Final Changes to the Pension Commuted Value Standard
Editor’s Note: This commentary was written before the April 6, 2020 announcement by the Actuarial Standards Board of the decision to delay the implementation for the new commuted value standards to ‘not earlier than December 1, 2020’. However, early implementation of the standard for target pension arrangements is still permitted.
The Actuarial Standards Board (“ASB”) has recently released its long-awaited changes to the Pension Commuted Value Standards. This communication will discuss the key changes to the standards and inform pension plan stakeholders on the action items they will need to consider.
Before I dive into the details, I will point out that it has been a long and arduous process to get these standards revised. With the original notice of intent released in October 2015, the first exposure draft released in July 2017, and a second exposure draft released in November 2018, we are now over 4 years from when this process started. Loyal readers will recall that we have discussed this topic in two previous blogs by Carly and Jason.
What is a Commuted Value?
One of the changes to the standards was to provide a definition of a commuted value. While this is not entirely new thinking, the standards now describe a commuted value calculation as a representation of the economic value of a pension that is paid from a pension plan – that is, it is intended to represent the value that the marketplace would attribute to a pension, while reflecting certain simplifications in the calculations. However, the standards also state that the economic value is not intended to reflect the potential costs for taking on the risks, and thus the value should be more reflective of an expected value, rather than the cost of an insurance product.
This definition should assist readers as they contemplate the changes noted below.
Two Sets of Rules
One of the main items to come out of the new standards is that there are effectively two different sets of rules for calculating pension commuted values – one set of rules for Target Pension Arrangements (“TPAs”) and another set of rules for all other pension plans.
Generally speaking, the rules for TPAs are more flexible and allow for the use of the going-concern valuation assumptions, with a potential to adjust the commuted value for the funded ratio of the plan. In contrast, the rules for all other plans are relatively consistent with the current commuted value standards but with some changes to the key assumptions used in the calculations.
Also, when plan sponsors can reflect these new rules can differ, as described in more detail below.
Determining Which Set of Rules Apply
A key item for pension plan stakeholders to consider is whether their plan qualifies as a TPA. The revised standard defines a TPA as a pension plan for which applicable legislation contemplates the reduction to the accrued pensions of plan members and beneficiaries while the pension plan is ongoing as one of the available options for maintaining the funded status of the plan, and where the reduction in accrued pensions is not necessarily caused by the financial distress of the plan sponsor(s). The new standards go on to specify that TPAs would include certain target benefit plans and multi-employer pension plans.
In the cover memo to the new standards, the Designated Group of the ASB that prepared the revised standard indicates that the definition of TPAs would not extend to Jointly Sponsored Pension Plans (“JSPPs”), largely due to the fact that accrued benefits in JSPPs cannot be reduced while the plan is ongoing. Nevertheless, the Designated Group acknowledged that the rationale for permitting JSPPs (and other similar plans) to use the commuted value rules for TPAs has some merit; and that this could be something that policymakers consider if they wish to legislate the rules for calculating commuted values from JSPPs.
Personally, I think the Designated Group got this distinction right. Further, I believe policymakers should give pause before extending the TPA commuted value standards to JSPPs, unless they are also willing to provide these plans with the ability to reduce accrued benefits while the plan is ongoing.
Commuted Values for non-TPAs
The new rules for commuted values for non-TPAs are consistent with the current commuted value standards, but key changes include:
- Adjusting the interest rate assumption so that the ‘liquidity spread’ from the government bond yields is no longer fixed at 90 basis points, and instead the adjustment becomes a time-varying and market-linked calculation based on a blend of the spreads in provincial and corporate bonds, and
- Adjusting the retirement age assumption so that it is no longer 100% at the ‘optimal age’, but instead determined using a weighting of 50% at the ‘optimal age’ and 50% at the ‘earliest unreduced retirement age’.
For clarity, the change in the retirement age assumption will have a significant impact on pension plans that provide reduced early retirement benefits that are more generous than ‘the actuarial equivalent’. Such plans will effectively need to prepare two commuted value calculations, one at the ‘optimal age’ and another at the ‘earliest unreduced age’ and take a 50%-50% weighting of these two calculations. The impact of this assumption change will produce lower commuted values for these plans.
The change in the interest rate assumption will result in the need to gather provincial and corporate bond spread information for use in determining the interest rate assumption – but these rates are expected to be determined by a service provider to the Canadian Institute of Actuaries. The new approach is expected to result in more month-to-month variability in commuted value calculations.
For clarity, these new standards are effective August 1, 2020, and early adoption of these rules is not permitted for non-TPAs. This provides pension stakeholders with time to consider these changes and to make the required updates to their pension administration systems to ensure they are ready to be implemented when they become effective on August 1st.
Further, with the recently filed Ontario Regulation 420/19, it is our understanding that these new rules will apply to all Ontario members effective August 1, 2020. Nevertheless, there may be other jurisdictions that need to amend their regulations for these new commuted value standards to become effective.
For our existing pension clients, I am happy to report that our systems are ready and capable to accommodate these changes, and I do not see any concerns with being able to implement these changes effective August 1st.
Commuted Values for TPAs
The changes to the standards are relatively dramatic for TPAs. Specifically, plans that qualify as a TPA will be able to determine their commuted value calculations as the actuarial present value of the pension entitlement using the going-concern assumptions from the most recent funding valuation or cost certificate. This value can also be adjusted to reflect the funded status of the pension plan or to reflect the member’s share of the plan assets, if required by legislation or by the terms of the plan. The net impact of these change will likely result in lower commuted values for members terminating from TPAs in the current low interest rate environment.
In fact, Plan Administrators for TPAs have a number of options to consider when adopting these new standards, including:
- Whether or not the Margin for Adverse Deviations (“MfAD”) or Provision for Adverse Deviations (“PfAD”) that are reflected in the going-concern valuation should be included in the calculation of the commuted value (the standard implies that the MfAD/PfAD would not be included in the calculation, unless required by applicable legislation or required by the terms of the plan);
- Whether or not to adjust the interest rate used in the calculation to consider any non-investment expenses that are expected to be paid from the plan’s assets;
- Whether to make any adjustments to the retirement age assumption (in the event that the retirement age assumption used in the last valuation does not capture the value of the early retirement benefits provided under the plan); and
- Whether to multiply the commuted value calculation by the funded status of the plan, to either reflect the funded status of the plan, or to reflect the member’s share of the plan assets.
Best practice would likely dictate that TPAs document these changes in either their administrative policies, or more formally through an amendment to the plan text. To this end, TPAs may wish to work with their members, employers, consultants, and legal counsel to address these options.
It is also worth noting that early adoption of these new standards is permitted for TPAs, so long as all revisions are adopted at the same time. As such, administrators of TPAs may be keen to review these changes sooner rather than later.
Where Do We Go From Here?
With these finalized standards just being released on January 24, 2020, and the dramatic shift in the approach available for calculating commuted values for TPAs, I would not be surprised if pension legislators come to the fore and weigh-in on some of the items noted above. For instance, it is conceivable that pension legislators could narrow the range of practice for the options available in the calculation of commuted values for TPAs. Also, I will be interested to see if the JSPPs attempt to lobby government to have their commuted value calculations follow the TPA rules.
In any event, pension plan administrators should review these new standards, and start the process of ensuring that their systems can comply with these upcoming changes.