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Pension sponsors hopeful about new funding framework

Focus on: Pensions Law
|Written By Michael McKiernan
Pension sponsors hopeful about new funding framework
Jana Steele says a new framework for defined-benefit plans will be a change from onerous solvency funding requirements to going-concern valuations.

Pension sponsors are cautiously optimistic about Ontario’s new funding framework for defined-benefit plans, according to lawyers in the field.

The long-awaited reforms represent a step away from onerous solvency funding requirements in favour of going-concern valuations, says Toronto lawyer Jana Steele, a past chairwoman of the Ontario Bar Association’s pension and benefits law section.

“It’s a welcome change for defined-benefit sponsors in the province, because it’s going to make their costs a bit more predictable and plans potentially more affordable,” says Steele, a partner at Osler Hoskin & Harcourt LLP.

Provincial law currently requires most private DB plans to report their funding ratios on a solvency basis, a method that calculates what percentage of the fund’s liabilities it could pay off using its existing assets if it were forced to wind up immediately.  

Any shortfall must then be made up with a special payment spread over five years.

Elizabeth Brown, the Toronto-based chairwoman of the pension and benefits practice group at Hicks Morley Hamilton Stewart Storie LLP, says solvency special payments have become “crippling” for employers over the last few years as low interest rates and poor market returns sent funding ratios plunging.  

Going concern valuations, by contrast, assume the plan will continue indefinitely, smoothing short-term fluctuations in market conditions.

Although average solvency ratios of pension plans in Ontario have improved generally since the government began its review, some private employers have been forced to take advantage of temporary solvency relief measures introduced by the province, while more stable plans sponsored by public sector employers operate under different rules.

“The system has become a patchwork of exceptions and special situations, so I think that pointed to the need for some more systemic change,” Brown says.

She says she’s waiting for the provincial government to unveil detailed legislation and regulations, expected later this fall, before delivering her final verdict on the changes, but she says her clients are “hopeful” they will have a positive impact.

“Sponsors were no longer able to sustain the large and very volatile solvency payments they are required to make under the current regime. That has been going on for many years and has caused many to stop offering defined benefits plans altogether,” Brown says.

“Logically, you would think nothing can be as bad as the horrendous solvency requirements, but there’s still some wait and see going on.”

Under the planned changes, which are the product of more than a year of consultations that attracted 90 submissions from interested parties, pensions with funding ratios of 85 per cent and above will no longer have to fund themselves on a solvency basis.

The province estimates that the vast majority of plans will meet the 85-per-cent threshold.

According to a recent report by the Financial Services Commission of Ontario, it says around 15 per cent of DB pension funds fall below that mark and will have to continue making special payments according to the old rules.

In what Steele calls a “trade-off” for the increased risk that plans wouldn’t be able to cover their commitments to retirees in the event a sponsor goes under, the province has developed enhanced going-concern funding rules that shorten the amortization period for shortfalls to 10 years from 15 years.

In addition, pension plans will need to create a reserve fund called a Provision for Adverse Deviation, designed to protect beneficiaries should administrators’ estimated market returns prove overly optimistic in cases where a sponsor suffers a financial collapse.

The province has also promised to boost the maximum amount it will cover under the Pension Benefits Guarantee Fund, a government-run insurance program for plans with bankrupt sponsors, to $1,500 from $1,000 per month.

“By providing more flexibility, defined-benefit pension plans will remain a vital part of our retirement income system in Ontario. With these changes, we are also ensuring that pension plans are affordable for businesses and benefit security for workers and retirees is protected,” Ontario Finance Minister Charles Sousa said in a statement announcing the move.

In its own statement on the changes, the Canadian Association of Retired Persons lent its support via its vice president of advocacy, Wanda Morris, who commended the government for its focus on “improving financial security for retirees.

“With unprecedented gains in longevity and historically low interest rates, defined benefit pension plans have experienced significant challenges in recent years.

“We are pleased to see that the government has taken a balanced approach to funding reform by providing welcome relief to plan sponsors while also improving plan security for pension recipients,” she added.

Brown says the lack of detail about the size of the required PfAD and the prospect of increased employer premiums to cover the swollen PBGF payments are part of the reason her clients have yet to fully embrace the changes.

“We’ve exchanged what has become a volatile and unworkable solvency regime for an enhanced going concern regime, the exact scope and magnitude of which remains unknown,” she says.

“Anyone with a funding ratio over 85 per cent is probably feeling good, but they don’t actually know what it will cost them. Depending on the form and how onerous it is, it may present some difficulties.”

Kyle Lambert, a lawyer in the Ottawa office of McMillan LLP, says he suspects some employers would have preferred the reforms to go further by eliminating solvency funding requirements altogether, especially those in the minority with funding ratios below the 85-per-cent threshold.

“If you have a smaller plan that’s stuck around 50 per cent and struggling to stay afloat, there’s still a significant burden there,” he says.    

Last year, Quebec eliminated solvency funding requirements for privately sponsored pension plans after a consensus among plan sponsors and members emerged in favour of the going-concern standard, coupled with its own version of Ontario’s new PfAD.  

Lambert says Ontario’s more conservative approach may not be enough to stop employers from abandoning DB plans in favour of the typically less generous defined-contribution model.

“This is just the latest of a number of moves that seemed designed to keep as many pension plans afloat as possible, but I’m not sure if it really matters to a sponsor that is thinking of moving to DC,” he says.

“The province seems much more focused on preventing the next Nortel than on preserving every single DB plan out there.”

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