NEWS & VIEWS CHOOSE THE INDEX WISELY. 1 Choose the Index Wisely 2 Right to Reduce Pension Benefits Retroactively. 3 Contribution Holidays and Surplus

Size: px

Start display at page:

Download "NEWS & VIEWS CHOOSE THE INDEX WISELY. 1 Choose the Index Wisely 2 Right to Reduce Pension Benefits Retroactively. 3 Contribution Holidays and Surplus"

Roberta Simon
5 years ago
Views:

NEWS & VIEWS IN THIS ISSUE 1 Choose the Index Wisely 2 Right to Reduce Pension Benefits Retroactively 3 Contribution Holidays and Surplus 3 Responsibilities of Fund Holders 4 Ontario Mandatory

1 NEWS & VIEWS IN THIS ISSUE 1 Choose the Index Wisely 2 Right to Reduce Pension Benefits Retroactively 3 Contribution Holidays and Surplus 3 Responsibilities of Fund Holders 4 Ontario Mandatory E-filing and New E-filing Options 4 Overpayments and Plan Wind Up 5 Update: Adoption of IFRS by Entities with Rate-Regulated Activities 5 Update: Application of Bill C-13 to Benefit Trusts 6 Market Indices 7 Tracking the Funded Status of Pension Plans 8 Impact on Pension Expense under International Accounting 9 About Us CHOOSE THE INDEX WISELY Compared to the investment performance of their passive benchmarks, 2011 was a difficult year for many active investment managers. The knee-jerk reaction for investors to avoid a repeat experience is to throw in the towel and invest in index funds, which at least assures them of getting the index return. However, investors should be careful what they wish for an index fund, like any other investment strategy, has its own risks and rewards. Before you place your bet, you should be aware of the shortcomings. Take for example the capitalization weighted indices such as the S&P/TSX Capped Composite Index. They are essentially a buy-and-hold strategy without any rebalancing. Bigger companies garner a bigger portion of your investment bet. Investors make their bet at the outset and let it ride. Winners in the portfolio are allowed to grow and compound. Invariably the performance of the fund becomes dominated by a few companies and/or a few sectors. Over 75% of the index is invested in three industry groups: financials, oil and gas, and materials. Is this a well diversified portfolio? Looking back three years from December 31, 2003, post the tech-bubble crash, had you placed an equal bet on each company in the S&P/TSX 60 (and rebalanced so that they remained equal), you would have enjoyed a return of 10.2%. The buy and-hold strategy returned -2.8%. When it comes to selecting an index, there are choices. Other types of market indices (and investable funds) include equal-weighted, risk-weighted, maximum diversification or indices determined based on fundamentals. Within a portfolio, strategies based on these other types of indices can significantly improve diversification and the risk/return profile of the portfolio. These indices can 2012 Morneau Shepell Ltd. April 2012 Volume 9, issue 4 1 of 9

2 actually mimic active management strategies that have a contrarian or low volatility focus. The right choice of benchmark indices is often overlooked in the process of constructing the target asset allocation. An inappropriate index assigned to an active manager may result in unwanted outcomes. The active manager wishing to minimize tracking error to a poor benchmark is unwittingly following a sub-optimal course. It is therefore important to fully understand the characteristics of the selected indices and to understand how these indices will behave in different market conditions. The moral of this story is to assess the viability and suitability of an index (or index fund) with the same diligence as any other investment strategy for its relative strengths and weaknesses. RIGHT TO REDUCE PENSION BENEFITS RETROACTIVELY Pension plan sponsors often question if they have the right to reduce pension benefits retroactively. In Synertech Moulded Products, Division of Old Castle Building vs. Tribunal administratif du Québec, the Quebec Superior Court considered the issue of amendments that reduce pension benefits retroactively. On September 9, 2011, the court ruled that the Régie des rentes du Québec (the Régie ) cannot arbitrarily refuse to register pension amendments to which the affected members had given their consent. QUEBEC LEGISLATION The decision is based on the provisions of the Quebec Supplemental Pension Plans Act (the SPPA ) which state, in particular, that no amendment to a pension plan which cancels refunds or pension benefits, limits eligibility therefor or reduces the amount or value of the benefits of members or beneficiaries may take effect, unless the affected members or beneficiaries have agreed to the amendment, provided the Régie has authorized the amendment. It should be noted that pension legislation in the other provinces limits or prohibits the right to reduce pension benefits retroactively. Applicable legislation should be referred to in order to determine the relevant specific requirements. SUMMARY OF THE FACTS In 2001, Synertech sets up two individual defined benefit plans for two key employees, with the same pension formula. Following the 2008 financial crisis, each one of the two members affected by these plans agreed in writing to an amendment that would reduce the pension formula with respect to all the service credited under the plan, effective retroactively to January 1, The pension plans were also terminated as at December 31, In 2009, the Régie refused to register the amendments to the above-described plans because the amendments reduced significantly and retroactively the value of the members benefits. The Régie s decisions were then contested before the Tribunal administratif du Québec (the Tribunal ), which upheld the Régie s decisions in In 2011, Synertech appealed the Tribunal s decisions to the Quebec Superior Court. MAIN REASONS OF THE DECISION The court overruled the Tribunal s decisions for the following reasons: zwhen exercising its discretionary power, the Régie must not act arbitrarily, unfairly or unreasonably in authorizing or refusing amendments. z In the absence of criteria in the legislation, the Régie s decisions must be based on the provisions as set out in the SPPA. It should be noted that the Régie s non-official internal position was not to authorize retroactive amendments that reduced the value of members benefits by more than 5% Morneau Shepell Ltd. April 2012 Volume 9, issue 4 2 of 9

3 CONCLUSION The SPPA should be amended to provide further clarification. It remains to be seen if the Régie will publish guidelines regarding amendments reducing benefits. If no measure is taken to further clarify the SPPA or to disclose the Régie s official position, it appears that it could be more difficult for the Régie to exercise its discretionary power in the future. CONTRIBUTION HOLIDAYS AND SURPLUS In Telecommunication Employees Association of Manitoba Inc. et al. vs. Manitoba Telecom Services Inc. et al., dated February 10, 2012, the Manitoba Court of Appeal reversed a decision that had ordered an employer to repay $43M to a pension fund. The dispute between the plan members and the employer, Manitoba Telecom Services, occurred after a public service pension plan was replaced by a private plan when the utility was privatized in Following the transfer, the employer took contribution holidays for several years, and the members objected. In reversing the trial award, the appeal court rejected the trial judge s conclusion that the contribution holidays were a wrongful taking of surplus to which the members were entitled because of the promise of benefits equivalent in value. The appeal court restricted the interpretation of benefits equivalent in value to mean only a member s monthly defined benefit pension, without consideration of surplus entitlement. It deemed that the trial judge had made an error in considering the actuarial surplus before it crystallized, since the asset transfer from the public to the private plan was not a termination under which surplus would crystallize. Finally, the appeal court rejected the trial judge s view of member expectations. RESPONSIBILITIES OF FUND HOLDERS Effective January 1, 2012, the Financial Services Commission of Ontario (FSCO) issued policy A , Pension Fund Administration Responsibilities of Fund Holders. The fund holder is the financial institution or party that is retained by the administrator of the pension plan to hold the pension funds. While the administrator may delegate investment functions to a third party service provider, it has ultimate responsibility for the investment activities. The fund holder is an agent of the administrator with certain fiduciary responsibilities and other obligations under the Ontario Pension Benefits Act (PBA) and Regulation, trust law (if applicable) and common law. The fund holder s responsibilities include: zensuring that the pension plan s funds are held exclusively for the pension plan and that the fund holder has clear, accurate and up-to-date records; zholding funds in a manner required by the PBA and Regulation, and the Income Tax Act; zacting in accordance with the fund holder agreement; zreporting omissions or delays in contribution remittances to the Superintendent of Financial Services; zmeeting reporting and recordkeeping responsibilities; zacting on direction from the administrator on the investment of the pension fund s assets; zensuring that the pension fund s assets are held separate and apart from the employer s and fund holder s assets; and zreporting back to the administrator Morneau Shepell Ltd. April 2012 Volume 9, issue 4 3 of 9

4 On March 1, 2011, the Canadian Association of Pension Supervisory Authorities ( CAPSA ) released the final version of Guideline No. 5: Guideline on Fund Holder Arrangements ( Guideline No. 5 ) (Please see News & Views, Volume 8, Issue 4, dated April 14, 2011). It discussed the roles and responsibilities of key players in fund holder arrangements, such as the administrator. FSCO s policy A gives greater weight to the regulator s intention of making the fund holder, the administrator, and other relevant parties more responsible for good pension fund governance. ONTARIO MANDATORY E-FILING AND NEW E-FILING OPTIONS The Financial Services Commission of Ontario ( FSCO ) announced on March 22, 2012, that it is making e-filing mandatory for filings with a due date of January 1, 2013, and later. Also, FSCO has expanded the options for electronic filing under the Pension Services Portal Web site (the Portal) effective December Plan administrators may now submit an actuarial report, actuarial information summary (AIS) and pension fund financial statements online. The valuation report and financial statements may be filed in PDF format, while the AIS is available as an online fillable form. To complete and certify the AIS form, the actuary needs access rights to the Portal. The plan administrator can grant these rights to the actuary on the Portal. A pension consultant can also make other filings on behalf of a plan administrator, provided that filing rights are delegated by the plan administrator on the Portal. The new e-filing options add to the previously announced e-filing options such as the Annual Information Return, the Investment Information Summary and the Pension Benefits Guarantee Fund Assessment Certificate. The previous options were discussed in our April 14, 2011, issue of News and Views. We believe this is a strong initiative by FSCO in support of environmental sustainability and if you are not yet using the online filing system, please contact your Morneau Shepell consultant for more information. OVERPAYMENTS AND PLAN WIND UP In December 2011, the Financial Services Commission of Ontario published an FAQ document applicable to cases where contributions made by the employer to fund a wind-up deficit result in a pension surplus. An employer may apply for return of overpayments by making an application that should include supporting documents and the following information: zthe amount of contributions made by the employer to fund the wind-up deficit; zthe surplus in the plan as a result of the overpayment; and zthe amount of the reimbursement from the pension fund being requested by the employer. The Superintendent may consent to a reimbursement from the pension fund for an amount equal to the lesser of: zthe assets remaining in the pension fund after all pension benefits related to the wind-up have been settled, and z the sum of all special payments made to the pension fund by the employer to fund the deficit, plus investment earnings on such payments, from the date that the special payments were made to the date that the overpayment is paid to the employer Morneau Shepell Ltd. April 2012 Volume 9, issue 4 4 of 9

5 UPDATE: ADOPTION OF IFRS BY ENTITIES WITH RATE- REGULATED ACTIVITIES Following its meeting on March 20-21, 2012, the Canadian Accounting Standards Board (AcSB) will extend the deferral of the mandatory IFRS changeover date for entities with qualifying rate-regulated activities by one year to January 1, 2013, based on the possibility that the International Accounting Standards Board (IASB) may include rate-regulated activities to its future agenda. This will allow the AcSB to take any appropriate action, should the IASB comment on this subject in the following months. A number of benefit trust plan sponsors are in the process of seeking legal advice to determine the impact to their program and/or are approaching their industry representatives (e.g. Multi-Employer Benefit Plan Council of Canada). In the meantime, we will continue to provide updates in future News & Views publications as this matter develops. The AcSB expects to issue the amendment to the Introduction to Part I of the Handbook in May Please note that entities with rate-regulated activities may still apply IFRS accounting in 2012, if they choose to. The AcSB had originally proposed an optional two year deferral (January 1, 2013) of the mandatory date to apply IFRS accounting, in its July 2010 Exposure Draft. It was ultimately decided, however, to limit the deferral to only one year (January 1, 2012). UPDATE: APPLICATION OF BILL C-13 TO BENEFIT TRUSTS In our last edition of News & Views (see CPP Changes to Employer-Paid Benefit and ASO Plans), it was noted that the application of Bill C-13 did not apply to benefit trusts. Recent developments have put into question whether this remains the case. If Bill C-13 includes trusts, there is a realization that the application of this legislation from a practical perspective for benefit trusts will be difficult, particularly for multi-employer plans, where employees/members are employed by several employers. As well, there may be additional financial costs to these plans if the trust is deemed the employer and will be required to remit CPP contributions Morneau Shepell Ltd. April 2012 Volume 9, issue 4 5 of 9

6 AS AT MARCH 31, 2012 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. TSX GROUP/PC-BOND Monthly Quarter to date RETURNS Year to date 1 year DEX Universe Bond Index -0.3% -0.2% -0.2% 9.7% DEX 91 Day Treasury Bill Index 0.1% 0.2% 0.2% 0.9% DEX Short Term Bond Index -0.1% 0.0% 0.0% 4.4% DEX Mid Term Bond Index -0.6% 0.0% 0.0% 11.1% DEX Long Term Bond Index -0.5% -0.8% -0.8% 18.7% DEX High Yield Bond Index 1.9% 5.0% 5.0% -0.4% DEX Real Return Bond Index -1.0% -1.1% -1.1% 16.4% CANADIAN EQUITY S&P/TSX Composite Index (Total Return) -1.6% 4.4% 4.4% -9.8% S&P/TSX Composite Index Capped -1.6% 4.4% 4.4% -9.8% S&P/TSX MegaCap Index -1.2% 3.7% 3.7% -10.7% S&P/TSX 60 Index -1.3% 4.6% 4.6% -10.2% S&P/TSX Completion Index -2.6% 3.9% 3.9% -8.7% S&P/TSX Small Cap Index -4.9% 6.0% 6.0% -15.0% BMO Small Cap Unweighted -4.4% 7.7% 7.7% -13.8% BMO Small Cap Weighted -3.8% 7.5% 7.5% -11.0% U.S. EQUITY INDICES S&P 500 (US$) 3.3% 12.6% 12.6% 8.5% S&P 500 (C$) 4.1% 10.4% 10.4% 11.7% FOREIGN EQUITY INDICES 1 MSCI EAFE (C$) 1.0% 8.8% 8.8% -3.2% MSCI World (C$) 2.8% 9.5% 9.5% 3.3% MSCI ACWI (C$) 2.1% 9.8% 9.8% 2.0% MSCI Europe (C$) 0.9% 8.6% 8.6% -5.0% MSCI Pacific (C$) 1.2% 9.2% 9.2% 0.7% MSCI Emerging Markets(C$) -1.9% 12.0% 12.0% -6.0% OTHER Consumer Price Index (Canada, February 2012) 0.4% 0.8% 0.8% 2.6% Exchange Rate US$/C$ 0.8% -1.9% -1.9% 2.9% MORNEAU SHEPELL BENCHMARK PORTFOLIOS 2 60% Equity/40% Bonds 0.2% 4.1% 4.1% 1.7% 55% Equity/45% Bonds 0.1% 3.6% 3.6% 2.0% 50% Equity/50% Bonds -0.1% 3.1% 3.1% 2.4% 45% Equity/55% Bonds -0.2% 2.6% 2.6% 2.7% 40% Equity/60% Bonds 0.0% 2.6% 2.6% 4.3% 1 Returns net of taxes on dividends, except for MSCI Emerging Markets. 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, FSA, FCIA, CFA, Partner Tel.: Fax: jbergeron@morneaushepell.com Robert F. Boston, CFA, 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, FSA, FCIA, CFA, FRM, CERA, Partner Tel.: Fax: pderoy@morneaushepell.com 2 The returns are compounded monthly Morneau Shepell Ltd. April 2012 Volume 9, issue 4 6 of 9

7 AS AT MARCH 31, 2012 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 $100 million as at December 31, The graph shows the impact of past returns on plan assets and the effect of interest rate changes on solvency liabilities THE EVOLUTION OF THE FINANCIAL SITUATION OF PENSION PLANS SINCE DECEMBER 31, 2007 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q Assets ($M) Solvency Liabilities ($M) Assets fell to their lowest level in February 2009, at which point the solvency deficiency (i.e. the difference between assets and solvency liabilities) reached $37 million. Liabilities climbed to their highest point in January 2012, and that month also showed the highest solvency deficiency yet, at $39.5 million. Financial markets remained virtually unchanged in March (less than a 0.1% increase) while solvency discount rates fell. As a result, assets increased but at a much slower rate than liabilities. This widened the solvency deficit to $36.3 million. Since the beginning of the year, assets have nonetheless risen at a greater rate than liabilities, respectively resulting in a 4.3% decrease in the solvency deficit. Please contact your Morneau Shepell consultant for a customized analysis of your pension plan. Comments: CANADA BOND YIELDS YIELD (CLOSING) DEC MARCH 2012 CHANGE 2012 Overnight rate target 1.00% 1.00% 0 bp 3 months 0.82% 0.91% 9 bps 2 years 0.95% 1.20% 25 bps 5 years 1.27% 1.57% 30 bps 7 years 1.51% 1.72% 21 bps 10 years 1.94% 2.11% 17 bps 30 years 2.49% 2.66% 17 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 February 16, 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. April 2012 Volume 9, issue 4 7 of 9

8 AS AT MARCH 31, 2012 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 and provincial (adjusted) bonds 1 and the median return of pension fund assets. EXPENSE INDEX FROM DECEMBER 31, 2011 Contributory plan Non-contributory plan The pension expense has increased since the beginning of the year largely due to a drop in the discount rate. 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). DURATION DISCOUNT RATE DECEMBER 2011 MARCH 2012 CHANGE IN % 4.01% -15 bps % 4.21% -18 bps % 4.33% -18 bps % 4.41% -17 bps Please contact your Morneau Shepell consultant for a customized analysis of your pension plan (In %) Discount rate Return on assets (55% equities) n/a Comments: 1. The discount rates shown reflect the educational note published by the Canadian Institute of Actuaries entitled Accounting Discount Rate Assumption for Pension and Post-employment Benefit Plans (September 2011). 2. The expense is established as at December 31, 2011, based on the average financial position of the pension plans used in our 2011 Survey of Economic Assumptions in Accounting for Pensions and Other Post-Retirement Benefits report (i.e. a ratio of assets to obligation value of 85% as at December 31, 2010). 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). 3. The return on assets corresponds to the return on the Morneau Shepell benchmark portfolio (55% equities and 45% fixed income). 4. The actuarial obligation is that of a final average earnings plan, without indexing (two scenarios: with and without employee contributions) Morneau Shepell Ltd. April 2012 Volume 9, issue 4 8 of 9

9 ABOUT US Morneau Shepell Inc. is the largest Canadian-based firm providing human resource consulting and outsourcing 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 CALGARY LONDON QUÉBEC FREDERICTON MONTRÉAL ST. JOHN S HALIFAX OTTAWA TORONTO KITCHENER PITTSBURGH VANCOUVER info@morneaushepell.com morneaushepell.com CONTRIBUTING EDITORS Patrick Duplessis, FSA, CERA Investment and Risk Management Lois Gottlieb, J.D., Ph.D. Tejash Modi, LL.B. Sébastien Rannaud, FSA, FCIA Retirement Consulting Larry Swartz, LL.B., CFA John Trieu, CEBS Benefits Consulting Julie Vandal-Lemoyne, LL.B. Andrew Zur, LL.B. Please contact your Morneau Shepell consultant for additional information about this newsletter Morneau Shepell Ltd. April 2012 Volume 9, issue 4 9 of 9

NEWS & VIEWS. Update: Bill C 13 Impact on Benefit Trusts. 1 Update: CRA Interpretation of Bill C 13 s Impact to Benefit Trusts

NEWS & VIEWS. Update: Bill C 13 Impact on Benefit Trusts. 1 Update: CRA Interpretation of Bill C 13 s Impact to Benefit Trusts NEWS & VIEWS IN THIS ISSUE 1 Update: CRA Interpretation of Bill C 13 s Impact to Benefit Trusts 3 Market Indices 4 Tracking the Funded Status of Pension Plans 5 Impact on Pension Expense under International