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Normandin Beaudry

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NB Bulletin Vol. 16 N. 3, May 2013

In its report Innovating for a Sustainable Retirement System released on April 17, 2013, the Expert Committee on the Future of the Québec Retirement System (the “Committee”), chaired by Alban D’Amours, issued 21 recommendations including recommendations concerning new funding rules that would apply to defined benefit pension plans that fall under the supervision of the Régie des rentes du Québec. This information bulletin focuses on these recommendations. 

An entirely new valuation method: the “enhanced funding” method

The Committee recommends standardizing funding rules for all pension plans under the supervision of the Régie des rentes du Québec:

  • Plans would be funded using a single funding method called the “enhanced funding” method, which is similar to the current funding method with the exception of certain constraints related to the choice of discount rate:
    • For retirees:  a single rate determined based on the yield of high-quality corporate bonds (this rate is similar to the rate used for accounting valuation purposes in the private sector).
    • For other members:  one rate that applies as of the assumed retirement date equal to the discount rate used for retired members and another rate that applies before the assumed retirement date that takes into account the expected return based on the pension plan’s overall investment policy.  
  • Under the “enhanced funding” method, deficits would be amortized over a period of 15 years, and this period would gradually be reduced to 10 years. Deficits would be consolidated annually and special amortization payments could not be reduced as long as the plan would be in a deficit position.

Click here to review and compare the current rules.
 


It should be noted that pension committees would remain responsible
for investment decisions. Even if the discount rate for retirees
would be based on corporate bond yields, the pension committee
would not be obligated to invest underlying assets in corporate bonds.



Financial impacts of the “enhanced funding” method

The impacts of the new “enhanced funding” method would vary depending on the specific situation of the plan (benefits offered, plan maturity, average age of members and actuarial assumptions currently used for funding valuations). 

The table below presents an example of a “mature” (significant proportion of liabilities allocated to retired members) private sector plan taken from the Committee’s report.
 



In this example, funding contributions amount to 52% of salaries according to the current rules and with the application of temporary relief measures. The new rules would reduce funding contributions from 52% to 35% of salaries. The current service cost would increase from 14% to 16% with the use of a lower discount rate. In addition, required special amortization payments would be reduced considerably (from 38% to 19%). This reduction can be explained in large part by the following two factors:

  • The deficit to be funded decreases from $49.2M (solvency method and current rules) to $31.0M (new “enhanced funding” method); and
  • The deficit amortization period increases from 10 years to 15 years. 

According to another example taken from the Committee’s report and involving a “young” private sector plan, the new rules would increase the total contributions related to plan funding. The increase in the current service cost, which is the predominant element, would be greater than the decrease in special amortization payments.
       


In the short-term, for a large number of private sector organizations,
the “enhanced funding” method would reduce
the required contributions associated
with pension plan funding while strengthening
the security of member benefits over the long term.



The table below presents an example of a “mature” public sector pension plan taken from the Committee’s report:

Funding contributions currently amount to 37% of salaries and exclude the use of temporary relief measures (public sector plans are exempt from solvency requirements). The new rules would significantly increase the required total contributions (from 37% to 57%). The use of a more conservative valuation method would in fact increase the current service cost (from 19% to 24% of salaries) and the special amortization contributions (from 18% to 33%). The increase in special amortization contributions would largely be the result of the increase in the deficit to be funded ($16.7M according to the current rules and $34.9M according to the proposed rules).
 


In the long term, the new rules would strengthen
the security of benefits for pension plan members,
and the “enhanced funding” method would reflect
the risk associated with plan maturity.



Lower transfer values

The Committee also recommends changing transfer values to reflect high-quality corporate bond rates. This change would:

  • Increase discount rates used by approximately 1%;
  • Reduce solvency liabilities by 10% to 20% depending on plan maturity;
  • Improve solvency ratio; and
  • Decrease the value of refunds paid to members requesting a transfer out of the plan.
     

According to the new rules, in the event of employer bankruptcy,
pension fund assets would be redistributed differently among
the different member groups. Retirees would be entitled to pensions
that would be less reduced because of a higher solvency ratio,
whereas other members who have more time to improve
their situation would receive lower transfer values.



New rules for surplus assets

The solvency method would no longer be used for funding purposes.  However, it would continue to be used for other purposes, including the management of surplus assets.  Two conditions would have to be satisfied before these surplus assets can be used: 

  • The plan would have to be fully funded according to the “enhanced funding” method; and
  • The plan would have to be fully solvent and the surplus assets must be greater than a provision for adverse deviation of approximately 15% of solvency liabilities. 

Only 20% of surplus assets could be used each year to improve the benefits offered by the plan, to take contribution holidays or to reimburse the employer, in part or in full, for amounts previously paid to fund deficits (important new option).
 


The provision for adverse deviation that would be increased
to approximately15% would thus be applied to decreased solvency liabilities.
The combined effect of these two elements would imply a similar level
of caution as in current rules before surplus assets could be used.   



Funding policy: beyond the investment policy

Finally, the Committee proposes reinforcing the Supplemental Pension Plans Act to ensure a better understanding and communication of the risks affecting pension plans. Employers would be obligated to develop a funding policy that defines the goals to be achieved, particularly in relation to the security of benefits. Every six years, pension committees would be required to prepare a valuation quantifying the different risks to which the pension plans are exposed.

To accompany these new pension plan funding rules, the Committee is proposing other measures for better governing and managing defined benefit pension plans, and tools for addressing deficits through plan restructuring. These recommendations will be discussed in an upcoming information bulletin.

 

Please feel free to contact us for additional information.

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Montreal, Quebec, H3B 1S6