Archived - Regulatory Impact Analysis Statement
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Solvency Funding Relief Regulations, 2009
Under the Pension Benefits Standards Act, 1985 (the "Act"), the federal government regulates private pension plans covering areas of employment under federal jurisdiction, such as telecommunication, banking and inter-provincial transportation. The Office of the Superintendent of Financial Institutions (OSFI) is responsible for the supervision of such plans. OSFI supervises some 1,350 pension plans or about 7 per cent of all pension plans in Canada, representing about 12 per cent of trusteed pension fund assets in Canada; 446 of the federal plans are defined benefit pension plans.
The Act requires that federally registered pension plans fund promised benefits in accordance with standards set out in the Pension Benefits Standards Regulations, 1985 (Regulations). Defined benefit pension plans must file actuarial valuations every three years, or more frequently as required by the Superintendent of Financial Institutions (the "Superintendent"). Where these valuations show a pension plan's assets to be less than its liabilities, payments must be made into the plan to eliminate the deficiency over a prescribed period of time, as described below. While private pension plans are voluntary, they must generally be registered, either federally or provincially. One of the main purposes of regulation is to set out standards for funding and investment of pension plans to ensure that the rights and interests of pension plan members, retirees and their beneficiaries are protected. In particular, regulation is intended to ensure that pension plan assets are sufficient to meet pension plan obligations.
Actuarial valuations of defined benefit plans are conducted using two different sets of actuarial assumptions: "solvency valuations" use assumptions consistent with a plan being terminated, while "going-concern valuations" are based on the plan continuing in operation. If a solvency valuation reveals a shortfall of plan assets to plan liabilities, the Regulations require the plan sponsor to make special payments into the plan sufficient to eliminate the deficiency over five years. Where a deficiency exists on the basis of a going-concern valuation, the Regulations require special payments to eliminate the going-concern deficiency over 15 years. In general, the payments that a plan sponsor must remit to a plan in a given year include the amount necessary to cover the ongoing current service costs associated with the plan, plus any "special payments" required in that year to pay down a funding deficiency over the relevant time period.
Pension plan funded levels have experienced much volatility in recent years. In the mid-part of this decade, a sharp decline in long-term interest rates along with changes in actuarial standards, such as the longevity assumptions, resulted in increased plan liabilities. Combined with poor investment returns, these factors led to many plans being underfunded on a solvency basis. To address the pressure that increased funding requirements put on plan sponsors, the government adopted the temporary Solvency Funding Relief Regulations (the "2006 Regulations") in November 2006. The 2006 Regulations provided solvency funding relief through four temporary measures. These measures provided for the solvency deficiencies of federally regulated defined benefit pension plans to be addressed in an orderly fashion while providing safeguards for pension benefits. The options included: a consolidation of solvency payment schedules with amortization over a single, new, 5-year period; an extension of the solvency funding payment schedule from 5 to 10 years, subject to a condition of buy-in by plan members and retirees; an extension of the solvency funding payment schedule from 5 to 10 years with letters of credit; and, an extension of the solvency funding payment schedule from 5 to 10 years for agent Crown corporations, subject to terms and conditions that would ensure a level playing field. As of March 31, 2008, 75 plans availed themselves of the funding relief offered under the 2006 Regulations.
Since the 2006 Regulations were adopted, funding levels have strengthened. As of December 31, 2007, OSFI estimated that the average funded ratio for federally regulated defined benefit plans was 1.05, which was up from 0.90 as of December 31, 2005. The percentage of plans in an unfunded position improved during this time period as well, moving from 78 per cent of plans as of December 31, 2005 to 56 per cent as of December 31, 2007.
Recently, the funding levels of defined benefit pension plans have been deteriorating. As of June 30, 2008, OSFI estimates that the average funded ratio for federally regulated defined benefit plans was 0.98. The percentage of plans in deficit in June 2008 was 71 per cent, compared to 56 per cent in December 2007. Since June, the global credit crisis has led to a sharp decline in global equity markets that has reduced the funded status of federally regulated private pension plans. The decline in the market value of plan assets will result in many sponsors being required to make large special payments. The magnitude of these special payments could damage the financial condition of the companies that sponsor these pension plans and divert available funds away from operating capital. These problems would be especially pronounced given current conditions in credit markets.
Plan valuations and funding obligations will crystallize with their next valuation reports, which for most plans will have an effective date of December 31, 2008. Given that reports must be filed with the Superintendent within six months after the valuation date, December 31 reports will be required to be filed by June 30, 2009.
As announced in the 2008 Economic and Fiscal Statement, under the present extraordinary circumstances, the Solvency Funding Relief Regulations, 2009, (the "2009 Regulations") will allow federal pension plans to extend their solvency funding payment schedule from 5 to 10 years in respect of a solvency deficiency reported at a plan year-end date from November 1, 2008 to October 31, 2009, subject to certain conditions.
Under the 2009 Regulations, a plan sponsor will be able to seek funding relief in respect of that deficiency by choosing one of the four temporary measures outlined below. Any prior or future solvency deficiencies would be funded in accordance with the Regulations, 2006 Regulations or Air Canada Regulations1, as the case may be. The measures are only available for plan sponsors that are up to date in their funding payments. Sponsors may also choose to continue to fund under the rules set out in the Regulations.
Plans that availed themselves of funding relief under the 2006 Regulations will be permitted to fund according to the terms of the 2009 Regulations. There is nothing in the 2009 Regulations that would impact the obligations or conditions imposed under the 2006 Regulations. Plans subject to the Air Canada Regulations would be eligible to be funded according to the 2009 Regulations with respect to the deficiency that emerged at a plan year-end between November 1, 2008 and October 31, 2009. Other deficiencies of such a plan would continue to be funded according to the terms applicable to those deficiencies.
Under the proposed 2009 Regulations a plan sponsor will be able to seek funding relief by choosing one of the four temporary measures outlined below, depending on its particular circumstances.
- Extension of the Solvency Funding Payment Period by an Additional Year: All sponsors who are up-to-date in their regulatory payments will be eligible to extend their solvency funding payment period to 10 years when filing the valuation report for a year-end date between November 1, 2008 and October 31, 2009. However, if members and retirees do not consent, or a letter of credit cannot be secured, or the conditions applicable to agent Crown corporations below are not met by the next plan year, the sponsor will be permitted to fund the outstanding amount of that deficiency over a new 5 year schedule commencing at that date.
- Extension of the Solvency Funding Payment Period to 10 Years
with Member and Retiree Support: Plan sponsors will
be permitted to extend the period for making solvency funding
payments from 5 years to 10 years, provided that no more than
one-third of active plan members or non-active members and beneficiaries,
including retirees, object. The support condition, which is
based on plain language disclosure, will ensure that the parties
are fully informed of the extended schedule and its implications.
The difference between the 5 year and 10-year level of payments
would be subject to a deemed trust. Under provisions of the
Act and the 2009 Regulations, this amount is deemed to be held
in trust for active members, non-active members and beneficiaries,
Under this option, there will be a restriction on plan improvements in the first 5 years unless the improvements are pre-funded so that the solvency ratio of the plan is not reduced by the benefit improvement. Alternatively, a plan sponsor could make plan improvements by opting out of the 10-year funding schedule and returning to the normal 5-year funding schedule.
- Extension of the Solvency Funding Payment Period to 10 Years
with Letters of Credit: Plan sponsors will be permitted
to extend the period for making solvency funding payments to
10 years on the condition that the difference each year between
the 5-year and 10-year level of payments is secured by a letter
of credit obtained by the plan sponsor and held by a trustee.
This option would reduce the level of annual solvency payments
for plan sponsors while protecting pension benefits.
By issuing a letter of credit to a plan sponsor, the financial institution would essentially be guaranteeing the difference between the 5-year and 10-year level of payments. Should the plan sponsor, for example, terminate the plan, go bankrupt or file for protection under the Companies' Creditors Arrangement Act during this period, the trustee would make a demand for payment from the financial institution issuing the letter of credit. The letter of credit would also be payable on the demand of the trustee if the letter of credit were not renewed or replaced on its expiry date. Upon receiving the demand for payment, the issuing financial institution would be required to immediately pay the full amount of the letter of credit to the pension fund. If the financial position of the pension plan improves due to changes in market performance and/or increase in long-term interest rates, plan sponsors would be able to reduce or eliminate the letters of credit to the extent that they are no longer required as set out in the 2009 Regulations.
The plan sponsor would normally have to pay an annual fee to the financial institution for obtaining a letter of credit. The fee typically would vary depending on the plan sponsor's credit worthiness.
- Extension of the Solvency Funding Payment Period to 10 Years for Agent Crown Corporations: Agent Crown corporations with defined benefit pension plans governed by the PBSA represent a special case. Agent Crown corporations will be eligible for the option requiring member and retiree support, but not for the measure requiring letters of credit. In place of the option requiring a letter of credit, agent Crown corporations are permitted to extend the period for making solvency funding payments to 10 years subject to meeting the applicable terms and conditions in the 2009 Regulations. These terms and conditions include the filing of an acknowledgement in writing by the Minister of Finance and the Minister responsible for the agent Crown corporation that it intended to pursue this measure. In order to encourage a level playing field, it is anticipated that if the agent Crown corporation uses this option it would agree to pay a fee to the Government comparable to the fee that would be paid to obtain a letter of credit. There are 10 agent Crown corporations with an active defined benefit pension plan.
In addition to these funding relief measures, federally regulated pension plans are able, subject to guidance established by OSFI, to take advantage of the smoothing of asset value changes over a period of not more than five years to stabilize short-term fluctuations. As detailed in OSFI specifications issued on March 6, 2009, plans will be permitted to temporarily use asset smoothing using market values above the 110 per cent limit. As announced in Budget 2009, under the 2009 Regulations, any deferral of funding that results from the use of an asset value in excess of 110 per cent will be subject to a deemed trust.
The current economic environment is placing significant stress on many plan sponsors, which could affect the viability of defined benefit pension plans and benefit security. The relief that would be provided by the 2009 Regulations recognises the immediate impact of current market conditions by allowing all plans to benefit from one year of funding according to an extended schedule. It also strikes a balance between the status quo, whereby the current 5-year funding rules would be maintained, and simply extending the funding period to 10 years without conditions, as advocated by some sponsors.
Maintaining the current funding requirements over the short-term in these difficult circumstances would result in continued financial stress for many plan sponsors, which could affect their business operations and on-going viability. The ongoing tightening of credit markets and economy further magnifies these difficulties. This could ultimately lead to a reduction in pension benefits.
The 5-year funding period is seen in most circumstances as an appropriate timeframe to eliminate any solvency deficiency, as it represents a balance between the funding of plans and the protection of pension benefits. Extending the solvency funding payment period to more than five years without any additional protections could negatively affect benefit security. As such, the 2009 Regulations provide protections to mitigate risks to plan members and retirees.
An assessment under the strategic environmental assessment policy has been conducted and concluded that there are no important environmental effects.
Benefits and Costs
The implementation of the 2009 Regulations will help protect the interests of plan members and other beneficiaries by providing solvency funding flexibility in recognition of the difficult circumstances facing federally regulated defined benefit pension plans. The 2009 Regulations will provide some regulatory relief for plan sponsors by offering them a choice of options. These options allow for reduced annual solvency payments in the short-term while providing appropriate safeguards to protect plan member's pension benefits, recognizing that the level of pension benefits is best secured through solid funding practices and a financially viable plan sponsor.
Only modest additional costs are anticipated for OSFI to administer the proposed 2009 Regulations, as the increased funding options will make the supervision of pension plans more complex and will require additional guidance be issued to plan administrators. Existing supervisory procedures and information systems will not require significant changes.
Potential costs to a pension plan sponsor would depend on whether it chose to avail itself of the 2009 Regulations, and which option it chose. For example, there would be a cost of obtaining a letter of credit for a plan sponsor that sought relief through this measure. In the case of agent Crown corporations, there could be a cost associated with the fee to the Government that would be comparable to the fee that would be paid to obtain a letter of credit. With respect to a sponsor who elected to pursue the buy-in measure, it would incur costs associated with disclosing the required information to active members, non-active members and beneficiaries including retirees and seeking their buy-in.
There will be no direct cost to beneficiaries of affected pension plans. However, because of potential risks associated with extending the period for funding solvency deficiencies, such as a plan termination with a deficiency, the 2009 Regulations include terms and conditions intended to mitigate potential risks to plan members. Accordingly, the 2009 Regulations will require that beneficiaries be informed of the implications of the longer amortization period for the solvency deficiency, and, for the extension with buy-in option, there will also be a requirement that no more than one third of active members or retirees object to the company's election to come under the provisions of the 2009 Regulations.
The 2009 Regulations benefit from extensive consultations in 2005 conducted by the Department in respect of defined benefit pension plans, as well as specific consultations on the 2006 Regulations. In addition, departmental officials are in regular contact with members of a wide range of stakeholder groups, including plan sponsors, retirees and labour unions. These consultations and ongoing communication with stakeholders have provided the basis for the 2009 Regulations.
Representations from plans sponsors underscore the immediate impact that anticipated funding requirements, absent funding relief, would have on both the plan and the financial needs of the sponsor. Many sponsors cautioned that the situation facing them as a result of current funding pressures is greater than what propelled the adoption of the 2006 Regulations, and as a result, enhanced relief is required.
Representations from labour groups and retiree organizations also recognize the difficulties plans would face as a result of current market and economic difficulties, with certain groups also recommending funding relief. Support for the course of action followed in the 2006 Regulations was expressed by several groups.
The Government has also launched a public consultation on pension issues with the release of a consultation paper in January 2009. As pension plans are regulated either federally (e.g. telecommunications) or provincially (e.g. manufacturing) and the regulatory regimes are closely related, the Government is coordinating its work in this area with provincial and territorial governments. Several provinces have also undertaken reviews of their own pension legislation.
Compliance and Enforcement
The proposed 2009 Regulations will not require any significant change in OSFI procedures or significant additional personnel resources.
No compliance problems are anticipated with respect to the proposed 2009 Regulations. OSFI's current supervisory process, which includes examining regular reporting and analyzing plans' risk profile, will enable OSFI to monitor compliance with the proposed 2009 Regulations. The Superintendent has the authority to issue a direction of compliance to the administrator of a pension plan, an employer, or any person to ensure that the funding requirements are being met. Pension plans that do not meet the requirements of these 2009 Regulations must fund according to the normal 5-year funding rules.
Director, Financial Sector Division
1 The Air Canada Pension Plan Solvency Deficiency Funding Regulations (Air Canada Regulations) were adopted in 2004 upon Air Canada's exit from bankruptcy protection. The Air Canada Regulations allowed the existing deficiency to be funded over a 10 year period, and were negotiated as part of the bankruptcy process. The Air Canada Regulations were approved by Cabinet and received the consent of plan members, retirees and other beneficiaries.