Review of the solvency funding framework for defined benefit pension plans in Ontario

On July 26, 2016, the Ontario government released a consultation paper entitled “Review of Ontario’s Solvency Funding Framework for Defined Benefit Pension Plans”, targeted at sponsors of single employer pension plans. This bulletin summarizes the approaches and options proposed during the course of these consultations. Interested parties have until September 30, 2016 to submit their comments.

Since the global recession of 2008, relief measures have been introduced to help sponsors fund their defined benefit pension plans. In an environment of prolonged low interest rates, the Ontario government announced in the 2016 Ontario Budget its intention to review the solvency funding framework for defined benefit pension plans.

The consultation paper sets out two approaches aimed at maintaining plan sustainability, affordability and benefit security and at balancing stakeholder interests:

• Approach A: Modified solvency funding rules while maintaining the requirement to fund on both going concern and solvency bases
• Approach B: Eliminate current solvency funding requirements while strengthening going concern funding requirements

To help frame the consultation, the Ontario government offers various options to comment on for each of the approaches.

Option 1: Average solvency ratios

The average solvency ratio would be calculated over three years and applied to the solvency liabilities on the valuation date to determine the funding contributions required on this basis over a period of five years.

Option 2: Lengthened amortization period

Lengthening of the period of time over which solvency deficiencies must be amortized. For example, the period could be lengthened from five years to ten years.

Option 3: Consolidation of solvency deficiencies 

Solvency deficiencies would be consolidated at each valuation date and amortized over a new five-year period.

Option 4: Funding a percentage of the solvency liability 

The target for solvency funding would be reduced from 100% to a lower threshold.

Adjustments could be made to the Pension Benefits Guaranteed Fund (PBGF) assessment formula to take into account this possible change. The guarantee provided through the PBGF could also be increased to maintain benefit security for pension plan members.

Option 5: Solvency funding for certain benefits only 

Benefits would be funded on a going concern basis only. However, plans offering certain additional benefits, such as subsidized early retirement benefits, could be required to fund such benefits on both a going concern basis and a solvency basis. As in Option 4, the guarantee provided through the PBGF could be increased to maintain benefit security.

Option 6: Solvency reserve account 

Accounting for funding contributions on a solvency basis in a separate account called a “solvency reserve account”. The sponsor could afterwards withdraw some of the plan’s surplus assets using this account, subject to a minimum level of surplus assets.

Option 7: Letters of credit 

Rules on the use of letters of credit could be changed to increase the current limit of 15% of solvency liabilities.

Option 1: Require a funding cushion (provision for adverse deviation) 

Obligation for pension plan sponsors to have financial cushions. These cushions would be expressed as a percentage of the plan’s going concern liabilities that must be funded before the plan sponsor can make decisions that could weaken the plan’s going concern funded position, such as benefit improvements or a contribution holiday.

Factors to consider when calculating these cushions could include the investment policy’s alignment with the plan’s demographic profile, the maturity of the plan, the actuarial assumptions and the financial strength of the sponsor.

Option 2: Shortened amortization period 

The current going concern unfunded liability amortization period of 15 years could be reduced.

Option 3: Restrictions on determining the expected return on plan assets assumption 

The expected return on plan assets assumption is a key component of pension plan funding that directly influences the discount rate used. The Superintendent could set a maximum discount rate that would vary based on factors such as the plan’s investment policy.

The consultation paper even proposes using on a going concern basis the same discount rate used for the accounting actuarial valuation.

Option 4: Solvency trigger for enhanced funding 

Additional going concern funding requirements would be triggered when the plan falls below a certain solvency threshold, for example, 80%.

Option 5: Enhance the PBGF 

PBGF assessments would need to be increased to reduce the additional risk to the PBGF because of the lack of solvency funding. In the absence of solvency funding, the plan could have lower asset values, thereby resulting in higher PBGF claims in the event of a wind-up involving an insolvent employer.

The two approaches described above aim to reduce the volatility of funding contributions and several of the proposed options are inspired by legislative changes that have already been made to federal legislation and to some provincial legislations, including legislation in Quebec, Alberta and British Columbia. However, since these proposals include different options that can reduce benefit security, the following measures could be considered to maintain benefit security:

• Actuarial valuations required annually regardless of the plan’s financial position
• Establishment of a governance policy
• Establishment of a funding policy
• Change regarding the determination of the commuted value when a member terminates employment to ensure a better balance between the interests of beneficiaries remaining in the plan and those of the member transferring his or her rights
• Restrictions on contribution reductions or holidays and benefit improvements
• Administrator discharge for annuity buyouts

Consultations with various stakeholders and experts will continue over the summer and fall. It remains to be seen what the conclusions of the Ontario government will be following the feedback obtained and the consultation period.

The Normandin Beaudry consultants will continue to closely monitor the progress of the work on the legislative changes concerning the funding of defined benefit pension plans and will keep you informed of future developments.

Please feel free to contact us for additional information.