Last month, while many of us were on vacation, the British Columbia government continued their consultations on their pension funding framework by publishing a report from their Stakeholder Committee and requesting comments by August 30, 2019.
BC is largely proposing to follow the funding reform template set by other provinces with a move toward a ‘going-concern plus’ model with a reduced solvency funding target. As we have seen in other jurisdictions, the result would be significantly reduced contribution volatility (the primary complaint of most plan sponsors), although this would also result in lower benefit security for most pension plan members.
Admittedly, the Provision for Adverse Deviation (PfAD) that gets added to the going-concern liabilities provides some measure of increased benefit security as it forces a higher going-concern funding target than a pure ‘best estimate’ valuation; however, benefit security matters most when the pension plan is winding up with a bankrupt plan sponsor. With the reduced prominence of solvency valuations (i.e. targeting an 85% solvency funded ratio) the result is lower benefit security in almost all situations.
The most creative/original/weird aspect of BC’s proposal is how they would determine the PfAD. In most scenarios, the PfAD would simply be 5 times the long-term Government of Canada bond yield (there would be a minimum PfAD of 5% and potential adjustments for plans with nearly all their assets in fixed-income investments).
If you’re paying attention to pension funding reform across Canada, this is the point where you throw your hands up in exasperation. Do we really need another way of calculating a PfAD? Earlier this year, the Canadian Association of Pension Supervisory Authorities (CAPSA – of which BC is a member) published their Recommendations: Funding of Benefits for Plans Other than Defined Contribution Plans in the spirit of “harmonization of pension regulation across Canada”. While we in the pension industry are all trained to following CAPSA’s guidelines, BC seems to be ignoring some key recommendations from CAPSA. Nowhere does CAPSA suggest that an appropriate way to calculate a PfAD is by multiplying the long-term bond yield by a factor.
Presumably as a defense for their unique position, the BC consultation paper claims that “basing PfAD requirements on investment mix inappropriately influence investment decisions”. Further, they say that it would be “unwieldy” to take into account other risks besides interest rate risk. I disagree with both of these assertions.
Prior to the current wave of funding reform, plan sponsors across Canada were often de-risking their investment strategies in order to achieve reduced contribution volatility. Now that lower contribution volatility is largely provided by the revised funding rules in several provinces, some plan sponsors are considering re-risking their investment policies to seek higher long-term investment returns. In Quebec and Ontario, higher investment risk leads to higher PfADs, which seems like a very sensible thing to me, and probably curtails some reckless investment risk taking. If in BC there is no higher PfAD for higher investment risk, plan sponsors may actually be tempted to take greater investment risks than in other provinces (which would be ironic given BC’s stated principle to not influence investment decisions).
A PfAD is really meant to provide a cushion for bad experience in the pension plan, which primarily comes from poor investment returns and declines in interest rates. Logically, higher PfADs should therefore be required with higher risk, which correlates to higher equity allocations and higher levels of ‘mismatch’ between the assets and liabilities. These are the drivers behind the PfAD calculations in Quebec and Ontario, which are easily manageable by any actuary.
The reality is that the current level of long-term interest rates does not corelate well to the level of risk in a particular pension plan. The only real advantage that I can see with the BC proposal is simplicity and a reduced level of contribution volatility in many economic scenarios; however, that could also backfire if interest rates were to rise during a prolonged period of poor investment returns (which was the story of the 1970s).
The PfAD as proposed in the BC consultation paper, if unchanged, should be renamed ‘stabilization provision’ so as to not mislead stakeholders in believing that we’re actually protecting against future rainy days.
If long-term interest rates stay low for the foreseeable future (a real possibility) then the PfAD in BC will be quite low and plan sponsors will certainly be happy with their reduced contribution requirements. Perhaps this is the result that the policymakers in BC are really aiming for?
To top it all off, for some reason BC seems to be rushing these significant changes with limited opportunity for reflection and consultation. The optics of releasing this paper in early August with a deadline of August 30th to provide comments seems to be a strategy to limit potential criticisms of their unique PfAD proposal. I suggest that BC take the time to re-read CAPSA’s funding recommendations and pick the PfAD formula from either Ontario or Quebec in the spirit of harmonization across Canada.