Radar. Health Management. Federal Budget Implementation Act: METC Amendments and Other Taxation Changes. Residential Care Facilities in Canada

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1 Radar October 11, 2011 The Aon Hewitt Radar is a weekly summary of regulatory developments and trends related to retirement and financial management, employee health benefits, and other HR issues in Canada. It highlights issues that may require employers to take action to comply with new rules or review existing plans. Health Management Federal Budget Implementation Act: METC Amendments and Other Taxation Changes Bill C-13, Keeping Canada's Economy and Jobs Growing Act, was introduced on October 4, The Bill would implement income tax and related measures proposed in the 2011 federal budget, including: removal of the $10,000 limit on eligible expenses that can be claimed under the medical expense tax credit in respect of a dependent relative; a new family caregiver tax credit for caregivers of infirm dependent relatives; and a new children's arts tax credit on up to $500 per child of eligible fees associated with children's artistic, cultural, recreational and developmental activities. Expanded Coverage for Optometry Services in Alberta The Optometric Benefits Regulation made under the Alberta Health Care Insurance Act has been amended, effective October 2011, to expand public coverage for medically necessary optometry services to cover all residents, regardless of age. Covered treatments include those for: diabetes mellitus; glaucoma; cataracts; removal of foreign bodies from the eye; retinal detachments, defects, and other retinal disorders; and disorders of the eye, globe, eyelids and cornea. Previously, only Albertans between the ages of 19 and 64 who required medical treatment for eye-related diseases and illness were covered under the Alberta Health Care Insurance Plan. Residential Care Facilities in Canada According to Statistics Canada, at the end of the financial year: there were 4,633 residential care facilities in Canada serving 247,270 residents; the industry generated revenues and expenses of $17.1 billion and $17.0 billion, respectively, up approximately $0.5 billion from the preceding year; the industry's profit margin was $116.5 million, or 0.7 per cent of total revenues, which reflected the prevalence of not-for-profit organizations and public facilities; industry activity was concentrated in 2,136 residences for the aged, which served 204,008 residents and generated $13.8 billion in revenue; residential care facilities employees worked million hours, which corresponds to 239,857 full-time equivalents, and generated $10.9 billion in wages and salaries. Addressing Prescription Drug Abuse According to the US Government Accountability Office, addiction to some controlled substances can be unknowingly financed by insurance companies and public drug programs. For example in 2008, 170,000 Medicare beneficiaries (mostly on disability) received prescriptions from five or more medical practitioners for classes of

2 frequently abused controlled substances and two classes of frequently abused noncontrolled substances representing approximately $148 million in prescription drug costs. Highly abused drugs include hydrocodone and oxycodone, while in one case an individual received prescriptions from 87 different medical practitioners during the 12-month period. To combat such over-prescribing, private sector insurers in the US are adopting "restricted recipient programs" that limit identified claimants to one prescriber, one pharmacy, or both for receiving prescriptions. However, such programs could potentially deny legitimate drug needs, and involve uncertain administrative costs. Pensions and Financial Management Federal Budget Implementation Act: IPP and Other Taxation Changes Bill C-13, Keeping Canada's Economy and Jobs Growing Act, was introduced on October 4, The Bill would implement the following measures proposed in the 2011 federal budget: new rules to limit tax deferral opportunities for individual pension plans; amending the pension-to-rrsp transfer limits where the accrued pension amount was reduced due to the insolvency of the employer and underfunding of its RPP; amending the Canada Pension Plan to include amounts received by an employee under an employer-funded disability plan in contributory salary and wages; accommodating an increase in the annual contribution limit to the Saskatchewan Pension Plan and aligning its tax treatment with that of other tax-assisted retirement vehicles; amending the Canadian Human Rights Act to repeal mandatory retirement; amending the Canada Labour Code to repeal a provision that denies employees the right to severance pay for involuntary termination if they are entitled to a pension; introducing anti-avoidance rules for RRSPs and RRIFs; clarifying that the "financially dependent" test applies to rollovers of the assets of a deceased taxpayer's RRSP or RRIF to an infirm child or grandchild's RDSP; allowing the reallocation of assets in RESPs for siblings without incurring tax penalties; reducing the minimum course-duration requirements for educational assistance payments from RESPs that apply to students enrolled at foreign universities; making additional Canada Education Savings grant amounts available to more than one of a beneficiary's parents under certain circumstances; and amending the Special Retirement Arrangements Act to permit the reservation of pension contributions from any benefit that is or becomes payable to a person. Federal and Quebec Governments Agree to Harmonize Sales Tax On September 30, 2011, the federal and Quebec governments concluded a Memorandum of Agreement regarding harmonization of the provincial QST with the federal GST, and will make best efforts to enter into a Comprehensive Integrated Tax Coordination Agreement by April 1, As a result: the tax bases and tax rules for QST and GST purposes will be harmonized going forward, and Quebec will remove the GST from the QST base; financial institutions will no longer be entitled to reimbursement of sales tax on their purchases; Quebec will mirror, under the QST legislation, the place of supply rules under the GST/HST legislation to avoid instances of non-taxation and double taxation; Quebec will phase out its existing restrictions on input tax refunds over a transitional period of no more than eight years; Quebec will replicate under the QST legislation any change that the federal government makes under its GST legislation, with such changes generally applicable on the same date as the corresponding GST change but, in any event, no later than 60 days from the coming-into-force date for the GST change; Quebec will continue to determine the QST rate and will be able to maintain all existing exemptions; and as is the case for other provinces, the QST base will be allowed to deviate by up to 5 per cent from the GST base.

3 RRQ Guidance on Multi-Jurisdictional Issues Quebec's Regie des rentes has provided the following update with respect to the CAPSA Agreement Respecting Multi-Jurisdictional Pension Plans (MJPPA) that came into force for pension plans with members in Ontario and Quebec on July 1, 2011: for plans under the supervision of Quebec and whose fiscal year end is December 31, annual statements at December 31, 2011 must be in conformity with Quebec laws and regulations, and be sent to each active member, non-active member and beneficiary, whether in Quebec or Ontario, at the latest by September 30, 2012; until the pension supervisory authorities in other provinces and territories sign the MJPPA, the Memorandum of Reciprocal Agreement signed by the provinces in 1968, or the agreement signed by the Quebec and federal governments in 1969 on behalf of the territories, will continue to apply; and Quebec does not currently have an agreement with the federal government regarding members whose work is under federal jurisdiction. Division of Pension Benefits Effective October 1, 2011, the provisions of the General Regulation made under the New Brunswick Pension Benefits Act dealing with the division of benefits or the commuted value of benefits between married spouses on marriage breakdown, are amended to apply as well to common-law partners on the breakdown of their commonlaw relationship. New definitions of "common-law partner's portion" and "spouses' portion" are provided, and other necessary amendments are made. As well, necessary amendments are made to the various waiver and consent to transfer forms attached to the General Regulation. Ontario Bill 133, the Family Statute Law Amendment Act, 2009, received Royal Assent in May 2009 and introduced major changes to the valuation, division and settlement of pension assets on spousal relationship breakdown. In June, regulations were published containing new rules for dividing pension assets, and FSCO has now released the related forms in draft to allow plan administrators and other stakeholders to prepare for implementation of the new regime on January 1, Although FSCO does not expect to make material changes, the forms are not final until the fillable PDF versions are posted later this year. The various forms are: FSCO Family Law Form 1 - Application for Family Law Value - including instructions and Q&A; FSCO Family Law Form 1A - Plan Administrator Request for Information/Payment of Fee; FSCO Family Law Form 2 - Joint Declaration of Period of Spousal Relationship - including instructions and Q&A; FSCO Family Law Form 3 - Contact Person Authorization - including instructions and Q&A; FSCO Family Law Form 4A - Statement of Family Law Value (Defined Contribution Benefit); FSCO Family Law Form 4B - Statement of Family Law Value (Active Plan Member with a Defined Benefit); FSCO Family Law Form 4C - Statement of Family Law Value (Active Plan Member with a Combination Benefit); FSCO Family Law Form 4D - Statement of Family Law Value (Former Plan Member with a Defined Benefit or a Combination Benefit); FSCO Family Law Form 4E - Statement of Family Law Value (Retired Member with a Defined Benefit Pension); FSCO Family Law Form 5 - Application to Transfer the Family Law Value - including instructions and Q&A; FSCO Family Law Form 6 - Application to Divide a Retired Member's Pension - including instructions and Q&A; and FSCO Family Law Form 7 - No Division of Family Law Value/Pension Assets - including instructions and Q&A. OSFI Annual Report According to OSFI's Annual Report, as at March 31, 2011, there were 1,396 private pension plans registered under the Pension Benefits Standards Act, 1985, covering over 647,000 employees. During the fiscal year: plan assets increased 7.4 per cent to approximately $132 billion; the number of private pension plans on OSFI's watch list decreased from 79 to 49; the number of transactions requiring the Superintendent's approval decreased 36 per cent; OSFI initiated a dialogue with selected plan sponsors facing potential difficulties in meeting 2011 minimum funding requirements; and

4 OSFI continued to use its authority to replace plan administrators and, in one instance, terminated a plan whose future was uncertain to ensure equitable treatment for all members and beneficiaries. New Pension Assessment Formula Proposed for Federally Regulated Plans The federal government has proposed draft Assessment of Pension Plans Regulations, with stakeholder input requested by October 31, The current formula would not change, according to which the annual assessment equals the plan fee base multiplied by the basic rate. However, effective April 1, 2012, the plan fee base would be amended to include all plan beneficiaries (active members, deferred vested members, retirees and beneficiaries) instead of active members only. As well, the per member fee base increase in excess of 1,000 members would be increased, from $0.50 to $0.75; the fee base cap would double, to $20,000 (or 26,333 members and beneficiaries); and the minimum plan fee base would increase, from 20 to 50 beneficiaries. As a result, based on the $22 basic rate applied in , the minimum annual assessment would increase from $440 to $600, while the maximum annual assessment would increase from $220,000 to $240,000 (note however that last month OSFI announced a decrease in the Basic Rate from $22 to $18). While the proposed assessment formula would not affect the overall amount paid by federal plans, their assessments would be better aligned with OSFI's costs of supervision and regulation. For example, including retirees and other beneficiaries is appropriate in light of plan demographic trends and recent legislative changes that will require five additional years of oversight for plans that terminate while underfunded. As well, it is considered appropriate that larger plans pay more to reflect their significant demand on OSFI resources when problems arise. Plan sponsors could also incur slightly higher administrative costs in relation to including retirees and other beneficiaries in their reports filed with OSFI. No Deduction for Pension Benefits During Period of Reasonable Notice The employee was terminated without cause or notice after 42 years of service, at age 65. As a result, he elected to receive pension benefits under IBM's non-contributory DB pension plan. At trial, the employee was awarded 20 months of reasonable notice, or $93,305. IBM, however, argued that $42,480 should be deducted from this amount, representing his monthly pension benefits throughout the notice period. The trial judge refused to do so, and IBM appealed. In Waterman v. IBM Canada Limited, the British Columbia Court of Appeal dismissed IBM's appeal. Vested pension benefits are a right in the nature of property belonging to a worker and, although they provide an income stream when paid, are not a substitute for salary. As such, the employee's pension benefits were not deductible from any damages awarded for his loss of salary during the reasonable notice period. The Court also noted that there was "no inherent inconsistency between an employee receiving both salary and pension", citing receipt of statutory pension benefits, and private pension benefits from former employment with another employer or during periods of subsequent re-employment with the same employer. Finally, the Court considered it important that employers facing economic hardship not be encouraged to terminate senior employees with many years of service and vested pension rights to secure a significant offset of pension against salary in estimating damages for wrongful dismissal. Husband's Pension Subject to Division 11 Years After Separation The parties separated in 1997, and divided their various assets except for the husband's pension. However, because no separation agreement was signed, pension division under the Family Relations Act was not triggered. In 2001 and without informing the wife, the husband took early retirement, thus incurring a 13.5 per cent reduction in benefits, and elected a single life annuity guaranteed for 15 years. The parties subsequently divorced in 2008, and at trial in 2010 the wife was awarded 34.5 per cent of the husband's future pension benefits (representing one-half of the pension earned during cohabitation) and a compensation order for a proportionate share of the $248,000 in pension benefits received by him since The husband appealed.

5 In Parminter v. Parminter, the British Columbia Court of Appeal largely upheld the trial judge's ruling in favour of the wife. Despite the lengthy period between separation and divorce in this case, the statutory premise of equal division remained fair in the circumstances. The husband's early receipt of benefits without the wife's knowledge, and the 13.5 per cent reduction due to his early retirement, had deprived the wife of her reasonable expectation of a potential family asset available for division when they later divorced. While the inclusion of post-separation employer contributions represented a minor reapportionment in favour of the wife, they were made before the date of divorce and therefore constituted part of the potential family asset. However, the Court of Appeal significantly reduced the value of the wife's compensation order. Until a triggering event actually occurred, the husband's pension benefits were simply an income stream and, despite the negative impact of his various elections, the pension itself remained available for eventual division. As such, the compensation order was reduced to cover the period from 2008 (when the parties divorced) onward, instead of 2001 (when the husband took early retirement). Problems with Core CPI According to new research from the CD Howe Institute, the "core" Consumer Price Index (CPI), which strips out from the consumer price basket some of the most volatile items, may give misleading signals about future inflation. For example, core CPI can over a longer-term horizon be biased downward with respect to headline CPI. Furthermore, this bias could be compounded by current economic trends suggesting that some of the components excluded from core, notably those related to food and energy, will be more subject to continuing positive price shocks instead of temporary fluctuations. As a result, it is recommended that the Bank of Canada rely less on core CPI as an operational target. DC Minimum Return Guarantees According to new research from the OECD, minimum DC investment return guarantees during the accumulation phase can strengthen and complement the risk-reducing properties of life-cycle investment strategies, thus protecting retirement income against major investment losses. By enhancing appreciation of and confidence in DC arrangements, they can also boost coverage and contributions. However, if the DC provider also guarantees the minimum return, switching providers could revoke the existing guarantee, thus limiting member mobility across providers or fund managers. While making the guarantee ongoing is possible, it is also very expensive. Alternative solutions include having a guarantee underwriter that is independent from the DC plan provider, or introducing a compensation mechanism between providers. Although return guarantees will reduce the expected value of retirement income from DC plans, they can also be relatively inexpensive, in theory costing less than 10 basis points of accumulated net assets. However, cost and complexity will increase if members are allowed to vary contribution periods or investment strategies. As well, costs are generally higher for shorter contribution periods and for riskier investment strategies. For example, halving the contribution period to 20 years would quadruple the cost of the capital guarantee applied at retirement, while reducing the allocation to equities from 80 to 50 per cent would halve the cost. Payment options include deducting the guarantee cost from the value of assets at retirement, or on an annual basis from contributions or accumulated assets. US Public Sector: DB Versus DC In recent years, several US states have offered public employees a choice between primary DB and DC plans. According to an analysis of choices made by such employees conducted by the National Institute on Retirement Research: when given a choice, between 75 and 98 per cent of public employees choose the DB plan; DB pensions are more cost effective than DC accounts due to higher investment returns (11 per cent versus between 6 and 7 per cent in the case of one state) and longevity risk pooling; in response to lower returns, some states offer employees with DC accounts the option of investing in the same manner as the DB pension system, thereby earning exactly the same returns as the DB plan; "do-over options" (being able to switch from one plan type to another) can benefit employees whose situations change unexpectedly; shifting from a DB pension to DC accounts does not close funding shortfalls, and can increase a sponsor's retirement costs; however a hybrid plan for new employees in Utah provides a unique case study by capping the employer's pension funding risk and shifting risk to employees.

6 Total Compensation Federal Budget Implementation Act: Changes to the Wage Earner Protection Program Act Bill C-13, Keeping Canada's Economy and Jobs Growing Act, was introduced on October 4, The Bill would implement income tax and related measures proposed in the 2011 federal budget, such as: amending the Wage Earner Protection Program Act to extend in certain circumstances the period during which wages earned by individuals but not paid to them by their employers who are bankrupt or subject to receivership may be the subject of a payment under that Act; allowing the tuition tax credit to be claimed for eligible occupational, trade and professional examination fees; and reducing the minimum course-duration requirements for the tuition, education and textbook tax credits that apply to students enrolled at foreign universities. New Statutory Holiday to be Introduced in British Columbia In its Speech from the Throne, the government of British Columbia announced the introduction of a new provincial statutory holiday, called Family Day, to be held on the third Monday of every February, commencing in Take Action If you would like further information on any of these topics, please contact Aon Hewitt at Infocan@hewitt.com. The Aon Hewitt Radar is provided for information purposes only and should not be relied on as legal advice or opinion. About Aon Hewitt Aon Hewitt is the global leader in human capital consulting and outsourcing solutions. The company partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. For more information on Aon Hewitt, please visit