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Normandin Beaudry

A more flexible legislative framework

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There, in black and white

NB Bulletin Vol. 16 N. 6, May 2013

Of the 21 recommendations issued by the Expert Committee on the Future of the Quebec Retirement System (the “Committee”), chaired by Mr. Alban d’Amours, almost half aim to make the legislative framework applicable to supplemental pension plans more flexible in order to better govern and manage defined benefit pension plans.

A difficult context for pension plans

In its report Innovating for a Sustainable Retirement System, the Committee sheds light on the reasons for the pension plans’ general deterioration in financial position:

  • Demography: People are living longer and retiring earlier. The pension payment period has nearly doubled since the 1960s. 
  • Interest rates: The steady decline in interest rates has led to in an increase in benefit costs. 
  • Level of margins: Margins existed up to the mid-1990s because benefit costs were valued based on a lower return assumption than federal bonds’ yield to maturity. Since that time, margins have been replaced by optimism because benefit costs are valued based on expected future returns, meaning beneficial stock market returns are anticipated. 
  • Stock market performance: Performance over the past 12 years was disappointing.
  • Use of surpluses: Surpluses accumulated in the 1990s were widely used to fund contribution holidays and plan improvements instead of remaining in the plans to build and maintain margins.

The report reveals that an increase in interest rates would only have a limited beneficial impact on pension plans’ financial health. The report also indicates that modest economic growth forecasts will lead to more modest return expectations. Given that the status quo is not an option, the Committee concludes that the solutions to be considered are to review plan funding rules and to redefine plan benefits.

As illustrated in our recent information bulletin, Return to Financial Reality, the proposed new funding rules would increase the current service cost for all plans. Special amortization payments could also increase, particularly for public sector plans.


The goal of the proposed measures is to adapt pension plans to the new economic and
demographic realities and to achieve an appropriate balance
between financial security and capacity to pay.


Restructuring over a five-year period

The law currently severely constricts the implementation of agreements to restructure past service benefits that would support plan sustainability.

The Committee makes an unprecedented recommendation: a five-year period for restructuring plans through a process of negotiation and consultation with active, inactive and retired members. Restructuring would not be mandatory, but would instead be an avenue offered to those parties wishing to use it. Even though the basic pension could not be reduced, certain vested rights could be reviewed or suspended, for instance:

  • Pension indexation, before and after retirement;
  • Early retirement subsidy, including a bridge pension;
  • Pension subsidy for surviving spouse;
  • Conversion from “final earnings” pensions to “career earnings” pensions (accrued pensions not automatically indexed to future salary increases).

It is important to note that pensions could not be reduced for retirees. For retirees, only indexation could be reviewed or suspended.

According to an example taken from the Committee’s report, for a plan whose pensions are indexed to inflation minus 1%, 18% of the current service cost is linked to the indexing provision. The table below illustrates, on a simplified basis, the potential impact of the elimination of this past service provision on the financial position of the plan.

If the parties fail to reach an agreement in years 4 and 5, the employer could decide to review or suspend pension indexation. Conditions concerning this unilateral right granted to employers would however be established:

  • The employer would be required to make a financial contribution equal to the deficit reduction resulting from the change.
  • The reduction in indexation would be required to affect active and retired members in the same way.

Finally, it should be noted that the parties could agree to suspend certain vested rights as opposed to agreeing to a definitive review. For example, indexation could be suspended as long as the plan is in a deficit position. Each plan would be responsible for defining its rules.

In the above example, if an agreement would be reached to eliminate 50% of the indexation in exchange for an equivalent financial contribution made by the employer, or if the employer would unilaterally opt to make this change in years 4 or 5, the impact would be as follows:

Whether or not past service benefits would be restructured, future service provisions could be discussed, particularly given the impact of the proposed new funding rules and the coordination of benefits with the Longevity Pension. This coordination would be mandatory for public sector plans.


A negotiation process is the recommended approach to restructure benefits,
and the unilateral right granted to employers in the event that negotiations fail would be tightly regulated.
Moreover, the basic pension of all active members and the pension paid to retirees could not be reduced.


Facilitating cost sharing

Under the current legislative framework, member contributions are generally fixed and the employer is responsible for financing the remaining funding costs (current service cost and special amortization payments). The employer therefore assumes all cost variations. Some plans have dynamic cost sharing agreements; however, application of these cost sharing agreements is indirect and is often constrained.

The Committee recommends expressly permitting dynamic cost sharing between the employer and members. The parties could thus agree to share up to 50% of the current service cost and special amortization payments. The Committee also recommends allowing retirees to share the cost of future deficits resulting from benefits accrued after the implementation of such an agreement.

For public sector pension plans, the Committee proposes making it mandatory to share equally the current service cost. Public sector plans would only have the latitude to decide whether or not special amortization payments would be shared.


With cost sharing, members would be more aware of the value of benefits
and thus the importance of effectively managing risks and
negotiating benefits that truly meet their needs.


Tools for securing retirees’ pensions

With the bankruptcy of certain companies in recent years, particularly in the pulp and paper industry, the importance of securing retirees’ pensions has become even more apparent. Some plans have already introduced measures for managing risks, such as annuity purchases and the funding of provisions for adverse deviations. The Committee’s report contains recommendations that would favour this type of initiative.

A first recommendation would allow for the creation of separate accounts for active and retired members. A plan that would take advantage of this measure could separately manage these two groups of members who clearly have very different characteristics. This approach would make it easier to manage the plan based on its maturity because the proportion of assets belonging to the retiree account would gradually increase as the plan matures.

A plan that would take advantage of this approach could have an investment policy tailored to each separate account. It would also be possible to make changes to one group’s provisions without impacting the other group’s financial position. Finally, the equity principle 1 set out by the Supplemental Pension Plans Act would not apply to this plan.

The Committee’s second recommendation is to introduce new rules concerning annuity purchases. Annuity purchases during a plan’s existence is currently considered an investment decision made by the pension committee. Accordingly, the plan remains ultimately responsible for paying pensions to insured retirees. In the event of plan termination, retirees for whom an annuity was purchased are entitled to their share of the surplus. However, if the plan is in a deficit position at termination as a result of employer bankruptcy, pensions for these retirees must also be adjusted according to available assets.

The Committee proposes permitting annuity purchases that would sever the link between retirees and the plan. By purchasing annuities from an insurance company, the plan would eliminate their responsibility towards the insured retirees, and these retirees would thus be better protected in case of the plan sponsor’ future bankruptcy. To do this, the plan would need to adopt an annuity purchase policy and, if the plan is in a deficit position, the employer would need to contribute the amount required to maintain the plan’s financial position following the annuity purchase. This type of annuity purchase is already permitted in other Canadian provinces.


With the introduction of separate accounts and new rules for annuity purchases,
the Committee is proposing tools that would facilitate plan risk management
by dissociating the risk assumed during an employee’s active career
from the risk assumed after retirement.


Recommendations concerning personal savings will be discussed in our upcoming information bulletin.

 


1 The equity principle is a legislative requirement applicable to plans regulated by the Régie des rentes du Québec according to which provision improvements financed from a surplus on an ongoing basis must be equitable between active and retired members.

 

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