Canada: Defined Benefit Plan Sponsors Given Guidance On Pension Plan Funding Policies

The sponsor of a defined benefit plan is legally obliged to ensure that the pension plan is funded over time. Minimum contributions must be made as specified by applicable law. The Canadian Association of Pension Supervisory Authorities recently released Guideline No. 7: Pension Plan Funding Policy Guideline to assist plan sponsors on the development and adoption of funding policies for defined benefit pension plans. A funding policy is not required by law but the Guideline can assist plan sponsors of defined benefit pension plans in determining whether to develop and adopt the use of funding policies.

FUNDING POLICY GUIDELINE

The purpose of a funding policy is to establish a framework for funding a defined benefit pension plan. Some factors that may be relevant to the plan and the plan sponsor in establishing a framework include: benefit security, the financial position of the plan sponsor and competing organizational demands for resources, and legislative and plan provisions with respect to the utilization of pension fund surpluses.

Although not legally required, there could be advantages of developing a funding policy, including providing guidance to the plan's actuary when selecting actuarial methods and assumptions, and improving the identification, understanding and management of the risk factors that affect the variability of funding requirements and the security of benefits.

It is the role of the plan sponsor to determine whether a funding policy is appropriate and if so, to develop and adopt such a policy. The Guideline elaborates on "elements" to consider including in a funding policy, which include the following:

• Funding Objectives. funding policy indicate how the funding objectives integrate with the plan's investment policy as well as the plan sponsor or plan objectives. Objectives can be stated as they relate, for example, to benefit security, stability of contributions, and to contribution or benefit levels. Circumstances where funding in excess of the legislated minimums would be considered could also be included in the funding policy.

• Key Risks Faced By The Plan. The Guideline suggests that the funding policy should describe the key risks that are facing the plan from the perspectives of various stakeholders. Examples of risks include the extent to which the plan's assets are mismatched against its liabilities and the demographic characteristics of the plan beneficiaries.

• Funding Target Ranges. The Guideline recommends that any funding targets, contribution target levels, mechanisms that would allow flexibility in funding and accommodating potential short term operational requirements, and established cost sharing arrangements, if applicable, be described in the funding policy. Funding targets can be expressed in relation to liabilities for a going concern, solvency, wind-up or some other measure.

• Utilization of Funding Excess. The utilization of funding excess is subject to statutory requirements and the terms of the applicable plan documents. The Guideline suggests that the funding policy should also describe the plan sponsor's policy on using funding excess for an ongoing entity, and if appropriate, could cover its use in the event of plan termination. The funding policy should also establish the factors that may be considered in deciding how and when to use a funding excess if the funding excess can be used for contribution holidays or benefit improvements.

Other elements of a funding policy could include a description of funding volatility factors and management of risk, cost sharing mechanisms, actuarial methods, assumptions, and reporting, frequency of valuations, monitoring, and a communication policy.

Where a plan sponsor adopts a funding policy, the plan administrator of that pension plan should ensure that the investment policy is consistent with the funding policy.

Special considerations may apply for pension plans where the employer has the dual roles of plan sponsor and the plan administrator. In such circumstances, the employer, acting as plan sponsor, is entitled to act in its own best interests but may be subject to an implied duty of good faith but, when acting as plan administrator, is held to a fiduciary standard of care. Special considerations may also apply for multi employer pension plans.

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.