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Normandin Beaudry

Pension plans: new developments affecting solvency valuation

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There, in black and white

NB Bulletin Vol. 6, N. 2, March 2011

In recent years, the solvency of pension plans has been a source of major headaches for plan sponsors. The disastrous investment performance in 2008, combined with the steep increase in solvency liabilities, has had catastrophic consequences on the financial health of pension plans.

On January 1, 2010, new permanent funding regulations were introduced in Quebec. On top of the commotion caused by these legislative changes, the Canadian Institute of Actuaries (CIA) brought modifications to their standards of practice.

In short, the CIA is responsible for establishing, for all actuaries working in Canada, standards of practice that contain detailed guidance for performing certain actuarial calculations, as well as requirements for disclosing actuarial elements in valuation reports. This bulletin outlines the two main additions to the standards of practice recently made by the CIA:

  • A change to the mortality table, effective February 1, 2011, for solvency valuation purposes; and
  • New actuarial disclosure requirements, effective December 31, 2010.

While these two changes stem mainly from the experience of recent years, their early application is nevertheless not authorized.

Mortality table with generational projection

In recent decades, especially since the advent of improvements in health care, life expectancy in both men and women has continued to increase. The repercussions on pension plans are major since annuities paid or promised to current and future retirees will have to be paid out over a longer-than-anticipated period of time. The Statistics Canada graph below illustrates the evolution in life expectancy over a little less than a century. 

As a result, pension plan funding must now take this longer life expectancy into account. Thus, to reflect this trend, effective February 1, 2011, a mortality table with generational projection will be required to evaluate the solvency liability and to calculate transfer values (i.e., the value resulting from termination of membership or death, for example).

This new way of projecting future life expectancy improvements consists in acknowledging a member's increased life expectancy up until death, whereas the traditional approach consisted in acknowledging his/her increased life expectancy up to a fixed date (e.g., the year 2020). The main drawback of the traditional approach was the need to push back the projected date to reflect the future improvement in life expectancy (traditional tables were extrapolated to 2015, then to 2020). With the generational approach, changes to the mortality table will be required less often.

The resulting increase in solvency liability and transfer values will depend on the participants' age and sex. To give an idea, the impact of the change is expected to vary between 1% for a group with an older average age to 5% for a younger group.

For the moment, this change to the mortality table applies only to the solvency valuation and to benefits paid out following termination of membership after January 31, 2011. However, it will eventually also inevitably apply to valuations on a going concern basis; the impact will be an increase in the current service contribution and, where applicable, special payments. The extent of the increase will also depend on the average age and sex of the target group of participants.

New disclosure requirements

Since December 31, 2010, all actuarial valuation reports must include additional disclosure elements. Specifically, actuaries will have to report elements that will require additional calculations, including for example:

  • The incremental cost on a solvency basis. Disclosed for information purposes only, this cost represents the total anticipated variation in the solvency liability between the valuation date and the next valuation date, based on the current valuation assumptions. The incremental cost is only an indicator of the expected change in the solvency liability;
  • The variation in the solvency and going concern liabilities caused by using an interest rate 1% lower than that used in the valuation. This variation will sensitize the plan sponsor to the impact of a drop in interest rates.

Other new disclosure requirements will not require additional calculations. For example, actuaries will have to describe the extent of any margin for adverse deviations included for each assumption in the going concern valuation.

In conclusion, the acknowledgement of increasing life expectancies combined with additional awareness-raising measures are interesting ways for pension plan sponsors to better control certain risks related to their plans. In our opinion, a sound risk management strategy is the key to the long-term survival of defined benefit pension plans.

 

Please feel free to contact us for additional information.

514.285.1122
 
630, René-Lévesque Blvd. West, 30th floor
Montreal, Quebec, H3B 1S6