2020 is Over… What Happened And Now What?
2020 is Over… What Happened? And Now What?
It is that time of year again when pension plan sponsors take stock of the past year — and hopefully have the time and ability to make plans for the year ahead.
What Happened in 2020?
The COVID-19 pandemic certainly stole the headlines in 2020. The financial markets took a significant dive in March, but made a dramatic recovery throughout the remainder of 2020.
All in all, equities had a decent year in 2020. The TSX Composite Index generated a return of about 6%, the US S&P 500 equity index was up around 16%, and most international equity indices also generated positive returns. Furthermore, fixed income indices posted respectable positive returns with short-term fixed income indices generating a return of about 5%, and long-term fixed income indices generating a return of about 12%.
When comparing December 31, 2019 to December 31, 2020, the yields on long-term government bonds decreased by about 65 basis points. Furthermore, the initial non-indexed commuted value interest rate assumptions decreased by 100 basis points, and the ultimate non-indexed commute value interest rate assumption increased by 40 basis points (inclusive of the changes to the interest rates in the new commuted value standards). As noted in a blog from last year, the commuted value standards changed effective December 1, 2020, with one of the key changes being that pension plans with generous early retirement subsidies could see a decrease in their solvency liabilities due to the changes in the pension commencement age assumption. As a result, and depending on the characteristics of the plan, I estimate that the solvency liabilities for pension plans that do not have overly generous early retirement subsidies are likely to increase by about 4% to 8%.
Thus, when looking at a pension plan as a whole, it is our expectation that unhedged pension plans (i.e. those that have not de-risked) that do not have overly generous early retirement subsidies will generally see that their solvency position at the end of 2020 relatively unchanged from their position at the beginning of the year. In contrast, pension plans that have generous early retirement subsidies may see that their solvency position improved by a slight margin in 2020.
Accounting Position at December 31, 2020
2020 also saw a fairly dramatic decrease in the yields on high-quality corporate bonds, with such yields decreasing by about 50 to 70 basis points from December 31, 2019 to December 31, 2020. Many plan sponsors use these yields to develop the discount rate assumption for the benefit obligations used in their financial statement accounting entries. As such, plan sponsors with December 31st financial reporting dates can expect the benefit obligations for their pension and other post-retirement benefit plans to increase by as much 6% to 10% due to the change in the discount rate alone.
When considering the relatively favorable investment experience in 2020, it is our expectation that unhedged pension plans may see a slight deterioration in their accounting position (with benefit obligations increasing slightly higher than plan assets).
Areas of Focus for 2021
My bold prediction for 2021 is that it will be a year where our industry devotes energy responding to the COVID-19 pandemic and trying to develop more robust rules to support plans.
In responding to the COVID-19 pandemic some jurisdictions are considering further funding relief options for 2021 – see my previous blog regarding the options being considered by the Federal government and Jason’s previous blog regarding the funding deferral options available to Ontario registered pension plans. As I have stated before, when considering funding relief options, I believe legislators and regulators should consider temporary broad-based funding relief provisions that would lead to a meaningful reduction in the solvency funding requirements on a short-term basis with no (or very limited) conditions.
Legislators and regulators are increasingly looking to improve regulations and implement new plan design options. To this end, I commend the Quebec government for implementing in December their version of target benefit pension plans and making this style of plan design an option for Quebec employers. Also, I commend the Ontario government and pension regulator for improving the regulatory efficiency and allowing employers of certain individual pension plans to elect to exempt these types of plans from the application of the Pension Benefits Act and its regulations. Furthermore, I will be following the progress of the Technical Advisory Committee on Defined Contribution Plans established by FSRA and OSFI which will review the approaches to supervising such plans and finding opportunities for regulatory improvement.
Updates to the CPA Canada Handbook
Finally, for plan sponsors who report under the Canadian Private Enterprises or the Not-for-Profit accounting standards, it is worth noting that Section 3462 of these accounting standards was amended in November 2020 to clarify the measurement of the Defined Benefit Obligation. Specifically, section 3462 was updated such that:
- for plans with a legislative, regulatory, or contractual requirement to prepare a funding valuation, entities may continue to use such a going-concern funding valuation as the measurement of the Defined Benefit Obligation, but they must include any amount that is required to be funded by the rules and regulations (e.g. including the Provision for Adverse Deviations for Ontario registered plans); and
- remove the accommodation to allow the use of a funding valuation approach for defined benefit plans without a funding valuation requirement (i.e. the Defined Benefit Obligation for post-retirement health benefit and supplemental executive plans will now need to be measured using a separate valuation for accounting purposes).
This change becomes effective for fiscal years beginning on or after January 1, 2022, and earlier application is permitted if used for all of an entity’s defined benefit plans.
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As a reminder, we always encourage plan sponsors to consider balancing the various risks inherent in their plans, and to frequently review their long-term strategy for providing pension benefits, as well as to review their investment and funding policies. As entities have worked hard to manage their response to the COVID-19 pandemic in 2020, and with the solvency position of many pension plans in a decent position, it may be an ideal time for plan sponsors to refocus and review their pension plan(s).
Like many of you, I was not sad to say goodbye to 2020, and here is hoping for a bright and sunny 2021!