Potential Solvency Relief for Federally Regulated Pension Plans in 2021
The federal government of Canada (or perhaps more accurately, the Department of Finance) has recently issued a Consultation Paper which seeks pension stakeholder input on potential options for temporary broad-based solvency funding relief in 2021; as well as other measures to strengthen the framework for federally regulated pension plans, such as: plan governance, solvency reserve accounts, variable payment life annuities, and the ministerial guidelines for defined benefit pension plan sponsors. To be clear, this is an extensive Consultation Paper issued by the federal government, and in some respects is a follow-up of the legislative changes announced in the 2019 Budget and their 2018 consultation on Enhancing Retirement Security. Interested parties are invited to provide the federal government with their written comments on the topics addressed in the Consultation Paper by January 14, 2021.
In this blog post, I will focus on the temporary broad-based solvency funding relief that is being proposed in this Consultation Paper.
Temporary Broad-based Solvency Funding Relief for 2021
The Consultation Paper accurately notes that while pension plan solvency ratios have improved from the lows that they reached during the market meltdown in March 2020, they are still worse than their position at the beginning of the year. As a result, solvency funding requirements for federally regulated pension plans are expected to be higher in 2021 than in 2020.
In light of the above, the federal government is considering funding relief measures to mitigate the impacts of the ongoing pandemic on business operations of DB plans sponsors, in a bid to maintain the long-term sustainability of pension plans for members and retires. Some of the funding relief options being considered for 2021 include:
- Extending the solvency amortization period, with conditions – for example, extending the amortization period for solvency special payments from five to ten years, with either buy-in from plan beneficiaries or with a letter of credit covering the difference in payments resulting from longer amortization.
- One-time extension of solvency amortization period – allow a plan to extend its amortization schedule to ten years for the 2021 plan year only.
- Extension of the letter of credit limit – temporarily extend the current letter of credit limit beyond 15% of solvency liabilities.
- Alternative valuation methodologies – examples include calculating the average solvency ratio over five years instead of three, using an average discount rate as opposed to a market-discount rate as of the valuation date, or deferring the requirement to perform an annual valuation at the end of 2020.
Generally speaking, my preference for temporary broad-based funding relief provisions would lead to a meaningful reduction in the solvency funding requirements on a short-term basis with no (or very limited) stipulated conditions.
Most of the options above broadly fit this description. In particular, I like the one-time extension of the solvency amortization period approach, whereby the amortization schedule is extended to ten years for the 2021 plan year only.
I also like the fact that the federal government is considering the possibility of deferring the requirement to perform an annual valuation at the end of 2020. On this topic, I find it interesting that the federal government effectively requires annual valuations for defined benefit pension plans but is proposing that valuations only be required every three years for Variable Payment Life Annuities. In my view, Variable Payment Life Annuities are more likely to need annual valuations, as compared to registered pension plans.
Another option the federal government should consider is temporarily reducing the solvency funding threshold from 100% to a lower threshold of say 85% as has been done in other jurisdictions.
Comparing to the Experience for Ontario Registered Pension Plans
To contrast with the pension funding rules for Ontario registered pension plans, where valuations are required on a triennial basis if they are sufficiently well funded, many plan sponsors did valuations at January 1, 2020 in an effort to lock-in their funding requirements for the next three years using a pre-pandemic financial position. Further, Ontario’s pension funding framework does not require plan sponsors to make solvency special payments so long as their solvency ratios are greater than 85%.
In this sense, Ontario’s pension funding framework provides plan sponsors with much greater flexibility in managing their contribution requirements than their federally regulated counterparts.
Nevertheless, where Ontario did not hit the mark was with their version of temporary funding relief. As noted in our recent blog, the Ontario government recently provided plan sponsors with the ability to temporarily defer pension contributions required for the period October 1, 2020 to March 31, 2021 – but the ability for a plan sponsor to elect to implement this deferral is subject to a number of restrictions (e.g. no dividend payments, share buy-backs, executive bonuses, plan amendments, etc.) as well as onerous reporting requirements. In light of these restrictions, the take up rate for Ontario’s version of temporary funding relief is likely to be extremely limited (early reports indicate that the answer may actually be zero).
Where do we go from here?
In closing, the federal government is prudent to consider the challenges faced by federally regulated pension plans in 2021, as solvency funding relief will be welcomed by cash-strapped plan sponsors. Again, I would recommend that any temporary broad-based funding relief provisions lead to a meaningful reduction in the solvency funding requirements on a short-term basis, with very limited or no conditions attached.
For pension plans, there needs to be a delicate balance between benefit security and affordability. To this end, while public policy strives for secure pensions, it must also be cognizant of the fact that employers are not mandated to offer defined benefit pension plans and thus long-term plan sustainability may require a bit of temporary funding relief from time to time.
Nevertheless, the federal government should strive for a more robust funding regime that attempts to reduce contribution volatility while protecting accrued pensions. In a future blog, I will turn my attention to the other proposals in the Consultation Paper, some of which attempt to address this challenge.