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Normandin Beaudry

Interest rates applicable to actuarial valuations as at December 31, 2004

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There, in black and white

Bulletin NB Vol. 7 N. 20, November 2004

The Bank of Canada recently published the nominal interest rate on long-term Government of Canada bonds and the rate on real return Government of Canada bonds for the month of October 2004. It is on these rates that the interest rates to use for solvency valuations as at December 31, 2004 will be based.

Solvency valuations for unindexed pensions

For these valuations as at December 31, 2004, the interest rate to use for unindexed pensions of active and non-active, non-retired members will be equivalent to 5.50% per year for the first 15 years and 6% for subsequent years (compared to 6% per year as at December 31, 2003). For the valuation of unindexed pensions at the end of 2004, this lower interest rate will result in an increase of approximately 5% to 7% in the actuarial liability.

We cannot yet confirm the interest rate to use as at December 31, 2004 for retired members. This rate should reflect the rate used when purchasing an annuity from an insurance company. The Canadian Institute of Actuaries does an informal survey of the main financial institutions to estimate the rates for purchasing unindexed group annuities in the past year. The results of this exercise are published at the beginning of each calendar year. This year, we expect this rate to be lower than the suggested rate as at December 31, 2003 (5% to 5.25% per year). It is interesting to note that each 0.25% drop in the rate results in an increase of about 2% to 3% in the liability associated with retirees.

Interest rates on long-term Government of Canada bonds remained relatively stable over the first six months of 2004 and then declined. For example, the interest rate applicable as at August 31, 2004 was 6% per year.

Solvency valuations for fully indexed pensions

For these actuarial valuations, the interest rate to use as at December 31, 2004 for fully indexed pensions of active and non-active, non-retired members will be equivalent to 2.50% year for the first 15 years and 3.25% for subsequent years (compared to 3.25% per year as at December 31, 2003). For the valuation of fully indexed pensions at the end of 2004,¸ this lower interest rate will result in an increase of approximately 8% to 10% in the actuarial liability.

For retired members, the interest rate to use as at December 31, 2004 should reflect the rate used when purchasing an annuity from an insurance company. For the purpose of solvency valuations, the rate used is the same as that for active and non-active, non-retired members. The effect of this lower rate will be to increase the actuarial liability associated with retirees by approximately 4% to 6%.

Valuations for accounting purposes

We cannot yet confirm the interest rate to use for valuations for accounting purposes as at December 31, 2004, which is based on the rate at that date for investment grade bonds whose cash flows match the expected benefit payments. However, if rates remain at their current levels, we expect a rate between 5.25% and 6% as at December 31, 2004, which would represent a drop of about 0.25% compared to December 31, 2003.

Impact of the new standard of practice for determining the discounted value of pensions

As we told you in our June 2004 bulletin, the Canadian Institute of Actuaries’ new standard of practice for determining the pension commuted values payable under a registered pension plan upon termination of participation will take effect on February 1, 2005. If this standard were to take effect on December 31, 2004, the rate to use for unindexed pensions would be 4.75% for the first 10 years and 6% thereafter. This rate is lower than that resulting from the application of the present standard but it applies to a shorter period (10 years instead of 15). If this new standard should be applicable as at December 31, 2004, the actuarial liability of pension plans, on the basis of a solvency valuation, should probably be higher, especially since the new standard provides for the use of a mortality table based on a longer life expectancy.

 

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