Impact of Bill 177: Stronger, Fairer Ontario Act (Budget Measures), 2017 on Pension Plan Funding Requirements
Context
In May 2017, the Ontario government announced that it would be implementing a new funding framework for defined benefit (DB) pension plans.
Following Royal Assent of Bill 177 on December 14, 2017, the Ministry of Finance released a document describing new rules for solvency payments; enhanced going concern funding rules, including how a new provision for adverse deviations will be determined; disclosure requirements and transition rules. This edition of Benefits News and Commentary takes a closer look at these major new legislative requirements, which will affect a large number of defined benefit (DB) pension plans registered in Ontario.
Highlights of the new funding framework
- Shortening the amortization period from 15 years to 10 years for funding a going concern shortfall in the plan.
- Consolidating going concern special payment requirements into a single schedule when a new report is filed.
- Requiring the funding of a reserve within the plan, called a Provision for Adverse Deviations (PfAD).
- Requiring funding on a solvency basis if needed to improve the plan's funded status to 85 per cent on a solvency basis.
- Increasing the guarantee provided by the Pension Benefits Guarantee Fund from$1,000 per month to $1,500 per month.
- Providing funding rules for benefit improvements and restricting contribution holidays to improve benefit security.
Not all pension plans will be affected
It should be noted up front that these new rules will not apply to Jointly-Sponsored Pension Plans (JSPP) or Specified Ontario Multi-Employer Pension Plans (SOMEPP), but will apply to multi-employer pension plans that are not SOMEPPs.
Also, in June 2017, Ontario announced that it would be implementing a new framework for target benefit multi-employer pension plans (TBMEPP). Consultations on the rules for TBMEPPs will be held separately.
Effective date
These changes to funding requirements will apply to valuation reports dated on or after December 31, 2017, that are filed after the new framework comes in force. Proposals regarding certain aspects of the new framework for DB pension plans, including providing a discharge of liabilities when annuities are purchased for retirees or deferred plan members, requirements for funding policies and governance policies and changes to the PBGF under the new $1,500 per month guarantee, will be posted for consultation in the near future.
The government invited comments on the new funding framework until January 29, 2018, after which the new regulations supporting these changes will be released.
Comments
Ontario is following in the footsteps of some of its counterparts in other provinces by tightening its going concern funding requirements while lessening the solvency funding requirements at the same time. However, it does not entirely do away with solvency funding, as plans must continue to achieve a minimum of 85% funding on that basis or face additional minimum contribution requirements.
According the latest annual report issued by the Financial Services Commission of Ontario in April 2017 on the funding of DB pension plans, 46.4% of the plans it monitors reported a solvency ratio that was below 85% as at their latest valuation date, between July 1, 2015 and June 30, 2016. While solvency ratios have been trending favorably lately due to rising interest rates, there are still undoubtedly many pension plans that will still need to contend with some measure of solvency deficit amortization under the new framework, albeit to a now lower minimum level of 85%.
One of the most impactful changes brought on by the new funding framework is the introduction of a PfAD, which will apply both to a plan’s going concern liabilities and its current service cost. Any unfunded portion of the PfAD will be included in the plan’s going concern unfunded liability and amortized over 10 years.
Again, Ontario follows general principles adopted in other provinces – namely, that a certain buffer should be built up within a pension plan to ensure it can better withstand future market fluctuations and maintain a high degree of benefit security for its members.
We look at the composition of the PfAD in detail on the following page.
Provision for Adverse Deviations (PfAD)
Under the new funding framework, the PfAD will depend on whether the plan is open or closed to new members, with a higher PfAD requirement applicable to closed plans.
The PfAD would be the sum of three distinct components:
- A fixed component of 5% for closed plans and 4% for open plans.
- A component dependent on the plan’s asset mix, determined by the table below.
| % of non-fixed income assets | PfAD for Closed plans |
PfAD for Open plans |
|---|---|---|
| 0% | 0% | 0% |
| 20% | 2% | 1% |
| 40% | 4% | 2% |
| 50% | 5% | 3% |
| 60% | 7% | 4% |
| 70% | 11% | 6% |
| 80% | 15% | 8% |
| 100% | 23% | 12% |
- A component based on the plan’s going concern discount rate, if it exceeds a benchmark discount rate (BDR) that is defined by regulation.
Comments
Proposed regulations view alternative investments (such as real estate and infrastructure) as having characteristics of both fixed income and non-fixed income. As such, 50% of such investments can be considered non-fixed income for purposes of establishing the PfAD using Table 1 above.
For example, with an asset allocation of 45% fixed income and 55% non-fixed income, an open plan would have a PfAD of 7.5%, while a closed plan with the same asset allocation would have a PfAD of 11%.
The funding of pre- and post-retirement indexation (also known as “escalated adjustments”) will be required under the new framework on the same basis as for other benefits. However, the PfAD in respect of accrued liabilities would be determined by multiplying the PfAD by the going concern liabilities, excluding liabilities for future indexation.
Contributions for the PfAD in respect of the normal cost would be paid by the employer along with the employer’s normal cost contributions.
Going Concern Funding Rules
Under the new framework, separate schedules of special payments will not be maintained for the amortization of going concern deficits established at different valuation dates. Instead a new consolidated 10-year amortization schedule will begin one year after the valuation date and continue to apply until one year after the effective date of the subsequent report.
However, separate 5-year amortization schedules would be maintained when needed for any benefit improvements.
Previous Solvency Funding Relief
Effective July 1 2016, Ontario Regulation 161/16 came into force. It provided a third round of solvency funding relief measures, after those released in 2009 and 2012. This last extension applied to the first report filed with a valuation date on or after December 31, 2015 and before December 31, 2018.
Under the new framework, new elections to use one or more of the solvency relief measures introduced in 2016 are not permitted.
Comments
According the latest annual report issued by the Financial Services Commission of Ontario in April 2017 on the funding of DB pension plans, 17% of the plans that were eligible to make use of the solvency relief measures introduced in 2016 had elected to use one or more of the options provided. The vast majority of those making use of these provisions chose to consolidate existing special payments for solvency deficiencies into a new 5-year payment schedule.
Disclosure Requirements
The first annual membership statement sent to active and inactive members following the adoption of this new framework will be required to explain that funding rules have changed and that solvency funding requirements have reduced from 100% to 85%. They will also need to describe the requirement to fund a PfAD on a going concern basis.
Benefit Improvements
Under the new framework, benefits can be improved in a plan only if after the improvement the solvency ratio is at least 85% and the going concern funded ratio is at least 90%. In this context, the going concern funded ratio would be the ratio of the value of the going concern assets (excluding the value of any going concern special payments) to the going concern liabilities (which would not include the PfAD in respect of the liabilities).
The increase in the going concern liabilities, including the PfAD, that arises after a benefit improvement is made is to be funded over 5 years, beginning on the effective date of the amendment that improves benefits. Special payment schedules to fund benefit improvements would not be consolidated with other going concern special payment schedules.
Contribution Holidays
Under the new framework, a “contribution holiday”, in which surplus is used to lower the contribution requirements of an employer or members for the current service cost, including the PfAD, is only allowed if:
- The plan’s PfAD is fully funded on a going concern basis (excluding the amount of any letter of credit held in trust for the pension plan);
- After reducing the solvency assets by the amount of surplus used to lower contribution requirements, the plan’s transfer ratio is at least 1.05;
- A cost certificate is filed each year a contribution holiday is taken; and
- Notice is provided to plan participants, any unions representing members, and the plan’s advisory committee (if there is one).
In addition, the value of assets that can be used for a contribution holiday for a given year is limited to 20% of the plan’s available actuarial surplus, as identified in the plan’s last filed valuation report.
Comments
It is noteworthy that the requirements for making benefit improvements or taking contribution holidays remain quite stringent. This is consistent with the overall purpose of “Strengthening and Modernizing Workplace Pensions”, the banner under which the Ontario government announced these changes in May 2017. In its initial release of the intended measures, the Ministry of Finance had stated the objective to “ensure retirement income security for workers and retirees is protected while helping keep workplace pension plans affordable”.
Transitional Funding Rules
If total contribution requirements under the new framework exceed those under previous rules, transitional rules will allow the increase to be phased in over a 3-year period, starting from the date of the next required actuarial valuation of the plan. No increase will be required in the first year following this valuation, then 1/3 of the increase will be required the next year, and 2/3 the following year.
Comments
As such, plan sponsors will have a minimum of 3 years to adjust to the new funding requirements. For example, a plan whose next valuation is due January 1, 2020, no increase in funding requirements will come into force before 2021.
