However, the changes will increase compliance costs for plans in surplus, since they would only otherwise be required to prepare a valuation every third year. Further, employer contribution holidays will only be permitted to the extent that plan assets are above 105% of solvency liabilities. This will provide a margin to reduce the likelihood that a plan is in deficit following a contribution holiday.
The regulatory changes will also impact partial plan terminations. Plan sponsors will no longer be able to declare a partial plan termination. This change was made to address the issue of plan members being treated differently depending on the precise circumstances and date of their termination.
Unlike Quebec, where all partial plan terminations were eliminated a few years ago, the Superintendent of Financial Institutions can still declare a partial plan termination. Following plan termination, the law has been clarified to require the plan sponsor to amortize any windup deficiency over a period not to exceed five years. This change brings the federal standards in line with other jurisdictions and eliminates the loop-hole whereby a plan sponsor could voluntarily terminate a plan and walk away from the deficit.
Increased member disclosure is also addressed in the proposed changes, requiring plan sponsors to provide additional information to plan members, particularly in respect of the financial status of the plan and the holdings of the pension fund. Annual statements will also be required for former members and retirees, which will further increase compliance costs for plan sponsors.
Financial relief for plan sponsors
There are four significant changes providing relief for plan sponsors faced with funding a solvency deficit.
Minimum funding requirements
First, minimum funding requirements will be determined based on the average solvency ratio over a three-year period. As an aside, solvency smoothing is in place in other Canadian jurisdictions, but this will be the first time that the solvency funded ratio (instead of the solvency assets or solvency liabilities) will be smoothed.
The federal changes should smooth out the volatility when the solvency ratio is declining. However, it is unclear how these new rules will work when the current solvency ratio is above 100% but the three-year average is below 100%. We have to hope that the final regulations do not require solvency amortization payments in this case—perhaps the funding deficit could be established as the lesser of the current deficit and the three-year average deficit.
Amortization payments
The second change is that amortization payments will be determined on a “fresh start” basis at each valuation. This will provide relief to sponsors as subsequent solvency gains will now immediately reduce the rate of payment (which is not permitted under the current regulations) and the impact of solvency losses will be lessened by re-spreading the unamortized amount of prior deficits over an additional year. This change will also eliminate complexity in the determination of contribution requirements and make the funding requirements easier to understand for sponsors and members.
Letters of credit
Third, plan sponsors will be able to use letters of credit to satisfy certain solvency funding requirements for the plan. While there is a limit to the amount that letters of credit can cover (15% of plan assets), these instruments provide an additional option for plan sponsors. While the change doesn’t address the inherent asymmetry of pension funding risks faced by sponsors (i.e., plan sponsors fund deficits while surplus ownership is often disputed), it does reduce the risk that a plan sponsor have a plan surplus soon after making substantial contributions towards a deficit. Of course, this option will only be available to plan sponsors who have sufficient credit available.
Special cases
The last significant change applies in the special case where a company is in serious financial trouble. Going forward, the stakeholders (plan sponsor, plan members and retirees) can jointly reach an agreement on how best to fund the deficit, subject to Ministerial approval. This would be a unique provision in Canadian pension law, but will provide additional flexibility and greater agility to develop customized solutions to be reached for special situations, similar to those recently addressed via regulation for various federal and Ontario-based pension plans.
Clearly, the devil is in the details with many of the proposed changes, and the exact impact on each stakeholder will not be known for awhile yet. While, it does not appear that these changes will increase the level of uniformity between Canadian jurisdictions, the federal changes may signify the start of a new period of pension reform which, hopefully, will see pension standards moving forward to address the challenges faced by the next generation of pension plan stakeholders.
Philip Morse is a Principal in Towers Perrin’s Toronto office.
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