Regulatory Impact Analysis Statement

Solvency Funding Relief Regulations

Description

Under the Pension Benefits Standards Act, 1985 (the "Act"), the federal government regulates private pension plans covering areas of employment under federal jurisdiction. The Office of the Superintendent of Financial Institutions (OSFI) is responsible for the supervision of such plans. OSFI supervises close to 1,300 pension plans or about 10 per cent of all pension plans in Canada, representing about 15 per cent of trusteed pension fund assets in Canada; 428 of the federal plans are defined benefit pension plans.

The Act requires that federally registered pension plans fund promised benefits in accordance with standards set out in the Pension Benefits Standards Regulations, 1985 (PBSR). Defined benefit pension plans must file actuarial valuations every three years, or more frequently as required by the Superintendent of Financial Institutions ("the Superintendent"). Where these valuations show a pension plan’s assets to be less than its liabilities, payments must be made into the plan to eliminate the deficiency over a prescribed period of time, as described below. While private pension plans are voluntary, they must generally be registered, either federally or provincially. One of the main purposes of regulation is to set out standards for funding and investment of pension plans to ensure that the rights and interests of pension plan members, retirees and their beneficiaries are protected. In particular, regulation is intended to ensure that pension plan assets are sufficient to meet pension plan obligations.

Actuarial valuations of defined benefit plans are conducted using two different sets of actuarial assumptions: "solvency valuations" use assumptions consistent with a plan being terminated, while "going-concern valuations" are based on the plan continuing in operation. If a solvency valuation reveals a shortfall of plan assets to plan liabilities, the PBSR require the plan sponsor to make special payments into the plan sufficient to eliminate the deficiency over five years. Where a deficiency exists on the basis of a going-concern valuation, the PBSR require special payments to eliminate the going-concern deficiency over 15 years. In general, the payments that a plan sponsor must remit to a plan in a given year include the amount necessary to cover the ongoing current service costs associated with the plan, plus any "special payments" required in that year to pay down a funding deficiency over the relevant time period.

In recent years, the sharp decline in long-term interest rates to historically low levels has increased plan liabilities and led to significant solvency deficiencies for many pension plans. Recent changes in actuarial standards that reflect longer life expectancy and make the calculation of solvency liabilities more sensitive to prevailing market interest rates have also contributed to these deficiencies. OSFI estimates that as of December 31, 2005, 78 per cent of federally regulated DB pension plans had a solvency deficit. OSFI’s estimates reveal that federally regulated DB pension plans were 90 per cent funded, on average, as at December 31, 2005, compared to 100 per cent funded as at December 31, 2004.

Many plan sponsors, while committed to funding their pension plans, are concerned that the funding requirements stemming from recent solvency deficiencies are driving excessive cash flow away from expenditures that could enhance productivity and competitiveness and benefit the economy. Some plan sponsors say that the high solvency payments could undermine their ability to provide ongoing support to their pension plans. In response to similar challenges, some other Canadian jurisdictions have provided temporary solvency funding relief, for example, by allowing, under certain conditions, the amortization period for solvency deficiencies to be extended to 10 years from five years.

The proposed Solvency Funding Relief Regulations (the Regulations) would provide solvency funding relief through four temporary measures that respond to these difficult circumstances. These measures would provide for the solvency deficiencies of federally regulated defined benefit pension plans to be addressed in an orderly fashion while providing safeguards for pension benefits. A plan sponsor would be able to seek funding relief by choosing one of the four proposed temporary measures outlined below, depending on its particular circumstances, for the first actuarial valuation showing a solvency deficiency before 2008. Any additional solvency deficiencies would be funded in accordance with the current rules. The proposed measures would only be available for plan sponsors that are up to date in their funding payments. Depending on their particular circumstances, sponsors would be able to choose from the following options for relief:

• Consolidation of Solvency Payment Schedules: Plan sponsors would be permitted to consolidate solvency payment schedules and amortize the entire solvency deficit existing over a new five-year period. This would have the effect of extending previously established solvency special payment schedules over the next five years.

• Extension of the Solvency Funding Payment Period to 10 Years with Buy-in: Plan sponsors would be permitted to extend the period for making solvency funding payments to 10 years from five years, provided that no more than one-third of active plan members or non-active members and beneficiaries, including retirees, object. The buy-in condition, which is based on plain language disclosure, ensures that the parties are fully informed about the situation and its implications. The difference between the five-year and 10-year level of payments would be subject to a deemed trust. Under provisions of the Act and the proposed Regulations, this amount would be deemed to be held in trust for active members, non-active members and beneficiaries, including retirees.

There would be a restriction on plan improvements in the first five years unless the improvements were pre-funded to not worsen the solvency deficit of the plan. Alternatively, a plan sponsor could make plan improvements by opting out of the 10-year funding schedule and returning to the normal five-year funding schedule.

• Extension of the Solvency Funding Payment Period to 10 Years with Letters of Credit: Plan sponsors would be permitted to extend the period for making solvency funding payments to 10 years on the condition that the difference each year between the five-year and 10-year level of payments is secured by a letter of credit (LOC) obtained by the plan sponsor and held by a trustee. This would reduce the level of annual solvency payments for plan sponsors while protecting pension benefits.

By issuing a letter of credit to a plan sponsor, the financial institution would essentially be guaranteeing the difference between the five-year and 10-year level of payments. Should the plan sponsor, for example, terminate the plan, go bankrupt or file for protection under the Companies’ Creditors Arrangement Act during this period, the trustee would make a demand for payment from the financial institution issuing the LOC. The LOC would also be payable on the demand of the trustee if the LOC were not renewed or replaced on its expiry date. Upon receiving the demand for payment, the issuing financial institution would be required to immediately pay the full amount of the letter of credit to the pension fund. If the financial position of the pension plan improves due to changes in market performance and/or increase in long-term interest rates, plan sponsors would be able to reduce or eliminate the letters of credit to the extent that they are no longer required as set out in the Regulations.

The plan sponsor would normally have to pay an annual fee to the financial institution for obtaining a letter of credit. The fee typically would vary depending on the plan sponsor’s credit worthiness.

• Extension of the Solvency Funding Payment Period to 10 Years for Agent Federal Crown Corporations: Federal agent crown corporations with defined benefit pension plans governed by the PBSA represent a special case. Agent crown corporations will have the funding relief options described above available to them, with the exception of the letter of credit proposal. Obtaining a letter of credit would represent a risk-free loan by that financial institution which would ultimately be at the expense of the Crown. Accordingly, it is proposed that agent federal crown corporations be permitted to extend the period for making solvency funding payments to 10 years subject to meeting the terms and conditions of the Regulations. This would include an acknowledgement in writing by the Minister of Finance that an agent federal crown corporation intended to pursue this measure. In order to encourage a level playing field, it is anticipated that in order to supply this letter, the Minister would require a fee to be paid to the Government comparable to the fee that would be paid to obtain a letter of credit.

Alternatives

The current difficult circumstances are placing significant stress on many plan sponsors, which could affect the viability of defined benefit pension plans and benefit security. The best security for pension benefits is a financially healthy plan sponsor that provides ongoing support to its pension plan. The proposals provide a balance between the status quo, whereby the current 5 year funding rules would be maintained, and simply extending the funding period to 10 years without conditions, as advocated by some sponsors.

Analysis

Maintaining the current funding requirements over the short-term in these difficult circumstances would result in continued financial stress for many plan sponsors, which could affect their business operations and on-going viability. This could ultimately lead to a reduction in pension benefits. Indeed, there have been a number of plan sponsors that have already reduced pension benefits as a result of the current circumstances or have approached the Superintendent for authorization of such reductions. While the reduction of benefits could be a positive approach towards making a plan more affordable, the difficult circumstances currently affecting many pension plans could require reductions in benefits that may not be in the best interest of plan members. In addition, some plan sponsors have started to close their defined benefit plans to new employees or to shift to defined contribution plans where benefits paid are subject to return on investment and the employee bears most of the risk.

The five-year funding period is seen in most circumstances as an appropriate timeframe to eliminate any solvency deficiency, as it represents a balance between the funding of plans and the protection of pension benefits. Extending the solvency funding payment period to more than five years without any additional protections could negatively affect benefit security. As such, the Regulations provide protections to mitigate risks to plan members and retirees.

Benefits and Costs

Benefits:

The implementation of the proposed Regulations would help protect the interests of plan members and other beneficiaries by providing solvency funding flexibility in recognition of the difficult circumstances facing federally regulated defined benefit pension plans. The Regulations would provide some regulatory relief for plan sponsors by offering them a choice of options which would allow for reduced annual payments in the short-term while providing appropriate safeguards to protect pension benefits, recognizing that the security of pension benefits is best secured through solid funding practices and a financially viable plan sponsor.

Costs:

Only modest additional costs are anticipated for OSFI to administer the proposed Regulations, as the increased funding options will make the supervision of pension plans more complex and may require that additional guidance be issued to plan administrators. Existing supervisory procedures and information systems will not require significant changes.

Potential costs to a pension plan sponsor would depend on whether it chose to avail itself of the Regulations, and which option it chose. For example, there would be a cost of obtaining a letter of credit for a plan sponsor that sought relief through this measure. In the case of agent crown corporations, there would be a cost associated with the fee to the Government that would be comparable to the fee that would be paid to obtain a letter of credit. With respect to a sponsor who elected to pursue the buy-in measure, it would incur costs associated with disclosing the required information to active members, non-active members and beneficiaries including retirees and seeking their buy-in.

There will be no direct cost to beneficiaries of affected pension plans. However, because of potential risks associated with extending the period for funding solvency deficiencies, the proposed Regulations include terms and conditions intended to mitigate potential risks to plan members. Accordingly, the proposed Regulations require that beneficiaries be informed of the implications of the longer amortization period for the solvency deficiency, and, for the extension with buy-in option, there is also a requirement that no more than one third of active members or retirees object to the company’s election to come under the provisions of the Regulations.

Consultations

On May 26, 2005, the Department of Finance released a consultation paper on Strengthening the Legislative and Regulatory Framework for Defined Benefit Pension Plans registered under the Pension Benefits Standards Act, 1985. The consultation paper included a discussion of the possibility of extending the solvency funding period, and sought stakeholder’s views on whether such an extension should be offered as a temporary measure. The Department received a broad range of views from stakeholders including plan sponsors, labour representatives, retirees, industry associations, actuaries and individual Canadians, with many stakeholders stressing that the funding status of private defined benefit pension plans is an important immediate issue affecting many workers, retirees, and pension plan sponsors. Many stakeholders have commented publicly and made representations to the Department on the need for immediate funding relief along the lines of what is being proposed.

Compliance and Enforcement

The proposed Regulations will not require any significant change in OSFI procedures or significant additional personnel resources.

No compliance problems are anticipated with respect to the proposed Regulations. OSFI’s current supervisory process will enable OSFI to monitor compliance with the proposed Regulations. In the event of non-compliance, plans would be required to return to the normal five-year funding period. The Superintendent has the authority to issue a direction of compliance to the administrator of a pension plan to ensure that the funding requirements are being met.

Contact

Diane Lafleur,
Director, Financial Sector Division
Finance Canada
Ottawa, Ontario
K1A 0G5
Telephone: 613-992-5885
FAX: 613-943-8436
Email: lafleur.diane@fin.gc.ca