Client Advisory. Pension Changes Proposed: Federal Funding and Investment Rules. Proposed Funding Rules. Summary

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1 Client Advisry Pensin Changes Prpsed: Federal Funding and Investment Rules May 7, 2010 Summary On May 3, 2010, the Federal Minister f Finance (Finance) released Regulatins Amending Certain Regulatins Made Under the Pensin Benefits Standards Act, 1985 (Prpsed Regulatins), which revise the permanent funding rules fr federally regulated defined benefit (DB) pensin plans and als include sme changes t the rules fr pensin fund investments applicable t many DB plans. The Prpsed Regulatins are the secnd step in planned refrms t the legislative and regulatry framewrk gverning federally regulated private pensin plans (Framewrk) that was annunced Octber 27, The Framewrk included a variety f ther significant prpsals related t benefit standards, gvernance, infrmatin disclsure and administratin fr bth DB and defined cntributin (DC) plans. Finance has stated that the Federal Gvernment intends t bring the ther prpsals frward at the earliest pprtunity. The Prpsed Regulatins are distinct frm earlier steps twards implementing the Framewrk, which invlved amendments t the Pensin Benefits Standards Act (PBSA) and prpsed changes t the Incme Tax Act (ITA) t increase the surplus threshld as part f the 2010 Federal Budget. The Prpsed Regulatins wuld revise the permanent pensin funding rules and als eliminate certain quantitative investment limits as discussed belw. Prpsed Funding Rules New Three-year Average Slvency Rati: A slvency rati (i.e., the rati f the market value f assets less the wind-up expenses ver the slvency liability) averaged ver three years (current plus tw previus years, based n market value f assets) wuld be used t determine minimum slvency cntributin requirements. Slvency deficiencies wuld be cnslidated and reamrtized at each valuatin. The slvency rati in the year f the valuatin, as ppsed t the new averaged rati, wuld cntinue t be used fr all ther purpses including disclsure in the annual member statements. The amrtizatin perid fr a ging cncern deficit remains at 15 years. At each valuatin, the slvency deficit is amrtized ver five years.

2 Transitinal Rules: The Federal gvernment intends fr the Prpsed Regulatins t apply t valuatin reprts with an effective date n r after December 31, 2009 and t cntributin requirements in Several transitinal rules apply, as fllws: A plan may cntinue t be funded under the current funding regulatins until the day n which the first actuarial reprt is required t be filed after the Prpsed Regulatins cme in frce; Fr the first valuatin reprt filed after the prpsed rules cme in frce, at the emplyer s ptin, the reprt can determine the slvency rati n the valuatin date and use that instead f an average that is based n the rati n the valuatin date and the tw previus years; and If (as mentined in the preceding bullet) the rati n the valuatin date is used rather than an average, then fr that first valuatin reprt, the slvency assets can be smthed ver a perid f up t five years. This is an imprtant decisin fr emplyers. Slvency Margin: A slvency margin f five percent wuld be required, meaning that cntributin hlidays wuld nly be permitted if a plan has bth a ging cncern surplus and slvency assets (i.e., the market value f assets less wind-up expenses) that exceed the slvency liabilities by at least five percent. The slvency margin wuld nt be explicitly funded. As a result, while the emplyer is nt permitted t take the cntributin hliday unless the margin exists, the emplyer is nt required t cntribute t create the margin. In sme situatins, the slvency special payments wuld be required even thugh the plan has a margin in excess f five percent. This can happen if the three-year average slvency rati is less than 1.0. Mnthly cntributins: Emplyer cntributins must currently be remitted quarterly (within 30 days f the quarter t which they pertain). The Prpsed Regulatins require that cntributins must be remitted mnthly beginning in and 2009 Slvency Funding Relief: The Prpsed Regulatins have very extensive transitinal rules fr spnsrs wh applied either the 2006 and/r the 2009 temprary slvency funding relief measures. The new funding rules wuld reflect the existing amrtizatin payments under the temprary slvency relief measures. The rules implemented by the Prpsed Regulatins wuld likely reduce the funding vlatility fr mst DB plans. Accrding t the Regulatry Impact Analysis Statement (Statement) released by Finance n the Prpsed Regulatins, the prpsed funding rules wuld lead t lwer slvency cntributins in the shrt term but wuld likely result in higher amrtizatin payments in later years than under the current funding rules. Similarly, imprvement in the funding psitin f a plan in deficit wuld result in a mre gradual reductin in amrtizatin payments than under the current funding rules. This is due t the fresh start amrtizatin at each valuatin, which has the effect f lengthening the perid f amrtizatin beynd 5 years. In mst cases, the transitinal rules wuld result in lwer cntributins in 2010 than under current rules. Pensin Changes Prpsed: Federal Funding and Investment Rules I 2

3 Prpsed Investment Rules The Prpsed Regulatins wuld remve the five percent, 15 percent and 25 percent quantitative investment limits regarding resurce and real prperty investments, as they are cnsidered unnecessary in a prudent persn investment envirnment. The Gvernment has stated its intentin t prpse additinal mdificatins t the 10 percent cncentratin rule and the prhibitin n investing in the spnsring emplyer in the near future. This simplificatin f the rules is a welcme change and will autmatically affect pensin plans registered in prvinces that have adpted the federal investment rules by reference (i.e., Alberta, British Clumbia, Saskatchewan and Manitba). Althugh Ontari has adpted the existing federal investment rules, an amendment t Ontari regulatins wuld be required fr these changes t becme effective fr plans registered in that prvince. Other Changes n the Hrizn A number f changes t the current rules gverning federally regulated pensin plans prpsed in the Framewrk are expected when Bill C-9, the Jbs and Ecnmic Grwth Act, cmes int frce. These include: Minimum Legislative Benefits: Changes include the adptin f immediate vesting (cmpared t the current tw years f membership requirement), and applicatin f bth the 50 percent minimum emplyer cst rule and the minimum pre-retirement death benefit t all years f service rather than just t benefits fr pst-1986 service as currently required. If there is n spuse, the minimum death benefit must nw be paid t the member s r frmer member s designated beneficiary r, if there is nne, t their estate r successin. These prvisins are expected t have minimal impact fr mst plans but will require changes t plan prvisins and administratin prcedures and systems. Annual Disclsures: In additin t disclsing the slvency rati t active members f the plan, disclsure f the rati will be expanded t include any members r frmer members f the plan entitled t a benefit. This will require at least a newsletter t be sent t pensiners. Partial Plan Terminatin: While spnsr-declared partial terminatins will be eliminated, the Superintendent will retain the ability t declare a partial terminatin. In additin, we nte that neither the Prpsed Regulatins nr Bill C-9 has addressed the frequency f valuatins. Hwever, based n the Framewrk and the Statement, we expect that annual valuatins will becme mandatry. Future Refrm As nted abve, the Prpsed Regulatins nly address sme f the tpics f refrm cntained in the Framewrk. The Framewrk als included a variety f significant prpsals related t benefit standards, gvernance, infrmatin disclsure, investment and administratin fr bth DB and DC plans. While the Gvernment has prvided its cmmitment that the remaining items will be brught frward at the earliest pprtunity, we believe that certain prpsals shuld be released sner than later these include: Pensin Changes Prpsed: Federal Funding and Investment Rules I 3

4 Letter f Credit Financing: Bill C-9 cntains prvisins making letter f credit (LOC) financing available t plan spnsrs n an nging basis. Hwever, we nte that many details regarding the use f LOCs will be subject t regulatins that have yet t be released. In additin, Bill C-9 must still be passed by the Huse f Cmmns and the Senate and be prclaimed in frce. We are cncerned that this situatin may result in plan spnsrs making funding decisins based n the expectatin that Bill C-9 s LOC financing prvisins will be implemented, nly t face prblems if the regulatins d nt pass, r if they cntain prvisins that make the use f LOCs impssible r inadvisable in their particular circumstances. Vid Amendment Rule: We nte that the Prpsed Regulatins d nt include prvisins t address the issue f vid amendments fr a pensin plan with a slvency rati belw a particular threshld. The Framewrk suggested that plans with slvency ratis belw 0.85 wuld be restricted frm making plan imprvements unless ffset funding is prvided at the time thse imprvements cme int effect t ensure that the slvency rati f the plan is nt decreased as a result f the imprvement. We understand that future regulatins may address this issue but we anticipate that plan spnsrs will need t see the details f the prpsed changes in rder t make decisins relating t the impact f the changes n their business peratins (e.g., timing f labur csts). Next Steps The Prpsed Regulatins are currently pen t cnsultatin until May 29, Once finalized, they will cme int frce upn registratin. The Statement indicates that the new rules will apply t valuatins filed with an effective date as f the end f December 2009 r later. If the cming int frce f the Prpsed Regulatins is delayed, it is expected that OSFI will extend the filing deadline fr December 31, 2009 valuatins until after that date. Spnsrs f plans that are required t file a valuatin in 2010 shuld cnsider the impact f the Prpsed Regulatins, particularly the ptin t use a smthed market value f assets as permitted in the transitinal rules. Yur Twers Watsn cnsultant can help yu in perfrming such analysis. Fr mre infrmatin This Advisry is nt intended t cnstitute r serve as a substitute fr legal, accunting, actuarial r ther prfessinal advice. Fr infrmatin n hw this issue may affect yur rganizatin, please cntact yur Twers Watsn cnsultant, r: Dug Chandler, dug.chandler@ Simn East, simn.east@ Gus Van Helden, gus.van.helden@ Pensin Changes Prpsed: Federal Funding and Investment Rules I 4

5 Abut Twers Watsn Twers Watsn is a leading glbal prfessinal services cmpany that helps rganizatins imprve perfrmance thrugh effective peple, risk and financial management. With 14,000 assciates arund the wrld, we ffer slutins in the areas f emplyee benefits, talent management, rewards, and risk and capital management. Fr mre infrmatin n this Client Advisry, visit. Pensin Changes Prpsed: Federal Funding and Investment Rules I 5