News & Views. Pooled Registered Pension Plans: Amendments to the Income Tax Act Proposed

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1 News & Views IN THIS ISSUE 1 Pooled Registered Pension Plans: Amendments to the Income Tax Act Proposed 2 Temporary Relief Measures for Pension Plans in Quebec 3 Financial Statements for Quebec Pension Plans: RRQ Allows Special Purpose Financial Statements 4 New Brunswick Provides Solvency Funding Relief, Amends Requirement for Annual Valuations Manitoba Regulations: Solvency Funding Relief And More 5 Amendments to the Quebec Pharmacy Act Proposed Amendment to the Ontario Employment Standards Act: Family Caregiver Leave 6 Update! > > CAPSA Finalizes Guidelines on Prudent Investment Practices and Funding Policies 7 As at December 31, 2011 > > Market Indices > > Tracking the Funded Status of Pension Plans > > Impact on Pension Expense Under International Accounting Pooled Registered Pension Plans: Amendments to the Income Tax Act Proposed On December 14, 2011 the federal government released for consultation their proposed amendments to the Income Tax Act that would accommodate Pooled Registered Pension Plans (PRPPs). The proposed amendments are welcome as they serve to clarify the taxation of these arrangements which are governed in most other aspects by the proposed provisions of the recently published Pooled Registered Pension Plans Act (not yet adopted). They are all the more welcome as the government has chosen not to apply the cumbersome pension adjustment rules to these arrangements. At a very high level, the proposed tax rules governing PRPPs are very similar to the rules for RRSPs except employers can contribute directly to a PRPP without requiring employees income to be grossed up and, upon retirement, the individual can draw annual income from the PRPP rather than having to roll the money into a LIF or RRIF. Both of these distinctions are welcome. Highlights of the announcement are as follows: > Contributions to PRPPs will be allowed for a given year up to the individual s RRSP room for that year. It is assumed that the Administrator will need to provide contribution receipts, similar to an RRSP plan as pension adjustments will not be calculated for PRPPs. > Employer contributions to an employee s PRPP account are not included in employment income. Therefore, they do not generate payroll taxes as do employer contributions to group RRSPs. For this reason alone, employers who currently make indirect contributions to a group RRSP on behalf of participants may now find PRPPs to be a more attractive vehicle. > Annual employer contributions to an employee s PRPP account will be limited to the maximum RRSP dollar limit for that year, unless the employee directs otherwise. > General rules will apply to ensure that investments are reasonably diversified. > Transfers between plans (e.g. RRSP to PRPP, defined contribution to PRPP, and vice versa) will be permitted. > Decumulation options (i.e. ways to cash money out of a PRPP) are provided for under the draft legislation and include the possibility of receiving RRIF-type payments from within the PRPP. This is currently not possible with RRSPs, as an account holder must transfer to a RRIF from age 71. > The tax rules contemplate the creation of special PRPPs (designated pooled pension plan) that have fewer than 10 participating info@morneaushepell.com January 18, 2012 Volume 9, Issue 1 1 of 10

2 employers or where more than half the participants work for a single employer. Given the special features of a PRPP, it is possible that some very large employers will wish to establish a designated pooled pension plan for their own employees in lieu of a defined contribution pension plan or a group RRSP. It remains to be seen whether provincial PRPP legislation also allows for the establishment of such plans. PRPPs are registered plans and, as such, each jurisdiction must enact legislation that would provide the framework (beyond the tax laws) for these vehicles to be established. Some of the provisions prescribed above (e.g. RRIF-like decumulation, designated pooled pension plans) may ultimately not be adopted by the provinces. Currently only the federal government has released proposed PRPP legislation, although Quebec should not be far behind. Employers in these jurisdictions who currently operate group RRSPs should take note given the potential payroll tax savings. Temporary Relief Measures for Pension Plans in Quebec In December 2011, Quebec published two draft regulations proposing relief measures for the funding of actuarial deficiencies for defined benefit plans. One covers the private sector, the other covers municipalities and universities. Private Sector A draft regulation titled Draft regulation on temporary relief measures for the funding of solvency deficiencies was published in the Gazette officielle du Québec on December 28, The draft regulation proposes relief measures, for a two-year period, related to the funding of technical actuarial deficiencies for defined benefit plans in the private sector. The proposed measures are as follows: Relief Measures First Actuarial Valuation after December 30, 2011 An employer who sponsors a pension plan, or, if it is a multi-employer plan, the party empowered to amend the plan, may give written instructions to the Pension Committee that administers the plan to implement one or more of the following optional measures for the first actuarial valuation of the plan performed after December 30, 2011: 1 Asset smoothing: smoothing of assets on a solvency basis for a maximum period of 5 years. 2 Elimination of amortization payments: elimination (consolidation) of the existing amortization payment schedules for technical actuarial deficiencies and for improvement unfunded liabilities if they were implemented before December 31, Extension of the amortization period: amortization of any technical actuarial deficiency determined at the valuation date or thereafter, for a maximum period of 10 years. Existing Relief Measures The draft regulation also proposes that the provisions of the Regulation respecting measures to reduce the effects of the financial crisis on pension plans covered by the Supplemental Pension Plans Act (which is the Regulation governing any existing relief measures the Pension Committee was instructed to implement before December 31, 2011) will cease to apply as of the date of the first plan valuation after December 30, 2011, if the Pension Committee is given new instructions to apply one of the relief measures in the draft regulation. Other Provisions in the Draft Regulation The draft regulation also sets out the terms and conditions governing the pension amount which must be guaranteed by an insurer in situations where the Régie administers the assets of a deficient plan pursuant to plan termination or employer withdrawal from a plan due to bankruptcy or insolvency. Comments Comments on the regulation must be sent in writing to the Régie des rentes du Québec by February 10, When enacted by the government and re-published in the Gazette officielle du Québec, the draft regulation will take effect retroactively to December 31, Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 2 of 10

3 Municipalities and Universities The draft Regulation amending the Regulation respecting the funding of pension plans of the municipal and university sectors was published on December 21, 2011, in the Gazette officielle du Québec. The draft regulation extends the relief measures related to funding of the technical actuarial deficiencies of defined benefit plans in the municipal and university sectors to December 31, The measures are similar to previous relief measures introduced to mitigate the impacts of the financial crisis of An employer who sponsors a pension plan, or, if it is a multi-employer plan, all the employers, may give written instructions to the plan s Pension Committee to reduce the monthly payments which fund a technical actuarial deficiency, if the following conditions are met: 1 The payments are due after December 31, 2011, and before January 1, 2014; and 2 The payments are for a technical actuarial deficiency determined in a complete plan actuarial valuation dated after December 30, 2008, and before December 31, Note that the draft regulation includes the new requirement that a pension committee which receives such instruction must: > promptly inform the Régie des rentes du Québec and provide the Régie with a copy of the instruction; > promptly provide the Régie with the following information: 1 the amount of the technical actuarial deficiency covered by the instruction; 2 the date of its determination; 3 the monthly amounts, to December 31, 2013, of the amortization payments required to fund the deficiency. This draft regulation could be enacted as of January 21, When it takes effect, the draft regulation will be retroactive to December 31, Financial Statements for Quebec Pension Plans: RRQ Allows Special Purpose Financial Statements On December 22, 2011, the Régie des rentes du Québec issued a press release in which it announced that pension plan administrators in Quebec will now have two options for producing plan financial statements after December 30, The Ordre des comptables agréés du Québec (OCAQ) issued a similar press release on the same day. The first option is to produce a special purpose financial report, accompanied by a report by an independent auditor with no disclosure restriction. The special financial report excludes the accrued benefit obligation. According to the RRQ, section 161 of the Supplemental Pension Plans Act (the Act ) constitutes a special purpose basis of accounting, since the Act does not require presentation of the obligation (as the Act already provides for such presentation by means of an actuarial valuation). The auditor therefore does not need to issue an adverse opinion on the financial report, by virtue of its special purpose basis. The second option is to produce general purpose financial statements in which the accrued benefit obligation is presented, in accordance with Generally Accepted Accounting Principles (GAAP). These financial statements must also be accompanied by a report from an independent auditor. Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 3 of 10

4 New Brunswick Provides Solvency Funding Relief, Amends Requirement for Annual Valuations On December 8, 2011, New Brunswick filed a new regulation with two important changes affecting defined benefit pension plans registered in New Brunswick: Solvency Funding Relief The plan administrator will be permitted to consolidate all existing solvency schedules and amortize the solvency shortfall over a 10-year period. The one-time solvency extension must be requested in a valuation report with a review date between April 1, 2010, and January 1, Plan member consent is not required, but notice must be provided to all members and other plan beneficiaries. During the extended period, annual valuation reports will not be required. Any benefit improvements during the extended amortization period must be fully funded. It should be noted that any special payments made between the review date and the filing date of the valuation report that are in excess of the special payment required under the 10-year solvency consolidation schedule cannot be used as a credit to further reduce special payments made after the filing date. Given the very significant increase in solvency liabilities and negative asset return for many pension funds during 2011, this announcement will be welcome relief for sponsors of New Brunswick defined benefit plans. Annual Valuation Requirements Effective for any valuation report with a review date on or after April 1, 2011, annual valuations are now required when the report identifies a transfer ratio of less than 0.9. Previously, annual valuations were required when the solvency ratio identified in the report was less than 0.9. Due to the financial markets and declines in long-term yields, many pension plans will have transfer ratios that are less than 0.9. Consequently many sponsors of New Brunswick registered pension plans will likely be required to file annual valuations. Please contact your Morneau Shepell consultant for additional information regarding these changes. Manitoba Regulations: Solvency Funding Relief And More Manitoba has amended its pension regulations to provide for additional solvency funding relief, the use of letters of credit to cover solvency funding obligations, and increased fines for plan administrators. The changes came into effect on January 1, Solvency relief will apply to the first valuation report filed before January 2, 2014, and will only be permitted for employers without payments in arrears. An employer will be permitted to consolidate past solvency deficiencies and the new solvency deficiency may be amortized over a new single ten year period. Prior notice must be given to members and beneficiaries and no more than 1/3 of each group may object. Employers with defined benefit plans (other than multi-unit pension plans) will now be able to use letters of credit, rather than cash, to fund all or part of a plan s solvency deficiencies. The new regulation prescribes the requirements the letter of credit must meet in order to qualify and sets out the employer s obligations, including paying the costs of obtaining and maintaining the letter of credit. A letter of credit may not be used if an employer elects solvency relief. Employers will also be faced with higher administrative penalties for non filing or late filing of plan amendments, annual information returns, audited financial statements, valuation reports, cost certificates, or termination reports. Penalties are based on the fee for the most recent annual information return, the number of days the filing is late, and multiple contraventions of the requirements, up to a maximum penalty of 100% of the annual information return filing fee or $10,000, whichever is less. Finally, the fees payable with the annual information return have increased effective January 1, The fee is now $250 for a simplified defined contribution pension plan, and the lesser of $18,000 or $7.20 for each active member in any other plan. The minimum fee is $120 per plan. Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 4 of 10

5 Amendments to the Quebec Pharmacy Act On December 8, 2011, the Quebec National Assembly adopted Bill 41 amending the Pharmacy Act. The amendments add professional activities to those already reserved to pharmacists. The new activities include the following: > renewal of prescriptions for a specified period; > adjustment of prescriptions; > therapeutic substitution if the supply of a drug is completely interrupted; > administration of a medication to demonstrate proper usage; > prescription of medications when no diagnosis is required; > prescription and interpretation of laboratory tests by pharmacists who work in a health or social services institution. For patients, these amendments will in all likelihood improve access to prescription drugs. For the Quebec government, the amendments will reduce the number of doctor appointments made solely to renew or obtain a prescription that does not involve a diagnosis (such as a prescription for contraception). The amendments further empower the pharmacist. However, pharmacists have also been placed in a potential conflict of interest by being able to substitute medications that they sell. Doctors and nurses have expressed concerns related to liability for medical acts performed by pharmacists, which were formerly reserved for doctors and nurses alone. For group insurance plan sponsors, better access to medications and the increased powers granted to pharmacists will no doubt lead to higher prescription drug usage. We do not believe that the financial repercussions on drug insurance plans will be very significant, but neither will they be negligible. We note, with regret, that insurance companies did not submit any briefs in defence of the interests of plan sponsors to the parliamentary committee. Proposed Amendment to the Ontario Employment Standards Act: Family Caregiver Leave The Ontario government has introduced a new Family Caregiver Leave, which will expand an employee s entitlement to a leave to care for an ill or injured family member. Under the proposed Bill 30, employees would be entitled to take up to 8 weeks of unpaid, job-protected leave of absence to care for an ill or injured relative. Relatives would include the employee s spouse, parent, child, spouse of the child, grandparent, sibling or a relative who is dependent on the employee for care or assistance. To qualify for this type of leave, the employee would need to provide the employer with a certificate from a qualified health practitioner stating that the relative has a serious medical condition. The proposed Family Caregiver Leave is a separate leave and in addition to the current Family Medical Leave. The Family Medical Leave also provides an 8 week unpaid, job protected leave of absence, but only if the ill family member is at a significant risk of dying within 26 weeks. The new Family Caregiver Leave provides for a similar leave without the requirement of a terminal illness. So an employee who is initially on a Family Caregiver Leave could further extend his or her leave by another 8 weeks under the Family Medical Leave if his or her ill family member is expected to die within 26 weeks. Under the Family Medical Leave provision, Employment Insurance benefits are available for up to 6 weeks, referred to as Compassion Care Benefits. The Ontario government is requesting that the Federal Government also extend Employment Insurance benefits to employees who are on a Family Caregiver Leave if this Bill is passed. Contact your benefits consultant to determine how this will impact benefits for employees taking this leave. Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 5 of 10

6 Update! CAPSA Finalizes Guidelines on Prudent Investment Practices and Funding Policies On November 15, 2011, the Canadian Association of Pension Supervisory Authorities ( CAPSA ) released the final versions of CAPSA Guideline No. 6: Pension Plan Prudent Investment Practices Guideline and the Self Assessment Questionnaire on Prudent Investment Practices (the Self Assessment Questionnaire ) as well as Guideline No. 7: Pension Plan Funding Policy Guideline. Draft versions of these policies and the Self Assessment Questionnaires were addressed in our News & Views of April 14, Guideline No. 6 is intended to guide plan administrators on how to demonstrate the application of prudence in the investment of pension plan assets. The Self Assessment Questionnaire is designed to help plan administrators review the investment practices of their pension funds. It suggests topics applicable to single employer defined benefit and defined contribution plans as well as multi-employer pension plans. Guideline No. 7 outlines the general principles and objectives of pension plan funding, the purpose of establishing a funding policy for defined benefit pension plans and the individual roles of the sponsor and administrator. CAPSA guidelines do not have the force of law. However, through these guidelines CAPSA has been instrumental in shedding light on what pension regulators in Canada consider to be sound practices. More importantly, these policies should be viewed as an integral part of a plan sponsor/ administrator s risk management. Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 6 of 10

7 As at December 31, 2011 Market Indices The following table shows the Morneau Shepell monthly summary of returns from various market indices. It also includes returns from benchmark portfolios used by pension funds. Monthly Quarter to date Returns Year to date 1 Year TSX Group/PC-Bond DEX Universe Bond Index 1.7% 2.1% 9.7% 9.7% DEX 91 Day Treasury Bill Index 0.1% 0.2% 1.0% 1.0% DEX Short Term Bond Index 0.5% 0.5% 4.7% 4.7% DEX Mid Term Bond Index 1.8% 2.0% 10.9% 10.9% DEX Long Term Bond Index 3.7% 4.9% 18.1% 18.1% DEX High Yield Bond Index 0.1% 2.5% -2.3% -2.3% DEX Real Return Bond Index 3.5% 7.7% 18.3% 18.3% Canadian Equity Indices S&P/TSX Composite Index (total return) -1.7% 3.6% -8.7% -8.7% S&P/TSX Composite Index Capped -1.7% 3.6% -8.7% -8.7% S&P/TSX 60 (total return) -1.8% 2.8% -9.1% -9.1% S&P/TSX MegaCap Index -2.0% 3.2% -8.2% -8.2% S&P/TSX Completion -1.5% 5.8% -7.9% -7.9% S&P/TSX Small Cap -2.1% 5.9% -16.4% -16.4% BMO Small Cap Unweighted -1.7% 4.9% -17.1% -17.1% BMO Small Cap Weighted -1.7% 5.0% -14.4% -14.4% U.S. Equity Indices S&P 500 (US$) 1.0% 11.8% 2.1% 2.1% S&P 500 (C$) 0.7% 8.5% 4.4% 4.4% Foreign Equity Indices 1 MSCI EAFE (C$) -0.8% 1.0% -10.0% -10.0% MSCI World (C$) 0.1% 5.1% -3.2% -3.2% MSCI ACWI (C$) -0.1% 4.7% -5.1% -5.1% MSCI Europe (C$) -1.4% 3.0% -8.9% -8.9% MSCI Pacific (C$) 0.3% -2.6% -11.6% -11.6% MSCI Emerging (C$) -1.0% 2.1% -16.1% -16.1% Other Consumer Price Index (Canada, November 2011) 0.1% 0.2% 2.9% 2.9% Exchange Rate US$/C$ -0.3% -3.0% 2.3% 2.3% Morneau Shepell Benchmark Portfolios 2 40% Bonds/ 60% Equity 0.2% 3.5% 0.1% 0.1% 45% Bonds/ 55% Equity 0.2% 3.3% 0.7% 0.7% 50% Bonds/ 50% Equity 0.3% 3.2% 1.3% 1.3% 55% Bonds/ 45% Equity 0.4% 3.0% 2.0% 2.0% 60% Bonds/ 40% Equity 0.7% 3.0% 3.2% 3.2% 1. Returns net of taxes on dividends, except for MSCI Emerging. 2. The returns are compounded monthly. If you have any questions, please contact your Morneau Shepell consultant, or us at info@morneaushepell.com. Asset Management Consulting Practice This practice provides objective advice on all aspects of asset management for pension funds, including investment policy statements, portfolio manager searches, investment performance measurement and investment strategy. Jean Bergeron, Partner Tel.: Fax: jbergeron@morneaushepell.com Robert F. Boston, Partner Tel.: Fax: rboston@morneaushepell.com Risk Management Consulting Practice Our team provides a structured, comprehensive approach to pension risk management, including implementation of liability-driven investment strategies, advice on allocation of the risk budget within an asset-liability framework and execution of continuous and dynamic processes for risk reduction. Patrick De Roy, Partner Tel.: Fax: pderoy@morneaushepell.com Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 7 of 10

8 As at December 31, 2011 Tracking the Funded Status of Pension Plans This graph shows the changes in the financial position of a typical defined benefit plan since December 31, For this illustration, assets and liabilities of the plan were each arbitrarily set at $100 million as at December 31, The graph shows the impact of past returns on plan assets and the effect of interest rate changes on solvency liabilities. Pension plans have experienced significant swings in their financial position since December 31, In February 2009, when assets fell to their lowest point, the solvency deficit reached $37 million. In December 2011, when liabilities peaked at their highest point, the solvency deficit almost reached $38 million. One of these two gaps was created by the financial crisis and the other by falling solvency rates. Assets finished the year with a slight 0.7% increase and stand at $109 million in December Liabilities ended the year at their highest point at over In millions of dollars The Evolution of the Financial Situation of Pension Plans since December 31, Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q Assets Solvency liabilities $146 million, increasing by almost 20% and financial markets do not improve then since the beginning of the year and by 4.8% the gap between assets and liabilities will in December alone. The solvency deficit further deepen in for this typical pension plan rose from $31.4 million in November to $37.9 million Please contact your Morneau Shepell in December, a staggering 20.6% increase consultant for a customized analysis of in one month. If solvency rates keep falling your pension plan. Canada Bond Yields Comments: Yields (at closing) Dec Dec Change in 2011 Overnight rate target 1.00% 1.00% 0 bp 3 months 0.97% 0.82% -15 bps 2 years 1.67% 0.95% -72 bps 5 years 2.41% 1.27% -114 bps 7 years 2.70% 1.51% -119 bps 10 years 3.11% 1.94% -117 bps 30 years 3.52% 2.49% -103 bps Source: Bank of Canada 1. No consideration has been made for contributions paid into the plan or for benefits paid out of the plan. 2. Solvency liabilities are projected using the rates prescribed by the Canadian Institute of Actuaries for the purpose of determining pension commuted values. Early application of the 2009 standards is not reflected. 3. The underlying typical defined benefit plan is a final average plan with no pension indexing. 4. Solvency liability calculations take into account revised CIA guidance on the solvency valuation assumptions (annuity proxy) announced on November 17, Assets are shown at full market value. Returns on assets are based on those of the Morneau Shepell benchmark portfolio (55% equities and 45% fixed income). Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 8 of 10

9 As at December 31, 2011 Impact on Pension Expense Under International Accounting Every year, companies must establish an expense for their defined benefit pension plans. The graph shows the expense impact for a typical pension plan that starts the year at an arbitrary value of 100 (expense index). The expense is influenced by changes in the discount rate based on high quality corporate bonds and the median return of pension fund assets. The table below shows the discount rates for varying durations and the change since the beginning of the year. A plan s duration generally varies between 10 (mature plan) and 20 (young plan). In order to promote comparability of results, please note that the discount rates shown below Discount rate Duration December 2010 December 2011 Change in % 4.58% -55 bps % 5.00% -49 bps % 5.27% -43 bps % 5.44% -40 bps do not reflect the new CIA educational note concerning the discount rate for accounting purposes (September 2011). This new methodology will be applied when determining the expense index starting in For your information, the new method would have resulted in a discount rate of 4.39% at December 31 (for a duration of 14), which is about 0.61% lower than that shown. Expense Index from December 31, 2010 Contributory plan Non-contributory plan (In %) Discount rate Return on assets (55% equities) n/a The pension expense has increased since the beginning of the year largely due to asset returns below expectations, as well as a drop in the discount rate since December Please contact your Morneau Shepell consultant for a customized analysis of your pension plan Comments: 1. The expense is established as at December 31, 2010, based on the average financial position of the pension plans used in our 2009 Survey of Economic Assumptions in Accounting for Pensions and Other Post-Retirement Benefits report (i.e. a ratio of assets to obligation value of 91% as at December 31, 2008). Also, we are assuming that, under the international accounting, the employer elected the exemption at transition with regards to past gains and losses, and that future gains and losses are recognized in other comprehensive income (excluded from expenses shown). 2. The return on assets corresponds to the return on the Morneau Shepell benchmark portfolio (55% equities and 45% fixed income). 3. The actuarial obligation is that of a final average earnings plan, without indexing (two scenarios: with and without employee contributions). Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 9 of 10

10 About Us Morneau Shepell Inc. is Canada s largest human resource consulting and outsourcing firm focused on pensions, benefits, employee assistance program (EAP) and workplace health management and productivity solutions. We offer business solutions that help our clients reduce costs, increase employee productivity and improve their competitive positions by supporting their employees financial security, health and well-being. CALGARY FREDERICTON HALIFAX KITCHENER LONDON MONTRÉAL OTTAWA PITTSBURGH QUÉBEC ST. JOHN S TORONTO VANCOUVER INFO@MORNEAUSHEPELL.COM More Information Please contact your Morneau Shepell consultant for additional information about this newsletter. Contributing Editors Colette Barbati, LL.B. Group Benefits and Pension Legislation Monica Bell-Johns, CEBS Benefits Consulting Paul Chang, FSA, FCIA Retirement Consulting Marc Drouin, FSA, FCIA Benefits Consulting Tejash Modi, LL.B. Pension Legislation Claire Ouellet, LL.B. Pension Legislation Francine Pell, FSA, FCIA Retirement Consulting François Turgeon, LL.L, D.N.L., Fin. Pl. Pension Legislation Sébastien Rannaud, FSA, FCIA Retirement Consulting Fred Vettese, FSA, FCIA Retirement Consulting Andrew Zur, LL.B. Pension Legislation Morneau Shepell Ltd., 2012 January 18, 2012 Volume 9, Issue 1 10 of 10