Information Bulletin. and sustainability of municipal defined benefit pension plans in Québec: The countdown has begun!

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1 Aon Hewitt Consulting Retirement Information Bulletin December 9, 2014 In this issue 2 Major amendments since October 2 3 Short-term measures to be taken by the different stakeholders 3 Actuarial valuation as at December 31, Service credited after December 31, 2013 (current service component) 4 Service credited prior to January 1 st, 2014 (past service component) 6 Surplus assets: calculation and order of use 6 Other funding rules 6 Negotiation, conciliation and arbitration 7 Comments An Act to foster the financial health and sustainability of municipal defined benefit pension plans in Québec: The countdown has begun! Notes to the reader: This newsletter is primarily geared to those involved in the Quebec municipal pension plans. It contains a lot of details given the complexity of the Act. We chose to send it to all our business contacts because a great many of them are interested in the subject. This newsletter has been prepared using the Bill submitted to the National Assembly on June 12 and the amendments which have been adopted since. At the time of its publication, the official and final text of the Act to foster the financial health and sustainability of municipal defined benefit pension plans in Québec was still not available. On December 4, 2014, the Quebec National Assembly adopted Bill 3, An Act to foster the financial health and sustainability of municipal defined benefit pension plans (Bill 3). Bill 3 was initially presented to the National Assembly on June 12, While Aon Hewitt has previously published two newsletters in respect of earlier versions of Bill 3, there have been a series of special consultations and a number of amendments made since then. This article provides an update on the final version of Bill 3. Risk. Reinsurance. Human Resources.

2 The Régie des rentes du Québec (Régie) will need to provide further details with respect to several aspects of Bill 3. A technical committee comprised of industry specialists has been created by the Régie to assist in this regard. Aon Hewitt has been invited to sit on this committee and it is with great pleasure that we have accepted this invitation. Within this context, this article sets out the most likely effects of Bill 3, according to the most reasonable interpretation that one can make of its provisions and the available information. Bill 3 introduces a significant change to the structure of defined benefit pension plans in the Quebec municipal sector. Effective January 1 st, 2014, any pension plan in this sector will include two components: one for service credited prior to January 1 st, 2014 (past service component) and one for service credited after December 31, 2013 (current service component). The terms past service component and current service component used in this article are also consistent with the Regulation respecting the funding of pension plans of the municipal and university sectors (Regulation). The Minister of Municipal Affairs, Regions and Land Occupancy has advised that the provisions of the Regulation shall continue to apply, except those that are incompatible with Bill 3. Major amendments since October 2 During the detailed study of Bill 3 within the parliamentary committee, several amendments were made. The main ones are the following: Main changes The calculation of deficiencies attributable to active members and retirees is better defined; When the current service cost is reduced effective January 1 st, 2014 due to the statutory 18% limit (20% for police officers and firefighters), the reduction of the current service contribution for the municipal body must be paid as an amortization payment to more quickly repay its share of the deficit attributable to active members; Despite the general equal cost sharing principle, on the basis of an agreement between the parties, the deficit attributable to active members may be borne by the municipal body up to a maximum of 55%; If the plan already maintains separate accounting for the various categories of employees, the deficit to be borne by the active members can be allocated between these categories as soon as a majority of active members make such a request; Active members may fund, in whole or in part, their share of the deficiency which they must bear through the payment of a contribution. The maximum payment period may not exceed 5 years and the contribution must represent at most 3% of their payroll. The indexation of retiree benefits may not be suspended in the event that the plan is fully funded as at December 31, 2013 or as at December 31, 2015; If the plan is not fully funded as at December 31, 2013 and as at to December 31, 2015, the smallest deficit attributable to retirees, determined at either of these dates, will be used to calculate the indexation reduction; Where the value of the suspended pension indexation allows the municipal body to bear 50% of the deficit attributable to retirees, the municipal body may decide to bear up to the maximum of 55% of this deficit; The past service component surplus must be allocated in the following order: To restore the indexation of retiree pensions payable as at December 31, 2013, since the last actuarial valuation; To restore the indexation of retiree pensions payable as at December 31, 2013, until the next actuarial valuation; To establish a reserve in order to restore the indexation of retiree pensions payable as at December 31, 2013, after the next actuarial valuation; The final version of Bill 3 improves protection for retirees at December 31, 2013; The conditions for the deferral of the negotiations have been relaxed. In the case of a plan whose funding ratio is equal to or higher than 80%, but less than 100%, the deferral is possible if the actuarial valuation as at December 31, 2013 shows that the current service cost does not exceed 18% of the active members payroll (20% in the case of police officers and firefighters) and that the agreement in effect on December 31, 2013 is still in force on the date of assent of Bill 3; and Where a Pension Committee is unable to take the necessary actions to meet the requirements of Bill 3 (e.g., prepare the actuarial valuation report required at December 31, 2013), Bill 3 authorizes the Régie to resolve such a stalemate and the Régie may: Decide on the transitional administration; Prepare or cause to be prepared any documents required by law; and Issue an order. Information Bulletin Aon Hewitt December 9,

3 Short-term measures to be taken by the different stakeholders With the adoption of Bill 3, the imposed timeline is very tight. All pension plans covered by Bill 3 must undergo an actuarial valuation as at December and submit the valuation report to the Régie no later than December 31, For pension plans that were not previously required to prepare an actuarial valuation as at December 31, 2013 pursuant to the Supplemental Pension Plans Act (SPP Act), this timeline seems unrealistic. For the rest, it remains a challenge that will be difficult to meet. The following measures need to be taken immediately by Pension Committees affected by Bill 3: Call for a special meeting of the Pension Committee in order to: Agree on the instructions to submit to the actuary concerning the assumptions and methods to be used for the December 31, 2013 actuarial valuation; Grant the actuary the mandate to make this valuation; Call for another meeting of the Pension Committee after receiving the valuation report in order for the members to acquaint themselves with it, to give their input and to decide to forward it to the Régie; Forward the report to the Régie; Forward the report to the municipal body. The following measures need to be taken immediately by municipal bodies affected by Bill 3: Give an opinion on the assumptions and methods to be used for the December 31, 2013 actuarial valuation; Where it s possible to defer the negotiations, decide whether to allow the associations representing the active members not to use the deferral. A decision must be made if such a request is forwarded by the association. This option is available according to the explanations of the Parliamentary Committee. Send a written notice to every association representing active members stating the date, time and place the municipal body s representatives will be ready to meet with the association s representatives. Such a notice must be submitted not less than 8 nor more than 15 days before that date and not later than January 15, 2015 Give public notice that a municipal council meeting will be held to report on the funded status of each plan it has established, at least 14 days before the date thereof; Hold this meeting no later than January 19, The following measures need to be taken immediately by associations representing active members affected by Bill 3: Give an opinion on the assumptions and methods to be used for the December 31, 2013 actuarial valuation; and Where it s possible to defer negotiations, decide whether to accept, where applicable, the municipal body s suggestion of not using the deferral or submitting such an offer to this body. Actuarial valuation as at December 31, 2013 As mentioned, above, all affected pension plans must undergo an actuarial valuation as at December 31, Specific rules and requirements apply to this actuarial valuation: The demographic assumptions are prescribed: The Mortality Table is the Canadian Institute of Actuaries 2014 Public Sector Mortality Table. This table may be adjusted to take into account the special characteristics of a plan; The other demographic assumptions are those used in the previous actuarial valuation; The discount rate is subject to a maximum of 6%. The assets for the purposes of determining the deficit to be shared include the funds transferred to the reserve and exclude sums paid by the municipal body in excess of the minimum amortization payment (without taking into account the relief measures). The portion of the deficit attributable to active members and the portion attributable to retirees should be presented separately; the deficit between these two groups should be apportioned in proportion to the liabilities determined on a funding basis; and The report must be submitted to the Régie before December 31, Information Bulletin Aon Hewitt December 9,

4 Service credited after December 31, 2013 (current service component) All pension plans must be amended to provide for the following: As at January 1 st, 2014, the current service cost must not exceed 18% of the payroll (20% in the case of police officers and firefighters). In respect of those maximum limits, several adjustments are now possible: If the average age of the active members is greater than 45 years, the applicable cap is increased by 0.6% for each full year over 45 years; If women represent more than 50% of the active member population, the applicable cap can be increased by 0.5% at the most (this increase must be justified by the impact of the proportion of women on the plan cost in the actuarial valuation report); If a plan s funding position is greater than 100%, the cap may be increased by 0.25%, for every 1% over 100%; Example : Current service cost as a % of payroll Basic maximum 18.0 Average age of 47 years +1.2 Higher female population +0.5 Funding position at 103% Maximum service contribution A stabilization fund that is: Funded by a stabilization contribution of at least 10% of the current service cost and the actuarial gains; Used to eliminate or to reduce a deficit. It may also be used to index paid pensions or fund other enhancements when surplus exceeds the provision for adverse deviations; The current service cost, the amortization payments and the stabilization contribution will be paid in equal parts by the municipal body and the active members; The equal sharing of current service cost may be gradual and phased over time, where the employee contribution is equal to 35% or less of the current service cost as at December 31, 2013; The abolition of automatic indexing. Ad hoc indexation may be provided for in the event that a surplus is identified in an actuarial valuation conducted after December 31, Service credited prior to January 1 st, 2014 (past service component) The deficit determined as at December 31, 2013 is apportioned between the active members and the retirees in proportion to their respective liabilities determined on a funding basis. For the purposes of Bill 3, retirees are those receiving a pension on June 12, 2014 and those who submitted a request to the administrator between January 1 st and June 12, 2014, while active members represent all other members. Retirees as of December 31, 2013: The retirees pension indexation may be suspended by the municipal body as of January 1 st, 2017, if the plan is not fully funded as at December 31, 2013 and as at December 31, 2015; In such a case, the smallest deficit attributable to pensioners determined at either of these dates (December 31, 2013 or December 31, 2015) will be used to calculate the indexation reduction; In the event that the municipal body decides to suspend indexation, retirees must be invited to an information session organized by the Pension Committee where the municipal body will communicate the plan s financial position and give an opportunity to retirees to be heard; When the value of the suspended indexation exceeds the portion of the deficit attributable to retirees, the excess will continue to be paid to retirees in the form of a partial automatic indexation; The municipal body can choose to bear a greater portion of the deficit attributable to retirees, up to the maximum of 55%; Information Bulletin Aon Hewitt December 9,

5 The remaining deficit is borne by the municipal body. The period provided to amortize the remaining deficit is 15 years and in no case may the deficit be consolidated. Sharing the deficit attributable to retirees and payment mechanisms Active members on January 1 st, 2014: 1 Possible agreement on a 45/55 sharing. Bill 3 stipulates that the deficit shall be split in equal parts between the municipal body and active members. On the basis of an agreement between the parties, the deficit attributable to active members may be borne by the municipal body up to a maximum of 55%; The portion of the deficit attributable to active members must be assumed through benefit reduction, the payment of an additional contribution, or a combination thereof. In respect of the additional contribution, the maximum payment period may not exceed 5 years and this contribution must represent no more than 3% of the annual payroll of active members; The automatic indexation of benefits, if any, must be eliminated and contribute to the reduction of the active members share of the deficit; If the value of the eliminated indexation exceeds 50% of the deficit attributable to active members, the excess is transferred to the reserve and must be used either for ad hoc pension indexation or for the purposes agreed upon by the municipal body and the active members; Bill 3 clarifies the other benefits that can be reduced. The salary or wages on which the normal pension is based may be modified. However, the accrual rate of the normal pension can only be changed for service subsequent to December 31, Insofar as the pension is not in pay, the post-retirement death benefit may also be modified; The share of the deficit attributable to active members and borne by the municipal body must be amortized over a period of 15 years and may in no case be consolidated; Sharing the deficit attributable to active members and payment mechanisms 1 Possible agreement on a 45/55 sharing. Information Bulletin Aon Hewitt December 9,

6 Surplus assets: calculation and order of use Service credited after December 31, 2013 (current service component) Bill 3 does not specify how to calculate surplus. With respect to the current service component surplus, it can be reasonably concluded that it corresponds to the difference, if positive, between the following two elements: The value of the assets of the current service component (i.e. the value of the general account and the stabilization fund); and The liabilities of the current service component, plus the provision for adverse deviations. This surplus must be used in the following order: Fund the ad hoc indexation of pensions where the plan provides for such indexation; and Fund plan improvements. The active members and the municipal body may agree on a different apportioning of surplus and order of use. Where the funded position of the current service component exceeds 125%, it appears that contribution holidays both for the municipal body and the active members remain possible. Service credited prior to January 1 st, 2014 (past service component) With respect to the past service component surplus, it can be reasonably concluded that it corresponds to the difference, if positive, between the following two elements: The value of the assets of the past service component(i.e. the value of the general account and the reserve, plus the present value of the amortization payments that the municipal body must pay in respect of the deficiencies attributable to retirees and active members); and The liabilities of the past service component, plus the provision for adverse deviations. If the value of the eliminated indexation for active members exceeds the deficit attributable to active members, the excess is transferred to the reserve. The transferred amount must not be included in the assets of the past service component. The identified surplus shall be used in the following order: 1. Restore the indexation of retiree pensions payable as at December 31, 2013, since the last actuarial valuation; 2. Restore the indexation of retiree pensions payable as at 31 December 2013, until the next actuarial valuation; 3. Establish a reserve to restore the indexation of retiree pensions payable as at December 31, 2013, for the period following the next actuarial valuation. This order cannot be modified in order to protect retirees who are not considered a negotiating party. If, following the uses described above, there is still a surplus, it should be used for the following purposes and in the following order: 4. Fund ad hoc indexation of the pensions of the other members, where the plan provides for such indexation; 5. Reimburse the amount owed by the pension plan to the municipal body (banker s rule); 6. Fund improvements other than indexations. For items 4 to 6, above, the active members and the municipal body may agree to a different allocation of surplus and order of use. Other funding rules Bill 3 provides that any additional obligation resulting from an amendment to the plan must be paid in full on the day following the date of the actuarial valuation. This value corresponds to the greater of the value of the additional obligation calculated on a solvency basis and the value calculated on a funding basis. This rule covers both the current service and the past service components. Negotiation, conciliation and arbitration The following table summarizes the steps to follow when conducting negotiations: Step Duration/date Comment Beginning of negotiations No later than February 1 st, 2015 Except if a deferral is allowed Negotiation 12 months Extension of the negotiation period 2 x 3 months Joint request to the Minister Conciliation (optional) 0 month Does not extend the negotiation period Arbitration 6 months When the negotiation period expires Information Bulletin Aon Hewitt December 9,

7 In making his or her decision, the arbitrator must take into account several considerations, including: Taxpayers ability to pay; Intergenerational equity; Sustainability of the pension plan; Compliance with the cost-sharing principles and the objectives of Bill 3; Contribution holidays; Improvements made to the plan; Past concessions made by the members with respect to other elements of the total compensation package. Bill 3 allows for the deferral of negotiations when certain conditions summarized in the table below are met: CSC : current service cost Where negotiations are deferred, an actuarial valuation as at December 31, 2014 will be required to determine the deficit attributable to active members. All other restructuring deadlines set out in Bill 3 shall apply, with the necessary adjustments. If negotiations are postponed, Bill 3 also permits the upcoming agreement on plan restructuring to take effect on the date that the collective agreement expires, unless the parties agree to an earlier application date. Comments Due to the many actions to be taken and decisions to be made by Pension Committees, the municipal bodies and the associations representing active members as a result of Bill 3, the statutory requirement to submit the December 31, 2013 actuarial valuation report to the Régie by December 31, 2014 is unreasonable. The deferral of certain deadlines provided for in the Bill, with an equivalent reduction of the negotiation period, would have allowed this process to start on solid ground while respecting the initial schedule. Pushing the stakeholders at the outset, even though some of them have already expressed serious concerns about the relevance of the exercise, is not suitable for creating an environment conducive to negotiation. In the pension plan industry, Bill 3 is the most controversial law ever adopted by the Government of Québec. Some stakeholders have already indicated that they intend to challenge this legislation in court. If they do, in 4 or 5 years, the courts could potentially render a decision invalidating certain provisions of Bill 3, for example those allowing for the reduction of entitlements. If such a scenario were to happen, it would understandably lead to administrative nightmares. As previously discussed, the Régie will need to provide further details with respect to several aspects of Bill 3, in order for the various stakeholders to understand how Bill 3 will apply to their pension plans. We welcome the initiative to create a technical committee made of industry specialists to assist in this regard. Information Bulletin Aon Hewitt December 9,

8 Contact Information Should you wish additional information on this topic, please contact your local Aon Hewitt Consultant, or send an to Aon Hewitt publishes Information Bulletin for the purposes of providing general information. The information in Information Bulletin does not constitute financial, legal, or any specific advice and should not be used as a basis for formulating business decisions. For information tailored to your organization s specific needs, please contact your consultant at Aon Hewitt. This issue of Information Bulletin contains information that is proprietary to Aon Hewitt and may not be distributed, reproduced, copied or amended without Aon Hewitt s prior written consent. About Aon Hewitt Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit aonhewitt.com Aon Hewitt Inc. All Rights Reserved. This document contains confidential information and trade secrets protected by copyrights owned by Aon Hewitt. The document is intended to remain strictly confidential and to be used only for your internal needs and only for the purpose for which it was initially created by Aon Hewitt. No part of this document may be disclosed to any third party or reproduced by any means without the prior written consent of Aon Hewitt. Risk. Reinsurance. Human Resources.