Ontario’s New Pension Funding Framework – The Good, the Bad and the Ugly

Further to our client memo on the current consultations by the Ontario Government on the proposed regulations relating to the new funding framework for DB pension plans, and the related consultation on the proposed regulations relating to a discharge of liabilities for annuities purchased by ongoing DB pension plans, I wanted to provide my views on the good and the bad of their proposals.

New Funding Framework

The reduced requirement to fund to 85% on a solvency basis is a good idea; however, I would have gone a step further and removed the requirement to fund on a solvency basis and simply required the reporting of the funded status on a solvency basis.  Thankfully the ability to use Letters of Credit remain under the new rules, and can be counted toward the 85% target.  I would have also followed Quebec’s example and specified that commuted values that are paid out to terminating members would reflect the funded status of the plan (i.e. if the plan is 85% funded on a solvency basis and the member elects a lump sum transfer rather than a deferred pension, they will get 85 cents on the dollar as a final settlement of their benefits).

The requirement for a Provision for Adverse Deviations (“PfAD”) is a good idea on the going-concern basis.  First, we start with a “best estimate” liability, then we layer on a PfAD which tries to capture the “riskiness” of the plan and its investment policy.  We then take any deficits and amortize them perpetually over new 10-year periods.  As an actuary, I can support this rational accumulation of assets to support the plan’s liabilities – although, I am curious (and somewhat suspicious) as to the actuarial rational behind the PfADs.  [Can someone please send me a copy of the actuarial work that lead to these formulas?]  Also, the fact that the contributions to fund any going-concern deficits start one year after the valuation date and continue for one year past the next valuation date raises an interesting technical question:  Can we reflect the value of next 12 months of pre-scheduled contribution when we calculate the funded status of the plan?

Now, let’s imagine a plan with surpluses on both solvency and going-concern – while this sounds utopian, unfortunately the new rules for contribution holidays and the use of surplus are very restrictive.  In particular, the requirement for cost certificates to be filed within 90 days of the start of the fiscal year will be problematic.  One reason is that cost certificates cause headaches for actuaries as they are not clearly outlined in our standards of practice, and the result is that we are often backed into doing a full valuation – which is difficult to do in 90-days and difficult to explain to our clients.  I would have simply required annual valuations in the usual 9-month timeframe unless the plan was significantly overfunded (as is done for Federally-registered pension plans).  I also would like to see an exemption for plans that have “excess surplus” under the Income Tax Act – this causes issues because the Canada Revenue Agency prohibits contributions but the Financial Services Commission of Ontario requires contributions to resume unless a cost certificate is filed.

Finally, with respect to the tricky problem of “surplus ownership”, I would have preferred that Ontario had done what Quebec did with their “banker’s clause” or “notional account” whereby excess employer contributions are notionally tracked and can be first used for contribution holidays and potential surplus refunds upon plan wind-up.  This would go a long way to alleviate employers’ concerns that they are on the hook to fund deficits but then if/when surplus arises they must “share” with the plan members.

My final disappointment with the new funding framework is the decision to retain the Pension Benefits Guarantee Fund – and worse, to increase the benefits and premiums!  I continue to firmly believe that this uniquely Ontario solution is unsustainable and just bad public policy.  The government should have taken this opportunity to put this ugly mistake behind us once and for all.   Oh, and to make matters worse, they removed the ability for employers to use any surplus in their pension plans to pay PBGF premiums.

With my criticisms above noted, overall, I believe that these new funding rules are a significant step in the right direction.  They will certainly provide for more stability in contributions, which has long been a complaint from plan sponsors.

As they say, “hindsight is 20/20” – and while I don’t like to dwell on the past, I wish that these rules were around 15-20 years ago when we first started to notice that solvency funding was doing more harm than good.  If so, I think we would have avoided the closure and wind-up of many DB pension plans; however, I also think that it’s far too late for these rules to cause most employers to want to restart offering DB pensions to their employees.  It will be interesting to see if there will be any.

Discharge of Liabilities for Annuities

The new rules for the discharge of liabilities for the purchase of annuities also seem like a step in the right direction; however, I do have a few concerns that hopefully can be addressed before the final rules are issued.

I completely support the concept that the ongoing pension plan members should not be harmed by any annuity purchase for their former colleagues’ benefits; however, the new rules take this a step too far.  For example, if the existing plan is 75% funded and annuities are purchased, then according to the new rules the annuities would need to be 100% funded and the ongoing plan would need to be 85% funded.

Also, the top-up contribution rules to gain a retroactive discharge for an annuity purchase done prior to the new rules are onerous.  The fact that the plan was likely topped up at the time of the original annuity purchase such that the ongoing plan was not harmed is effectively ignored as the plan must be topped up again to at least 85%.

Finally, the new rules specify that annuitized members will retain their entitlement to any future surpluses in the plan.  While this is mostly a legal issue, I would be curious what the smart pension lawyers think of this requirement – it looks very problematic to me.

Let Your Voice be Heard

The comment deadline for these new rules is Monday, January 29, 2018.  If you have any strong feelings on these new requirements, I suggest that you let the government know.

Jason Vary
Jason Vary
Jason Vary, President of Actuarial Solutions Inc., has practiced in defined benefit pension and retiree health plans for twenty years. He has experience with many plan designs including single-employer, multi-employer, private sector, government, unionized, non-unionized, as well as registered and non-registered executive plans.

4 Comments

  1. Bob says:

    A couple of comments, the question becomes if one noticed 20 years ago solvency funding was becoming a problem why was it not addressed, the problem was of course that no one wanted to lower on-going concern actuarial assumptions in the early 90’s. Had this occurred, surpluses would have been reduced requiring contributions be made to fund current service costs and benefits would not have been improved in many cases.

    Another issue is during the “old days” members terminating who transferred their money out got far less than the funded level, they did not enjoy in the surplus existing and or created by their leaving, if times reverse and plans get to a surplus, should members leaving get more than the value of their benefit.

    Finally in a variety of plans in the UK to which I have been or am a Trustee had the problem that none took out the CV of their pension as it would be reduced by the funded status, thus increasing the volatility of their plans based on a significant number of deferred and retired members. I have seen a couple of SMEPP’s in Canada where the same situation occurs as they do pay out based on the funded status of the plan, so again their deferred populations and then retiree populations are growing putting pressure on the active generation. If the plan wanted to de-risk, the full cost of getting rid of the liability would be charged.

    Again the plan sponsors were happy when interest assumptions were increased and took on greater risk, now we wish the plan members to bear the risk they had no input into the risk taken.

    Yes the PBGF should be eliminated especially as an Ontario only program but somebody has to pay the money already spent. At least they should have amended the rules to return “grow in” to its original intent, this by itself would resolve a significant portion of the solvency liability and would be far more fair to retirees and the rest of the plan members.

    Finally on the issue of “buy outs” maybe if it is difficult to do, fewer would do it, leaving more liabilities and assets in the plan which would keep the new PBGF fees at a high enough level to fund the pensions, reducing the governments liability.

  2. I think you missed some bad and ugly.

    In terms of bad: To give the government time to come up with appropriate funding rules for target benefit plans, the new DB funding rules will not apply to SOMEPPs or JSPPs, but they will apply to DB MEPPs that are not SOMEPPs or JSPPs. If DB funding rules are not appropriate for target benefit plans, why subject some target benefit plans to them and exempt others ? The result will no doubt be that DB MEPPs that are not SOMEPPs will either apply for SOMEPP status (where they qualify), seek exempting regulations (like some already have), convert to DC (most likely), or just suck it up and reduce benefits in order to fund a cushion and create intergenerational subsidies within the plan. It is bad because it discriminates unfairly against plans for non-union and non-profit workers -i.e., sectors in which most Ontarians work, and in which there is very little pension coverage.

    In terms of ugly: The drafting of the legislation around target benefits looks like it fell out of the ugly tree and hit every branch on the way down. For example, we will now have two types of target benefits. Those that meet the criteria of proposed section 39.2 which will be legislatively defined as “target benefits”, and those that don’t. I guess we can refer to those that don’t meet the criteria in s. 39.2 as “target benefits within the plain and ordinary meaning of those words”, as opposed to “target benefits”. That is an interesting mouthful that will no doubt add confusion, inconsistency with other jurisdictions, and more work for lawyers and consultants.

  3. Bob says:

    One note is that in The US there are so called ‘ Cash balance” plans and “target benefit” plans and I think to some degree we get the two mixed up or intertwined in Canada. We should expand our views and build both,

    My guess is the initiative taken within the legal world is pushing for the “cash balance” approach and the legislation is looking at the traditional Multi-ER world.

    • A cash balance plan is a defined benefit plan that looks like a defined contribution plan. The plan is set up on an individual account basis and the plan specifies the contribution to be credited to each participant’s account. But conceptually it is a defined benefit plan because the plan also specifies the investment earnings to be credited to the contributions, regardless of how the pension fund actually performs. Accordingly, the employer bears the financial risk to provide the stipulated investment earnings. From an employer financial and legal risk perspective, it is a defined benefit plan — i.e. high financial risk, low legal risk. (A defined contribution plan on the other hand has high legal risk and low financial risk.)

      A target benefit plan is in many respects a perfect hybrid. Like a defined benefit plan it communicates a “target benefit” payable for life at retirement, pools investment risk and pools longevity risk in order to provide lifetime retirement income. But because employer contributions are fixed, the ultimate benefits are whatever can be provided by the accumulated funding, since accrued “target benefits” can be reduced if plan liabilities run ahead of plan assets. The purpose of an actuarial valuation for a target benefit plan is not to determine the rate of funding, it is to determine the level of benefits that can be provided – so minimum actuarial funding rules effectively place limits on the level of the target, or will trigger reductions to the target. From an employer financial and legal risk perspective, it has low financial risk and fairly low legal risk – the main legal risk being to properly communicate the target nature of the benefit. In the Netherlands and the UK they are “collective defined contribution” plans. The closest US equivalent may be so called “church plans” which are very loose arrangements; although Congress was also presented with a research paper last year dealing with “composite plans” that more like target benefit plans (or defined ambition or shared risk … etc.).

      As a lawyer, I think target benefit plans are a better way forward. They provide low levels of financial and legal risk and also provide predictable lifetime income that is sustainable and extremely cost efficient.

      About 70% of Ontario workplaces have no pension plans. Those workplaces tend to be non-union small to medium sized enterprises (SMEs). Multi-employer pension plans that provide target benefits open a door to greater retirement coverage for SMEs; but this government appears determined to discriminate against non-union workplaces by requiring such plans to be funded on a pure DB basis. Unionized workplaces can set up these kinds of multi-employer plans within a benefit funding framework that is more appropriate to the target benefit design. The policy rationale is not clear to me, since 75% of unionized workplaces already have pensions. Why not enable representative organizations like professional or trade organizations do this as well, such as the Ontario Non-Profit Network, the Canadian Bar Association, or an association of franchisees? That could lead to a material expansion in predictable, cost efficient and sustainable workplace pension coverage in the province.

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