Last Fall, the Financial Services Regulatory Authority of Ontario (FSRA) published an outside-the-box Guidance Approach which has not gained much attention, but I believe that it can be a game changer for more than a few pension plans in Ontario. I’m branding it “Wind-up by Stealth™”.
How Did We Get Here?
For a while now, private sector employers have been shifting their pension plans from defined benefit (DB) to defined contribution (DC). The result is either a single combo pension plan with both DB and DC components within the same legal pension plan, or two totally separate pension plans (one DB and one DC).
Many employers get to the point where they are ready to wind-up the DB pension plan. If it’s a standalone DB pension plan then this is usually straightforward – declare the wind-up, actuaries prepare a wind-up valuation report, FSRA reviews and approves the wind-up, members choose between annuities or lump sum transfers, the employer funds any remaining deficit, benefits are settled, any surplus is addressed, the pension fund is depleted to zero, and you’re done.
Unfortunately for a combo DB+DC pension plan, the wind-up of the DB component is anything but straightforward after the elimination of partial wind-ups effective July 1, 2012. Today, if the employer wants to wind-up what they consider the “DB plan”, the entire plan must actually be wound up, including the DC component. Given that the DC component of the plan is where all the members are currently earning pension benefits, it is fairly disruptive to put them through a DC wind-up as well and this effort creates no value. While there is the possibility of splitting the combo DB+DC pension plan into two separate plans before winding-up the newly standalone DB plan, this adds complexity and costs which, in my experience, many employers are not willing to endure. The most common result I have seen thus far has been to hold one’s nose, setup a brand-new standalone DC plan (or a Group RRSP) for future pension benefits, and wind-up the entire combo DB+DC pension plan.
Enter Annuity Discharges
Effective July 1, 2018, employers were given the ability to seek a discharge when annuities are purchased on behalf of deferred and retired members in a DB pension plan. As we’ve outlined in a previous blog, there are a number of hoops to jump through, but these are not onerous and discharges are fairly common already.
The problem with annuity discharges is that they are legally not permitted for active employees. This blanket prohibition doesn’t make much sense in my view, as you can have active employees with 100% frozen DB benefits (which can easily be annuitized) but because they are happily earning future DC benefits, they are not eligible for a discharge. This restriction is very important because if you could discharge every single DB benefit then your combo DB+DC pension plan is now magically transformed to a simple DC pension plan!
The fundamental rule for obtaining a discharge should be that if you can buy an annuity that exactly replicates all of the DB benefits that the member is entitled to, then you can get a discharge. It shouldn’t matter whether or not the person still works for the employer.
FSRA Connected the Dots
To give FSRA credit, they are testing their new powers for reducing regulatory burden as well as risk-based regulation by publishing this new policy, which effectively says that if annuities can be purchased that would otherwise be eligible for a discharge they will consider on a case-by-case basis eliminating the DB filing requirements for a particular pension plan. Presto, your combo DB+DC pension plan is now considered a DC pension plan by the regulator! No more actuarial valuation reports and no more fees to the Pension Benefits Guarantee Fund (PBGF). A DB wind-up without declaring a wind-up – aka a Wind-up by Stealth™.
As noted, FSRA will make their decision on a case-by-case basis and the onus will be on the employer to satisfy FSRA’s requirements for burden reduction. Based on their guidance document, “almost all” of the annuities that were purchased must be in respect of deferred and retired members and a discharge must be obtained for these members. FSRA implies that only a very small number of active members with 100% frozen DB benefits for whom annuities have been purchased will be acceptable.
FSRA indicates that employers must first contact them to determine if this new regulatory approach will apply to the fact situation of their pension plan. Hopefully this guidance will evolve over time based on FSRA’s experience, as there doesn’t appear to be a logical reason to have a hard limit on the number of active DB members. As I said previously, if you can buy annuities that exactly replicate all of the DB benefits then you should be able to get a full discharge and no longer have a DB pension plan. That being said, I understand FSRA’s preference to start small to see how this goes.
Step up to the Plate
The time is right for combo DB+DC pension plans that are ready to eliminate all their DB risks to consider buying annuities for all their frozen DB members and working with FSRA to be treated like a pure DC pension plan going forward. An important decision in all of this is whether or not now is the right time to buy annuities, but that’s too big of a question to answer in this blog.
One More Thing
While we’re on the topic of reducing regulatory burden, in case you missed it, the Government of Ontario recently amended the pension Regulations to increase the threshold where pension fund audits are required from $3 million to $10 million in plan assets.
This means that if a DB and/or DC pension plan has less than $10 million in assets as at the plan’s year-end date, no official audited financial statements for the plan are required. Unaudited financial statements, along with a Form 8 for DB pension plans, will still need to be filed with FSRA within 6 months of the plan’s year-end date.
This increased threshold will be welcome news for many pension plan sponsors who have been asking for an increase for many years.