Québec: Pension Funding Relief Regulation Published in Response to the Financial Crisis

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1 Special Issue November 19, 2009 Québec: Pension Funding Relief Regulation Published in Response to the Financial Crisis On November 11, 2009, the Quebec government published a Regulation aimed at reducing the effects of the financial crisis 1. This Regulation, which was eagerly anticipated by pension plan sponsors, is intended to supplement the relief measures contained in Bill 1, that was adopted on January 15, 2009 (see the January 16, 2009 Special Issue of Ready). A draft of the Regulation was pre-published in May. The key components of the draft Regulation were summarized in our May 6, 2009 Special Issue of Ready. The final version of the Regulation contains few significant changes compared to the draft version. As permitted by law, the Regulation will have a retroactive effective date of December 31, Pension Plans Affected The Regulation only applies to the funding of pension plans that are registered under the Supplemental Pension Plans Act (SPP Act). It does not apply to pension plans that fall under the supervision of another province or the federal government, even though they have Quebec participants. The funding relief measures contained in the Regulation apply exclusively to solvency rules. Consequently, they have no practical effect with respect to plans where the employer is a municipality or university because such plans are already exempt from these rules. Funding relief measures that apply specifically to municipalities and universities are expected to be published by December 31, It is important to note that, in the case of actuarial valuation reports dated after December 30, 2008 and before March 31, 2009, the Regulation extends the deadline for filing these reports with the Régie des rentes du Québec to December 31, This deadline is likely to be extended again for municipal and university pension plans. Temporary Measures: Similar to the measures that were adopted in 2005, within the context of Bill 102, the measures described in the new Regulation are temporary. In fact, the main effect of these measures will be to reduce the contributions that would otherwise be required from employers in 2009, 2010, and The regular rules will be restored beginning in Therefore, unless a pension fund enjoys more than significant gains during this 3-year period, the measures will have the effect of substantially increasing the contributions required during the subsequent 5-year period (i.e., from January 1, 2012 to December 31, 2016). 1 Regulation respecting measures to reduce the effects of the financial crisis on pension plans covered by the Supplemental Pension Plans Act. Page 1

2 The decision to take advantage of the measures must be made when the first actuarial valuation after December 30, 2008 is being prepared. If the plan sponsor 2 does not take advantage of the measures at that time, it will not be permitted to do so afterward. Choice of Measures The government is giving each plan sponsor the option of choosing one or more of the four funding relief measures that the plan sponsor believes will reduce the financial burden with respect to the pension plan in the context of the financial crisis. These measures are as follows: 1. Smoothing of plan assets considered for solvency purposes. 2. Consolidation of previous deficiencies considered for solvency purposes. 3. Extension of the solvency deficiency amortization period. 4. Early application of the new Canadian Institute of Actuaries ( CIA ) standard. The main features of the measures are summarized below. However, decisions regarding funding relief measures should not be made solely on the basis of this material. It is only a summary and plan-specific details must be taken into consideration before a decision is made. Contact your Aon consultant in order to determine which of the measures outlined is appropriate for your organization. Decision-Making Body The body that is able to decide to take advantage of the available relief measures depends on the specific measure and the type of plan. In the case of a plan in which only one employer participates, the decision to use one or more of the relief measures mentioned above will be made by the employer. In the case of a pension plan in which more than one employer participates, the decision pertaining to the first three measures will be made by the employer that has the power to amend the plan, and the decision pertaining to the measure involving the advanced application of the CIA standard will be made by all employers that participate in the plan. Consequences of Using the Measures The consequences described below apply only if at least one of the first three relief measures is used. In other words, if only the measure involving the advanced application of the CIA standard is chosen, the consequences described below are not applicable. Using the relief measures will mean that several provisions of Bill 30 concerning funding rules will apply earlier. These provisions would otherwise apply only to valuations at the end of December 2009 and afterward. The most significant consequence of the advanced application of Bill 30 is that actuarial valuations will have to be prepared annually. For example, a plan with a valuation as at December 31, 2008 will be 2 It should be noted that the decision-making body to which this Regulation confers the power of choosing to take advantage of the relief measures depends on the chosen measure and the type of plan. Aon Consulting Ready Special Issue November 19, 2009 Page 2

3 subject to a valuation as at December 31, However, if at least one of the relief measures is chosen, an actuarial valuation will have to be conducted as at December 31, It is also important to remember that, within the meaning of Bill 30, funding deficiencies will now be consolidated in every actuarial valuation. If Bill 30 takes effect earlier, these deficiencies will also be consolidated earlier (in addition to solvency). Using one or more of the four relief measures described above does not mean that the new equity principle provided by Bill 30 will be applied earlier if an employer allocates surplus plan assets to fund the cost of an improvement. In fact, the rules concerning the equity principle come into effect on January 1, 2010 in all cases, regardless of whether the relief measures are applied or not. Finally, a somewhat surprising feature of the Regulation is that it prohibits any change to the asset valuation method using a funding approach that would increase the value compared to the value that would be determined with the method used in the last actuarial valuation. As a result, if the actuary did not use asset smoothing in the last valuation, the liquidation value of assets will have to be used in a valuation involving the relief measures and, therefore, 100% of the losses incurred will have to be recognized beginning with that valuation. The Four Measures Measure 1: Smoothing of plan assets considered for solvency purposes Since 1990, assets must be valued at their liquidation value for the purposes of valuation on a solvency basis. According to this approach, the full value of losses incurred since the last valuation would normally be recognized and capitalized starting from the valuation date. The Regulation now allows the value of assets to be determined by smoothing the short-term fluctuations in the market value of the assets over a maximum of 5 years, for a temporary period (from 2009 to 2011). For example, this would allow losses incurred in 2008 to be recognized at a rate of 20% per annum for capitalization purposes beginning on December 31, 2008, rather than 100% as of that date. The Regulation requires this new method to be applied throughout the entire period of the application of the temporary measures, which basically runs until the end of Starting with the valuation required on December 31, 2011, the market value will have to be used once again. Measure 2: Consolidation of previous deficiencies considered for solvency purposes This measure allows the plan sponsor to combine most of the previous deficiencies, along with the new solvency deficiency, into a single deficiency. This consolidation makes it possible to reamortize the previous deficiencies considered for solvency purposes over a longer period. Measure 3: Extension of the solvency deficiency amortization period The solvency deficiency (consolidated where applicable) may now be amortized over a period ending on December 31, 2018 at the latest. In theory, the purpose of this measure is to increase the solvency deficiency amortization period from 5 years to 10 years. In practice, it will have a different effect. Although contributions will initially be determined based on an amortization period ending on December 31, 2018 at Aon Consulting Ready Special Issue November 19, 2009 Page 3

4 the latest (10 years in the case of a valuation as at December 31, 2008), the relief measures will cease at the end of 2011, and the following rules will apply for plans with a financial year ending on December 31: A valuation of the plan will be required as at December 31, The assets will be valued as at December 31, 2011 at their liquidation value (i.e., with no smoothing). The amortization payments applicable to most of the deficiencies, including the consolidated deficiency, will be eliminated. The new solvency deficiency will be amortized over a maximum period of 5 years. Although reference is made to amortization over 10 years for an actuarial valuation as at December 31, 2008, any asset shortfall that is established prior to January 1, 2012 will have to be paid by no later than December 2016, which is a period of 8 years from the effective date of the Regulation. If gains are realized by then, they will definitely limit the increase in contributions. Measure 4: Advanced application of the Canadian Institute of Actuaries standard The final measure, already implemented as a result of Bill 1, allows for the advanced application of a new CIA standard that affects the valuation of the liabilities of a pension plan on a solvency basis. This new standard, effective since April 1, 2009, changes the assumptions used by actuaries to determine the commuted value of a pension. This results in a decrease in such values, and therefore, a decrease in solvency liabilities. The real impact of this measure on pension plans will depend on plan-specific features. For example, the application of the new standard will reduce the commuted values by up to 20% for the youngest participants and less than 5% for participants who are approaching retirement. Minimum Contributions If an employer uses at least one of the first three funding relief measures described above, it will have to pay the highest of the following three amounts during each fiscal year in the relief period: 1. The amount required to liquidate the funding deficiency over a period of 15 years (in general). 2. The amount required to liquidate the consolidated solvency deficiency (where applicable) over a period ending no later than December 31, The minimum contribution, as determined pursuant to the new Regulation. Determining the minimum contribution is rather complex but, in general terms, it is the contribution that would have been required if the relief measures had not been applied (i.e., with no asset smoothing or deficiency consolidation) and if the new solvency was amortized over 5 years. This will all be determined as though the financial losses of 2008 were not incurred. The government is prepared to provide relief from the effects of the financial crisis in 2008, but it is not prepared to allow a plan sponsor s required contributions to be less than they would have been if the financial crisis had not occurred. As a result, the impact of the financial crisis on the value of the plan assets will be based on the difference between: Aon Consulting Ready Special Issue November 19, 2009 Page 4

5 (a) the market value of the assets on December 31, 2007, adjusted for inflows and outflows and increased by an interest rate of 4.75 %; and (b) the market value of the pension fund on December 31, This difference will bear the same interest rate starting on January 1, Contribution Holidays and Pension Plan Improvements Although it does not result from the new Regulation, the funding component of Bill 30 will come into effect on January 1, 2010, and new measures will impact the ability to take contribution holidays and the funding of pension plan improvements. If a pension plan sponsor intends to take or continue a contribution holiday after 2009, or improve the benefits provided by the plan by using the surplus assets, they should consult their Aon consultant first. In fact, the conditions applicable to such uses of surplus assets have changed somewhat, and the new measures should clarify the rules that apply over the short term. Next Steps If the decision has not already been taken, plan stakeholders (depending on the type of plan and the measures) will soon have to determine whether they want to take advantage of the relief measures allowed by the Regulation and Bill 1. They will also have to select specific measures and some of their parameters. If relief measures are selected when the first actuarial valuation after December 30, 2008 is prepared, notice to that effect must be sent to the pension committee by the decision-maker. The actuarial valuation report must be accompanied by a document from the decision-maker specifying that either: (a) (b) the report has been prepared according to the instructions given by the decision-maker; or the decision-maker has not taken advantage of any measure. These measures are simply a way to buy time. They cannot reduce investment losses incurred in 2007 and 2008 or the actuarial liabilities determined within a context of lower interest rates. Unless high returns are achieved during the 2009 to 2011 period, the increase in contributions at the end of the relief period threatens to be brutal for many plan sponsors. Other measures may then be required. For more information, please contact your Aon consultant or one of the following individuals: Ghislain Nadeau Luc Villiard ghislain.nadeau@aon.ca luc.villiard@aon.ca Aon Consulting Ready Special Issue November 19, 2009 Page 5

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