report is filed. Once the report is filed, the amount of available actuarial surplus to reduce contributions for normal costs in the fiscal year could be based on the new report. A catch-up contribution, calculated using existing rules in the PBA regulations, may be required if the contributions based on the cost certificate are less than indicated in the filed report.

The new rules for contribution holidays would commence on the valuation date of the first report filed under the new Funding Framework.

Transitional Funding Rules

Transitional rules under the new Funding Framework will allow any increases in total contribution requirements due to new funding rules to be phased in over a period of three years following the valuation date of the first report filed under the new Funding Framework. In the first year, any increase in contributions due to the new funding rules would not have to be paid. In the second year, one-third of the increase would be required to be paid and, in the third year, the remaining two-thirds of the increase would be required to be paid. These transitional rules will give sponsors three years to adjust to the new funding requirements.

Disclosure Requirements

New rules will require administrators to include in the first annual and biennial member statements provided after the new Funding Framework is in effect, an explanation of the new funding rules, including a description of the reduced solvency funding requirements and the requirement to fund a PfAD on a going concern basis.

Consequential Amendments Regarding Surplus

To maintain consistency with the new funding rules, the PBA regulations will be amended to require that, when determining whether a plan has a surplus, the liabilities used would be the greater of:

  • The solvency liabilities plus the liabilities for any benefits excluded from the solvency liabilities (other than those payable under qualifying annuity contracts); and
  • The going concern liabilities plus the PfAD for the going concern liabilities.

The same liabilities would be used to determine the requirements for the amount of remaining surplus following a withdrawal from a continuing plan under subclause 79(1)(d)(ii) of the PBA. Further, surplus plan assets would not be available for assessments that employers are required to pay to the Pension Benefits Guarantee Fund.

ADMINISTRATOR DISCHARGE UPON ANNUITY PURCHASES

Bill 177 adds new section 43.1 to the PBA, which provides a discharge for the administrator of a single employer defined benefit pension plan where the administrator complies with specified requirements regarding the purchase of a pension, deferred pension or ancillary benefits from an insurance company.

According to the description of the new regulations relating to section 43.1, these regulations will ensure that an annuity purchase does not change the nature of former or retired members' benefits, that plan solvency funding levels are maintained and that adequate notice and disclosure of the annuity purchase and discharge are provided to affected former and retired members. The following requirements will be included in the new regulations:

Funding Requirements

In order to qualify for the administrator discharge, the solvency funding ratio of the plan after purchasing the annuity must be at least the greater of: the plan's solvency funding ratio immediately before the annuity purchase; and a solvency funding ratio of 100 per cent (or 85 per cent if the new solvency funding rules come into effect). If the solvency funding ratio does not meet the above threshold, the employer must remit contributions to the pension fund within 30 days of the date of the annuity purchase to cover the shortfall.

Annuity Contract Requirements

In order to qualify for the administrator's discharge, an annuity contract under which a pension, deferred pension or ancillary benefit has been purchased must provide a clear description of the benefits purchased and set out that:

  • Money payable under the contract is exempt from execution, seizure and attachment and that any contrary transaction is void.
  • Money transferred, including interest, cannot be assigned, charged, anticipated or given as security except as permitted by an order under the Family Law Act, a family arbitration award or a domestic contract and that any contrary transaction is void.
  • A spouse or former spouse of the annuitant will not be entitled to more than 50 per cent of the payments under the life annuity (determined as of the family law valuation date), notwithstanding an order under Part I (Family Property) of the Family Law Act, a family arbitration award or a domestic contract that states otherwise.
  • If the annuitant has a spouse at the time payments commence, the annuity shall be in the form of a joint and survivor annuity, unless the annuitant and the spouse provide a waiver.
  • The amount of the annuity will be determined on a basis that does not take into account the sex of the annuitant.
  • If the annuitant dies prior to the payment of the annuity, the annuity shall be administered in accordance with the pre-retirement death benefit provisions of the PBA.
  • Variation in the terms of payment will be permitted in circumstances of shortened life expectancy.

Pre-Existing Annuity Requirements

To obtain a discharge with respect to a pre-existing annuity (i.e., an annuity purchased before section 43.1 of the PBA comes into effect), the annuity contract must meet the requirements of the new PBA sections and regulations relating to annuity purchases. If no adjustment to the pre-existing annuity is required, the administrator will be eligible for the discharge if the plan's solvency funding ratio at the date of discharge is 100 per cent (or 85 per cent if the new solvency funding rules come into effect). If the pre-existing annuity does not meet the requirements of the new PBA sections and regulations, it must be adjusted either by way of amendment or by entering into a new annuity contract. If an adjustment to a pre-existing annuity contract causes the plan's solvency funding ratio to be less than the greater of the solvency funding ratio before the adjustments and 100 per cent (85 per cent if the new solvency funding rules come into effect), the employer must fund the shortfall within 30 days from the date of adjusting the annuity contract.

Notice and Filing Requirements

A notice containing prescribed information must be provided to the affected former and/or retired members before the administrator is discharged. Further, a copy of the annuity contract must be filed with the Superintendent.

TAKEAWAY

The Ontario government is accepting comments on the proposed Funding Framework until January 29, 2018.

Although the descriptions of the two Proposed Regulations discussed above provide considerable detail about the upcoming changes, it will be important to review the wording of the actual regulations, once released, as well as the additional regulatory changes that are anticipated in connection with Bill 177. These are significant changes with wide-ranging effects on sponsors and administrators of defined benefit pension plans. We will provide further updates once the regulations and/or further information is provided by the Ontario government.

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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