On October 27, 2009 the Honourable Jim Flaherty, Minister of Finance, announced measures to modernize the federal private pension legislative and regulatory framework. The reform follows consultation earlier this year and will affect all pension plans registered under the federal Pension Benefits Standards Act, 1985 (PBSA). A change to the Income Tax Act (ITA) was also announced that will apply to all registered defined benefit pension plans in Canada.

Amendments to the PBSA, the PBSA Regulations and the ITA will be necessary to implement the reform. Many details will not be known until these amendments are released.

With the exception of the ITA change, which is to be effective for 2010, the effective date of the changes is not disclosed. We expect, based on the usual process of tabling legislation and publishing regulations, that the reforms will not be enacted until mid-2010 at the earliest.

Financial Measures for Defined Benefit Plans

There are several measures that affect the financing of defined benefit pension plans.

Some measures are described as enhancing protection for plan members:

• An employer will be allowed to take a contribution holiday only if the pension plan is more than 105 per cent funded on a solvency basis.
• Upon plan termination, an employer will be required to fully fund pension benefits. Any solvency deficit that exists at the time of termination will be required to be amortized in equal payments over no more than five years. The employer obligation will rank as unsecured debt in bankruptcy.
• The existing void amendment rule will be brought into effect to prevent benefit improvements for plans with a solvency ratio after the improvement of 0.85 or less. It will be possible to make immediate additional contributions to support an amendment that would otherwise be void.

Some measures are intended to reduce funding volatility for plan sponsors:

• Consolidation of solvency special payment schedules will be made at each actuarial valuation, with a reamortization of the deficit over five years.
• Minimum funding requirements on a solvency basis will be based on an average of solvency ratios over the three most recent consecutive years. The solvency ratios will be based on market value of assets. This averaging is expected to replace the current ability to smooth assets over a period of not more than five years. The exact calculation method for this average solvency ratio is not yet known.
• Solvency special payments may be replaced by letters of credit provided the total value of letters of credit does not exceed 15 per cent of plan assets.
• The going concern contribution requirement would be maintained. The going concern methodology and its 15 year amortization period will remain unchanged.
• The 10 per cent pension surplus threshold in the ITA, above which employers are not allowed to make current service contributions, will be increased to 25 per cent. This change will affect all registered defined benefit pension plans in Canada.

Other financial changes include:

• Actuarial valuations will be required annually regardless of funded status.
• Annuity purchases for an ongoing plan will be restricted in the same way the transfer of commuted values is restricted for underfunded plans.
• Employer contributions to a plan will be required monthly rather than quarterly.

Some of these measures, such as the ability to replace solvency payments by letters of credit, will be welcomed by plan sponsors. However, letters of credit may not be easily accessible during difficult financial markets when they would be most needed. Other proposed measures generally fall short of plan sponsors’ expectations and may have limited, if any, impact in reducing financial pressure. In fact, the combined effect of the solvency ratio averaging and the 5 per cent margin required before a contribution holiday can be taken creates a bias toward greater funding without any additional access to surplus for the employer if overfunding occurs.

Measures for Members

Members’ benefits and rights will be enhanced as follows:

• Immediate vesting (while maintaining the two year locking in rule and the waiting periods for membership).
• More financial disclosure in annual statements including total assets and liabilities of the plan, total employer contributions for the year and a summary of the plan’s investment allocation and top 10 investment holdings.
• Annual statements for deferred vested members and pensioners with relevant plan information.
• Extension of small pension unlocking to apply at retirement, not just at termination or death.

Although not specified, these measures appear to apply to all plans, except for the financial disclosure which is oriented toward defined benefit plans. There is a promise to allow electronic communication on a positive consent basis that might alleviate the added administrative burden somewhat. However, obtaining the positive consent may be administratively cumbersome.

A new rule will allow separated spouses to deal with pension entitlements in a way that would otherwise fail to comply with the PBSA requirement for a joint and survivor pension. This could mean that waiver of a spouse’s joint annuitant status will be permitted after pension commencement when occasioned by breakdown of the relationship, even if the pension is not divided.

Customized Rules by Plan Type

The reforms respond to the call for better differentiation in the rules as they apply to different types of plans.

Defined Contribution Plans

There is a promise to revise the PBSA to clearly articulate the rules that apply to defined contribution plans. The announcement mentions that these rules will include:

• Guidance on employer, member, administrator and investment provider responsibilities using the Capital Asset Plan (CAP) Guidelines as best practice.
• Elimination of the requirement for a Statement of Investment Policy and Procedures for CAP defined contribution plans.
• It will be possible for defined contribution plans to offer Life Income Fund-type benefit payments directly from the plan.

Fixed Cost Defined Benefit Plans

A formal definition of Negotiated Cost Defined Benefit Plan will be created. For these plans there will be:

• Criteria for the composition of the Board of Trustees concerning employer, employee and retiree representation.
• Authority to reduce benefits, subject to the Superintendent’s approval, regardless of plan provisions.
• An exemption from the successor plan rules where a defined contribution component of a negotiated contribution plan is created.
• Enhanced disclosure of the nature of the plan and its funded status.
• A requirement for a valuation report to include options for the Board of Trustees to consider if the plan is not meeting funding requirements.

The benefit reduction rule will provide clarity and might prevent litigation about the plan terms on this point. For purposes of valuations and options for the Board of Trustees to consider for managing funding shortfalls, a lag between the valuation date and the remedial measure will be needed. Glaring in its absence is a proposal to exempt fixed cost plans from solvency funding requirements.

Plan Termination

Sponsor declared partial plan terminations will be eliminated. It is not evident why regulator declared partial plan terminations are not also eliminated. This measure is not significant for members as they will now enjoy immediate vesting in any event. While the Monsanto surplus distribution problem for sponsors of federal pension plans has been resolved by the Marine Atlantic litigation, a stronger lead from the federal government by eliminating partial terminations entirely would have been welcome.

There will be improved disclosure to members in plan termination situations.

Most importantly, the benefits of members who cannot be located may be transferred to “a central repository”. The announcement does not provide any description of the repository.

Plans in Distress

A scheme will be adopted for distressed pension plans where a plan sponsor is not able to meet funding requirements. The scheme is intended to be used in very limited circumstances. A plan sponsor, through its Board of Directors, can declare that it is unable to make its upcoming special payment. This will trigger a short moratorium on solvency payments. Then a settlement would be negotiated by the sponsor and representatives for employees, deferred members and pensioners, all subject to Ministerial approval. Changes that could be negotiated include the schedule of payments and, presumably, benefit reductions.

This scheme is similar to what was implemented for Air Canada pension plans in 2009 through the Air Canada Pension Plan Solvency Deficiency Funding Regulations.

Investment Rules

The existing prudent person standard for investment of plan assets will be maintained but some changes to the quantitative investment limits will be made as follows:

• The limit on resource and real property investments will be removed.
• The 10 per cent concentration limit for investment in any one entity will be based on market value rather than book value. There will be an exception to this rule for pooled investments not directly controlled by the employer.
• Direct self investment in the debt or shares of the employer will be prohibited.

These changes will also take effect for plans registered in provinces that adopt the rules in Schedule III of the PBSA Regulation as amended from time to time, including Alberta, British Columbia and Saskatchewan. Ontario uses the federal rules as they were in effect as of December 31, 1999.

Supervision

The Superintendent will acquire power to intervene when there are concerns about the work of a plan’s actuary. It will be made clear that a plan custodian’s obligation to report late remittances applies for both amount and time. In keeping with the trend in other jurisdictions, Ministerial authority to enter agreements with the provinces for the administration of multi-jurisdiction plans will be added.

Comment

The proposed measures do modernize and clarify some of the rules that have been in the PBSA or PBSA Regulations since their coming into force.

Several of the measures will increase protection for plan members and will likely be viewed favourably by members.

The measures will do little to promote the continuation of defined benefit pension plans. The rules encourage higher funding of pension plans by employers with no corresponding additional access to surplus assets for employers when overfunding occurs.

The short term impact on funding requirements, which is the main priority and concern for a vast majority of defined benefit plan sponsors, will highly depend on how transition rules are designed.