Municipal sector pension plans: Is your funding strategy optimal?

It has been six years since the MSPP Act[1] was adopted for municipal sector pension plans. Section 1 of the Act states that the legislation aims to improve the financial health of pension plans and ensure their sustainability, notably by introducing cost sharing and stabilization mechanisms that allow various funding strategies to be considered. How about now? Are these strategies optimally applied?

Over time, our experts have noted the impact the different funding strategies adopted by our municipal clients have had on the financial health of their plan.

Since the entry into force of the MSPP Act, we’ve carried out several analyses to determine how the financial health of pension plans has evolved based on their funding strategies, while taking into account each plan’s circumstances.

From these analyses and related mandates, the expertise and general understanding we acquired could allow you to optimize your funding strategies in service of your plan’s financial health and of your members’ best interest. Here are some interesting aspects that you may wish to consider when it will be the right time to review your funding policy. Based on your funding policy’s governance rules, your policy may need to be reviewed following the latest actuarial valuation.

This is essential, as the funding strategy should ultimately reflect each component’s risk profile. It’s usually the starting point when considering funding strategy optimization. When carrying out this exercise, some plans favoured a funding policy aimed at the gradual reduction of risk in the Prior Component and at the addition of risk in the New Component, based on each component’s funding mechanisms and their expected evolution in maturity.

The two main funding mechanisms used to manage risk in the Prior Component are the margin used in the discount rate assumption and the statutory reserve. The statutory reserve is generally more effective in reducing the amplitude of amortization payments in unfavourable financial situations, while the margin is usually more effective in eliminating small deficits. However, it’s important to consider that the margin can have an impact on asset surpluses. An optimal use of these mechanisms should consider your intended goals.

Which strategy should you use to achieve this goal? Is it better to implement a dynamic margin that varies in function of the plan’s financial health and required contributions to the New Component, or to choose a dynamic stabilization contribution to help absorb changes in plan costs and/or maintain an agreed-upon contribution rate? These strategies must be analyzed while considering the plan’s characteristics, the parties’ ability to pay and the impact on asset surpluses.

Many plans contribute to the stabilization fund amounts above the minimum required. In order to be robust and adequately prevent possible deficits, the stabilization fund must be established and maintained at an adequate level. This allows to stabilize contributions by absorbing the volatility of amortization payments. The depletion of the stabilization fund would have serious consequences on the plan’s sustainability.

The use of surplus assets should be aligned with the funding strategies used and the funding objectives. Be careful: using surplus assets too early or too late may result in intergenerational inequity.

The funding of municipal pension plans is a complex expertise. At the core of this expertise lies the strong connection between investments, funding mechanisms, and asset surpluses. A thorough analysis of the relation between these elements results in an optimal funding strategy for each component and for each plan. It is therefore essential to find THE optimal strategy that meets your funding objectives.

Each pension plan is unique. Contact your Normandin Beaudry consultant or email us. We would be happy to share our observations and help you find the best funding strategy based on the realities of your pension plan. Stay tuned for more information.

[1] Act to foster the financial health and sustainability of municipal defined benefit pension plans, assented on December 5, 2014.