Strengthening the Framework for Federally Regulated Pension Plans
There are just two more days to respond to the Consultation Paper issued by the Department of Finance of Canada, which is seeking input on the potential options for temporary broad-based solvency funding relief in 2021, as well as measures to strengthen the framework for federally regulated pension plans. In my previous blog, I provided commentary on the temporary broad-based solvency funding relief. In this blog, I will focus my commentary on the measures proposed to strengthen the framework for federally regulated pension plans.
Again, this is an extensive Consultation Paper which follows-up on the legislative changes announced by the Federal Government in the 2019 Budget and their 2018 consultation on Enhancing Retirement Security.
Plan Administration and Governance
The government is proposing that all federally regulated pension plans establish a governance policy that would be made available to OSFI upon request. In developing a governance policy, a plan sponsor formally documents their various plan governance processes, and the roles and responsibilities of plan managers and service providers. For plan sponsors that do not already have a formal governance policy, developing one can help formally document individual responsibilities, and illuminate processes that can be improved. Having a formalized governance policy is often helpful – however, simply documenting a governance policy will not lead to better plan governance on its own.
Another proposal is to extend the pension committee representation to include plan members and retirees. It is my belief that the pension committee should be limited to those who have decision making authority. Extending representation to individuals who do not have decision making authority will increase administrative costs and will not have any meaningful impact. Clearly, for multi-employer and negotiated contribution style plans, whereby the benefits can be altered, it makes sense to have member and retiree representation so that they can have input on the risk management of these types of plans. However, for the typical single-employer defined benefit plan, whereby the plan sponsor bears the risk of providing the benefits, I do not see any value of extending pension committee representation to plan members or retirees. If the government has specific concerns on this topic, I feel they should be addressed with additional disclosure requirements.
The government is also proposing that all multi-employer negotiated contribution plans establish a funding policy; and while not required, single-employer and non-negotiated contribution plans would be encouraged to establish funding policies. My view on this subject is consistent with the commentary provided in the consultation paper – that funding policies are very important for negotiated contribution plans whereby benefits can be increased or decreased in response to funding ratios, and that they are not necessary for single-employer defined benefit plans whereby the benefits are backed by the employer.
Solvency Reserve Accounts
I am very pleased to see the federal government considering the implementation of Solvency Reserve Accounts. A Solvency Reserve Account is a separate account within the DB pension fund into which an employer could remit solvency special payments that could later be recovered when the plan is in a surplus position. By implementing Solvency Reserve Accounts, plan sponsors may feel inclined to contribute more than the bare minimum to their plans, and at the very least it lessens the funding asymmetry related to trapped surplus.
However, in implementing Solvency Reserve Accounts, there are a number of items that the federal government would need to consider, including whether contributions to the account should be limited to only solvency special payments, the funding thresholds required to allow for a refund, and the restrictions on withdrawals.
In my opinion, while it seems reasonable to limit Solvency Reserve Accounts to solvency special payments, consideration should be given to the fact that some plans are well over 100% funded on a going-concern basis, and are only required to make contributions due to the fact that they are less than 100% funded on a solvency basis. Also, it seems appropriate to set certain thresholds, such as a funding ratio of over 105% on a solvency and going-concern basis, before permitting a withdrawal. While it would be ideal to have these thresholds reflect the risk profile of the plan, such an approach would be impractical. As such, it is likely best if any surplus is withdrawn gradually over a period of say three to five years.
Finally, when disclosing information about Solvency Reserve Accounts to plan members, it should be kept simple. For example, the annual member statements provided to members could simply outline the total value of assets in the Solvency Reserve Account, as well as the contributions or withdrawals made in the past year.
Variable Payment Life Annuities
In a previous blog, I applauded the federal government for implementing VPLAs. However, I noted that as VPLAs are currently proposed, they will only draw interest from sponsors of extremely large DC plans that are willing to provide a more paternalistic decumulation option. For this reason, my preference would be to see VPLAs established by financial institutions like insurance companies or large multi-employer pension funds (e.g. a Pooled VPLA product administered by a financial institution or plan administrator). Nevertheless, I believe VPLAs are structured best if they allow members from other DC RPPs, or even RRSPs, to transfer a portion of their accumulated retirement savings into a VPLA pool at pension commencement (i.e. members should be able to control how much money is allocated to a VPLA, but be required to select an immediate pension option with spousal consent).
Personally, I believe VPLAs should be required to perform actuarial valuations on an annual basis, and potentially required to consider updating benefits on an annual basis too. While this will produce greater volatility in the benefits being provided by the VPLA, it will ensure that any issues with the funding are addressed sooner rather than later. [To elaborate on this further, I do not understand why the federal government effectively requires single-employer DB pension plans to perform full valuations every year, but then would allow VPLAs to do valuations on a triennial valuation cycle. While I understand the arguments for reducing the administrative burden, in my mind, this should be prioritized for single-employer DB plans where the benefits are backed by the plan sponsor, not for VPLAs where the benefits should be adjusted regularly to capture plan experience.]
Overall, I believe the measures addressed in the Consultation Paper are a step in the right direction. That being said, if the federal government really wants to enhance retirement security by a having a more robust retirement savings system, then it needs to give serious consideration to adopting rules for target pension arrangements. To this end, the work on VPLAs is a decent place from which to start. However, in my opinion, the measures to support the sustainability of DB plans outlined in the Consultation Paper are merely a stop-gap solution along the eventual declining path for DB plans in Canada.