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For sponsors of defined benefit pension plans, the first half of 2020 has been interesting, to say the least.  When the COVID-19 pandemic first started to spread through North America, the financial market experienced a sharp and significant decline.  From mid-February through mid-March, we saw equity indices decline by upwards of 35%, and long-term government bond yields decrease by almost 100 basis points.  For plan sponsors, this unfavourable experience was somewhat mitigated by a significant increase in corporate bond spreads – which dampened the increase in plan liabilities caused by the decrease on government bond yields.  But nevertheless, a typical unhedged pension plan would have seen their funded status, as determined on a hypothetical wind-up basis, deteriorate by around 10% to 15% from the end of 2019 to the end of March. 

Since those dark days in March, the financial markets have recovered rather nicely.  Many equity indices are now only 10% off the all-time high’s they reached in mid-February, long-term bond yields are only down about 50 basis points since mid-February, and corporate spreads have also started to come in from their highs in March.  Nevertheless, the funded status for a typical unhedged pension plan is still around 8% to 12% lower since the end of 2019.

In light of the above, many plan sponsors who were not scheduled to perform funding valuations in 2020 are now contemplating the merits of doing an early valuation as at January 1, 2020 (or December 31, 2019).

Considerations for an Early Valuation at January 1, 2020

Many plan sponsors who are on a triennial valuation cycle (and not required to perform a valuation in 2020) are deciding to prepare an early funding valuation as at January 1, 2020 in order to ‘lock-in’ the funding requirements based on the Plan’s pre-pandemic financial position at that date.

In considering this option, plan sponsors are weighing the following factors:

1. The risk of increased contributions when preparing a future valuation.  This risk is dependent on the future outcomes in the financial markets, the risk inherent in the Plan (namely the investment risk incurred in a plan’s investment policy), and the plan sponsor’s ability to afford these additional contributions. 
   • To this end, some plan sponsors are concerned that Fall 2020 could be a challenging environment for their plan’s investments and are deciding to ‘lock-in’ their funding requirements based on the results of an early valuation, and/or considering updates to their investment policy.
2. The funded status of the Plan as at January 1, 2020, and the contribution requirements that would result if an early valuation is prepared as at January 1, 2020. 
   • It is noted that most pension plans were reasonably well funded at January 1, 2020, and thus a valuation at that date would likely produce favourable results.
3. The cost of preparing an early valuation.
   • In most circumstances, the cost of preparing an early valuation pales in comparison to the potential additional contributions that would be incurred if a valuation is required to be performed at a suboptimal date. 
   • Also, because most pension plans were reasonably well funded at January 1, 2020, preparing an early valuation will allow the plan sponsor to ‘reset’ the 3-year valuation cycle, allowing more time for a pandemic recovery.  As a result, the costs of preparing the valuation can be ‘amortized’ over a new 3-year period. 
4. Fiduciary considerations.
   • When considering the merits of performing an off-cycle valuation, plan sponsors should consider their fiduciary obligations to plan members and are well advised to document the process they followed in making their decision.
5. Union Negotiations, Plan Amendments, Plan Wind-ups and other transactions
   • The potential for a plan amendment, plan wind-up, or other transaction may also factor into the plan sponsor’s decision to do an early valuation. 
   • It is worth noting that, in previous years, we would try to incorporate the impact of a plan amendment in a full valuation prepared at a plan year-end date.  However, under Ontario’s new funding regime, the threshold tests for plan amendments need to be measured at the later of the effective date of the benefit improvement and the date on which the amendment is adopted (generally the Board approval date).  As a result, we expect to see in increase in the use of cost-certificate type reports to reflect benefit improvements (as opposed to reflecting benefit improvements in full valuations performed at the previous year-end date).
   • It is also worth noting that, in times of high volatility like these, it is even more important for plan sponsors to ensure that they fully understand the financial implications of any benefit improvements prior to amending their plan or agreeing to any plan changes in a union negotiation.
6. Commuted Value Transfers
   • Plan sponsors may also want to consider FSRA’s new guidance on transferring commuted values when they “know or ought to know” that their pension plan’s transfer ratio has declined by the prescribed amount since the most recent filed valuation, and the potential need to prepare a mini-valuation and Form 10 filing shortly after a January 1, 2020 valuation is filed.

It is interesting to note that valuations performed at January 1, 2020 (including ‘off-cycle’ valuations performed at this date) would normally need to be filed with the regulators by September 30, 2020 – but the regulations have recently been updated to allow January 1, 2020 valuations to be filed as late as December 31, 2020.  It is also observed that if such a valuation is filed late in the year, there may be a need to revise and re-file the Pension Benefit Guarantee Fund Assessment Certificate that must still be filed by September 30, 2020.

We are currently in the process of discussing the merits of filing early valuations at January 1, 2020 with many of our clients – and we expect many will decide to file early valuations at January 1, 2020 for their plans.