Bill 29: the target level of the stabilization provision is now known

The draft regulation entitled Regulation to amend the Regulation respecting supplemental pension plans (Draft Regulation) was published in the Gazette officielle du Québec on April 6, 2016. This Draft Regulation relates to the Act to Amend the Supplemental Pension Plans Act mainly with respect to the funding of defined benefit pension plans (Bill 29).

Bill 29, which came into force on January 1, 2016, makes significant changes to the funding rules for private sector defined benefit pension plans. These changes were discussed in two Normandin Beaudry bulletins issued in June and December 2015.

Some measures introduced by Bill 29 still needed to be specified by regulation, including the target level of the stabilization provision. Employer and employee representatives were mandated by the Quebec government to create a scale to be used to establish the target level of the stabilization provision for private sector pension plans. This scale is presented in the Draft Regulation.

The target level of the stabilization provision would be established using two measures: the percentage of assets allocated to variable-income securities and the “ratio between the duration of plan assets and the duration of plan liabilities.”

The table below presents the scale agreed on to establish the stabilization provision.

The target level of the stabilization provision that was communicated during the parliamentary committee sessions was around 15% for a pension plan for which 50% of the assets are invested in variable-income securities. Using the scale agreed on, the stabilization provision would vary between 9% and 17% for this same plan.

Under the Draft Regulation, the following assets would be considered fixed-income securities:

• Cash
• Money market securities that meet a certain quality standard
• Bond market securities that meet a certain quality standard
• Mortgages that meet certain criteria related to collateral
• Up to 50% of the assets invested directly in infrastructure or real estate

The minimum quality standard (ratings from credit rating agencies) for money market securities and bond market securities is prescribed by regulation and equal to the minimum quality standard generally provided for in pension plan investment policies (for example, BBB rating or higher assigned by DBRS). The remaining assets would be considered variable-income securities.

Duration is a measure of the sensitivity of the assets and liabilities to a change in interest rates. More specifically, it would be calculated as follows:

Liabilities

• Change in actuarial liabilities as a result of a 1% change in the discount rate

Assets

• Total of the duration of each fixed-income security investment weighted on the basis of the target investment policy for each asset class
• The duration of investments would be determined by portfolio managers
• The duration of a real estate or infrastructure investment would be limited to 6

If we take the example of a pension plan for which 60% of the assets are invested in variable-income securities and for which the ratio between the duration of assets and the duration of liabilities is 25%, the stabilization provision target level would be 17%.

The boxes added to the scale show the stabilization provision target levels for pension plans with different demographic profiles, according to the percentage of variable-income securities generally allocated by these plans (assuming that the fixed-income securities consist mainly of long-term bonds).

Some pension plans could also choose leverage strategies that allow for the duration of the plan’s assets to be extended, thereby reducing the target level of the stabilization provision. These strategies are especially relevant for achieving objectives related to the solvency of the plan or the accounting on financial statements (i.e., ensuring greater stability for the sponsor’s financial statements). These strategies would, however, impact the volatility of funding contributions. For this reason, we believe that a more thorough analysis that takes into account the plan’s specific context is essential.

In recent years, risk management for many pension plans has focused on reducing the fluctuation in the solvency funding contribution.

Going-concern funding, which is less volatile in nature, makes it easier for pension plan sponsors to predict the required funding contributions. Pension plans have the opportunity to make it even easier to predict funding contributions by adopting a strategy with respect to investment optimization, the use of margins for adverse deviations and the purchase of life annuities.

Under Bill 29, triennial actuarial valuations are required if the funding ratio is above 90%. For the two fiscal years between the triennial valuations, an annual notice must be sent to Retraite Québec to determine the solvency ratio at the end of the fiscal year. The Draft Regulation specifies that the notice should be accompanied by a document containing the data, assumptions and methods used, as well as the certification of the actuary attesting to the degree of solvency.

The Normandin Beaudry consultants will continue to monitor developments relating to Bill 29 and will keep you informed. They will also be available to support pension plan stakeholders in their thinking related to risk management.

Please feel free to contact us for additional information.