Traditional defined benefit (DB) pension plans have long been a cornerstone of the retirement income system in Canada, helping to provide lifelong, stable income for retirees. More recently, changes in the economic environment—prolonged low interest rate conditions, coupled with decreasing bond yields and more volatile asset returns—have posed new challenges for the sustainability of DB plans.
Over the last decade, a series of temporary measures have been enacted to provide relief from the challenges facing the DB sector. In 2017, the Government of Ontario announced a proposed suite of pension reforms that would provide more permanent solutions to enhance the sustainability and stability of DB plans going forward. The reforms are expected to come into effect shortly, although no firm timeline has been announced.
Ryan Silva, Director, Head of Pension and Insurance, Global Client Coverage at RBC Investor & Treasury Services, recently moderated a panel discussion sponsored by the Association of Canadian Pension Management (ACPM) that discussed the actuarial and investment implications of proposed funding reforms for defined benefit pensions in Ontario.1 Ryan shares his insights from the session.
- Who will be affected by the new rules?
The proposed changes largely affect:
- single-employer DB plans of private companies
- Broader Public Sector (BPS) plans
- public sector plans with valuations dated on or after December 31, 2017, filed after the new rules come into force
- multi-employer plans that do not currently qualify as specified Ontario multi-employer pension plans
Jointly sponsored pension plans, target benefit multi-employer plans and plans that are not subject to the Pension Benefits Act (such as Supplemental Executive Retirement Plans, federally regulated plans, or plans from out of province) are not impacted.
- What impact will the reforms have on defined benefit plans in Ontario?
There are three main areas of change:
Solvency and going concern reform: Under the solvency and going concern reforms, a new lower solvency target (85 percent, down from 100 percent) will be established, while deficits can be funded over five years with a 12-month deferral. For going concern reform, deficits are to be funded over 10 years (instead of the current 15), also with a 12-month deferral.
New provisions for adverse deviations (PfAD): The PfAD rules propose new explicit margins to be applied when determining minimum contributions to both going concern liabilities and normal costs. These new provisions may result in additional employer contribution requirements.
Changes in respect of Pension Benefit Guarantee Fund (PBGF) benefits and fees paid by plans: The monthly maximum PBGF benefit will increase from CAD 1,000 to CAD 1,500, and PBGF assessment fees for plans will also increase.
In addition to these proposed changes, there are adjustments to annuity purchase provisions, contribution holidays, and disclosure requirements, among others.
- What is the rationale for the proposed changes to solvency funding?
The existing solvency rules were put in place around three decades ago, during a very different fiscal environment. Adhering to these rules today can require relatively high contribution levels. Since 2008, plans have relied on solvency relief provisions that were implemented in response to the global financial crisis.
The bundle of proposed reforms in Ontario follows on from other reform efforts across Canada that introduce or contemplate changes in legislation affecting DB pension funding, including solvency requirements. The proposed reforms in respect of plan solvency are essentially formalizing the temporary provisions that have been in place for the last decade.
- How could the proposed PfAD rules affect how plans invest?
While the draft rules do not specifically rule out any investment strategies, they do encourage some strategies and downplay others. At the same time, the reforms will not have the same impacts from sponsor to sponsor, which means plan managers will need to develop their own customized responses based on individual circumstances. In effect, the regulations are standardized for all plans, but will affect each plan differently.
To best optimize their responses, plans should seek expert guidance from advisors, including actuaries, investment managers, and custodians. In implementing their responses, plan sponsors should also ensure they focus on delivering the best outcomes, rather than more narrowly attempting to optimize the PfAD.
- What is the impact of the changes to PBGF rules?
There are plans that have surpluses on both a going concern and solvency basis that will face increased contributions as a result of the new rules for the PfAD and significantly higher PBGF premiums. One concern that has been raised by ACPM is that these new rules will further discourage employers from offering DB plans, and plan sponsors may seek to avoid the premium increases through plan wind-up or annuity buy-outs.
As only comparatively well-funded plans are positioned to opt for either of these choices, a potential consequence is that the PBGF may end up covering only relatively higher-risk plans, which in turn could result in claims increases and limiting the intended impact of these reforms on plan sustainability.