The new standard of practice for determining the pension commuted valuesLinkedIn
There, in black and white
Bulletin NB Vol. 7 N.1, February 2004
The Canadian Institute of Actuaries (CIA) recently approved a new standard of practice for determining the pension commuted values payable under a registered pension plan upon termination of participation. The new standard of practice will take effect September 1, 2004, and will replace the current one, which has been in use since September 1, 1993.
Overview of the changes to the current standard
The new standard of practice introduces two important changes to the current one. First, a new mortality table is prescribed, which more accurately reflects the current life expectancy of individuals, and takes into consideration future increases in life expectancy. Pursuant to the new standard, the mortality table to be used is UP-94, projected forward to 2015 using a prescribed projection scale.
Second, a new method for determining interest rates must be used for calculating commuted values. The current standard requires the use of a variable interest rate for the first 15 years, and a fixed one thereafter. The variable interest rate in the current standard is based on the yield of return on long-term Government of Canada bonds, and varies from month to month. The new standard calls for the use of two variable interest rates. The first one, which is based on the yield of return on medium-term Government of Canada bonds, applies for the first 10 years, while the second one, which is based on the long-term yields, applies thereafter. The principle of the method remains the same, regardless of whether the pensions are indexed or not, although the absolute values differ.
The general principle underlying this latest change in the new standard of practice is that, to the extent possible, the pension commuted value should reflect financial market conditions as of the valuation date and the value the market places on future payments.
Impact of the changes
The changes to the method of determining interest rates may result in an increase or decrease in the commuted value of pensions from the amount calculated under the current standard. If market interest rates are low, around 5% or less for example, the commuted value of pensions will increase when the new standard is used. Conversely, when rates are high, the commuted value will decline.
In reflecting financial market conditions at the time of calculation, the commuted value of pensions, although it is more accurate, is far more sensitive to market interest rate changes. Under the current standard, a 1% change in interest rates causes an opposite variation in the commuted value of at most 15% for all ages. Under the new standard, the same 1% change results in a variation in commuted value that could be as much as 45% for a 35-year old (the volatility becomes less and less pronounced as age at termination rises).
The changes made to the mortality table produce a slight increase in the commuted value of pensions, which is more significant for men.
Plan solvency or wind-up valuations
The new standard will have impacts on pension plan solvency or wind-up valuations. In fact, the solvency liability of active plan members is based on commuted values calculated according to the CIA standard of practice. For example, if interest rates are low, an increase in the solvency liability can be expected. Furthermore, due to the anticipated high variability of values calculated under the new standard, the results of these valuations, including the determination of the required contributions to the plan, are likely to vary more in the future than they have in the past.
The new standard and provincial jurisdictions
Pension plan legislation in some provincial jurisdictions is worded in such a way as to automatically refer to the new standard of practice. However, Québec, Ontario, New Brunswick, and federal legislation refer directly to the current standard, and will have to be amended in order to allow application of the new standard. In Québec, the Régie des rentes plans to amend the regulations stemming from the Supplemental Pension Plans Act and accessory provisions (SPPA) as of September 1, 2004, in order to allow use of the new standard of practice when it comes into effect.
The new standard of practice must be applied to termination of participation calculations and to solvency valuations as of September 1, 2004, subject to an amendment to pension plan legislation if necessary. This makes it important to quickly measure the extent of the variations noted with respect to your pension plan.
It is also important to check the wording of your pension plan text for a direct reference to the September 1993 standard of practice in which case the text should be amended. Finally, in terms of plan administration, it will be important to communicate effectively with members concerning possible variations in transfer values, especially with the addition of these values to annual statements as a result of changes made to the SPPA in 2001.
Please feel free to contact us for additional information.
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