Breaking down Ontario pension reform

The changes will affect plan sponsors differently, but it isn’t immediately obvious whether a particular plan sponsor will benefit from the government’s announcement. However, while the proposed regulatory amendments to support these updates have not yet been posted, the government has indicated that stakeholders will be provided an opportunity to review the draft amendments and it’s expected that they will also accept commentary for consideration.

Redefining the Funding Rules
The government is refining several aspects of Ontario pension law, including the regulations affecting pension funding. Ontario, like other Canadian jurisdictions, recently implemented temporary changes to facilitate a degree of funding relief for many Ontario plan sponsors. While this provided employers with a one-time opportunity to mitigate significant contribution increases to their pension plans, it was not a long-term solution.

The stated objective of the new regulations is to strengthen the funding of Ontario plans to achieve not only greater financial security for plan members, but to provide an environment where plans are better able to handle adverse financial experience.

The government is considering the following changes:

• Eliminate smoothing of solvency discount rates — this will bring Ontario back into line with other provinces in requiring that the solvency liability be a current market estimate of the costs to settle the plan, and not a derived value.

• Require asset smoothing methods to consider experience over no greater than a five year period and limit the smoothed value of assets to be within 20% of market value — these changes will require some actuaries to update their asset smoothing methods to comply with the five-year rule, but this should not materially affect the results of most actuarial valuations. The ability to maintain asset smoothing for solvency valuations (without the corresponding discount rate smoothing) will provide plan sponsors with a degree of natural solvency funding relief following periods of significant asset decline.

• Define “solvency concerns” to mean any plan with a solvency funded ratio below 85%, and continue to require a plan which has solvency concerns to file valuations at least annually — this change will be a relief to most sponsors, given that the current approach is complicated (80% is the threshold for some plans, 90% for others, with a sliding scale for plans in a certain size range). For plans with over $50 million of solvency liabilities, the threshold will decrease from 90% to 85%.

• Defer amortization of experience losses or new solvency deficits by up to one year from the valuation date — this change will bring single employer plans in line with Jointly Sponsored Pension Plans (JSPPs), for which this rule already exists. This will be a welcome change for plan sponsors who can otherwise be faced with significant “retroactive contributions” owing following the filing of their updated actuarial valuations. The change will allow companies to better budget for their upcoming pension contributions, rather than scrambling to make a significant special payment immediately.

• Permit employers to pledge a letter of credit instead of making certain contributions — employers will have the ability to use a letter of credit as an asset in the plan, reducing the immediate cash flow requirements for the employer. This creates a potential mechanism for reducing the likelihood of surplus development. If a plan with a letter of credit otherwise develops a surplus, presumably the letter of credit can be eliminated or reduced, without any surplus ownership complexities.

• Accelerate the funding of benefit improvements — To reduce the adverse effect that plan improvements can have on a plan’s funded position, any amendment which serves to reduce the going concern’s funded ratio or transfer ratio below 85% will require an immediate lump sum contribution to restore the transfer ratio to the level immediately prior to the amendment. The balance of the cost of the amendment must be funded over no more than five years. This means that a plan which is 70% funded will need to fund 70% of any improvement immediately upon amendment. This would particularly affect collective bargaining in cases where the company cannot afford to immediately fund a sizable portion of a negotiated pension improvement.

Surplus and Contribution Holidays
The government’s proposed changes will only permit plan sponsors to take a contribution holiday if, by taking the holiday, the plan’s transfer ratio will not be reduced below 105%.

It will be necessary to see the proposed regulation to understand how a plan sponsor will demonstrate compliance with this requirement. For example, it appears acceptable for a plan which has a transfer ratio of 110% in the latest actuarial report to take a contribution holiday of up to 5% of the windup liability. However, in the year of the contribution holiday, the plan could suffer adverse experience (asset decline and/or changes in market interest rates) after taking the contribution holiday causing a degradation of the transfer ratio below 105% (or even below 100%).

One would hope that the final regulations will be written to clarify the responsibilities of the employer around monitoring the funded status of the plan between actuarial valuations.

For plans that take a contribution holiday under the proposed regulations, the plan sponsor will be required to disclose certain information to all eligible beneficiaries of the plan. This may not affect many plans in the current economic climate but it creates another disclosure requirement for plans with a surplus.

The surplus entitlement rules and surplus sharing processes are being updated to reduce some of the complex and costly processes, including litigation, which often arise following plan wind-up or during the development of a surplus-sharing agreement. In particular, plan sponsors will be able to withdraw surplus from an ongoing plan with the consent of 2/3 of members, as long as the remaining surplus exceeds the greater of 25% of windup liabilities or two years of normal actuarial cost plus 5% of windup liabilities.