Session: Session 1 - Pension Plan Financial Reporting (PPFRC) Update Speaker: Deborah McMillan (moderator), Gavin Benjamin, and Manuel Monteiro

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Financial Reporting (PPFRC) Update Speaker: Deborah

1 Canadian Institute of Actuaries Institut canadien des actuaires Session: Session 1 - Pension Plan Financial Reporting (PPFRC) Update Speaker: Deborah McMillan (moderator), Gavin Benjamin, and Manuel Monteiro

2 Agenda Updated Group Annuity Purchase Guidance Accounting Discount Rate Guidance Other PPFRC Projects 2

3 Group Annuity Purchase Guidance Guidance provided by PPFRC to date in 2011 for non-indexed group annuity purchases Effective period Interest rate Mortality table Source Dec 31, 2010 to Mar 30, 2011 V bps UP94@2020 May 2011 EN Mar 31, 2011 to current V bps UP94 fully generational June 2011 & August 2011 EN Supplements No variation in assumptions based on size of annuity, or immediate vs. deferred pensions 3

4 Group Annuity Purchase Guidance Illustrative quote information at June 30 and September 30, 2011 AVERAGE OF THE THREE MOST COMPETITIVE QUOTES (USING UP94 GENERATIONAL MORTALITY TABLES) Retirees Discount rate Spread over CANSIM V39062 Deferred vesteds Discount rate Spread over CANSIM V39062 Large Purchase Small Purchase 30/06/ /09/ /06/ /09/ % % 4.14% % 3.57% % 3.59% % 4.12% % 4.11% % 3.56% % 3.52% % PPFRC has recommended to Practice Council that, effective September 30, 2011, the guidance should be revised to increase the spread from 70 bps to 90 bps This recommendation is subject to review, approval (or revision) by the Practice Council and, therefore, should NOT be applied by actuaries until official guidance is released 4

5 Concerns with current approach for setting hypothetical wind-up and solvency valuation assumptions 1. Not reflective of how benefits would actually get settled for large plans, particularly those with indexed benefits Legislation generally requires settlement through annuity purchases (or commuted values, if members so elect) Standards of Practice require that benefits be assumed to be settled on the wind-up date No clear ability under Standards of Practice to contemplate plan amendments or exercise of regulatory discretion where no practical method of settlement 2. Regulatory concerns regarding potential wide range of practice with respect to alternative settlement methods 3. Frequency of updates and time lag in release of PPFRC guidance 5

6 Notice of Intent regarding assumptions for hypothetical wind-up and solvency valuations Designated Group established by the ASB to review the Standards of Practice and consider whether changes should be made to address the identified issues Notice of Intent Amendment to the Practice Standards for Pension Plans Assumptions for Hypothetical Wind-up and Solvency Valuations published June 6, 2011 discusses two approaches: Amend Standards of Practice to provide uniform basis for hypothetical wind-ups regardless of method of settlement Maintain status quo 6

7 Feedback on Notice of Intent Very limited support for the use of a uniform basis Strong support for reflecting the unique circumstances of large and indexed plans and the use of alternative settlement methodologies where permissible and appropriate Support for continuing to reflect estimated cost of settlement through annuity purchases, where such purchases are practical Concerns about further deviations from actual wind-up position Strong support for maintaining current approach, with some suggestions for improvement: Additional guidance on alternative settlement methods Use of alternative reference bond yield indices Reduce time lag in release of guidance Reflect market price for indexed annuities Refining guidance to reflect liability characteristics (duration etc.) 7

8 Next Steps The Designated Group has recommended and the ASB has agreed NOT to proceed with the changes to the Standards of Practice proposed by the Notice of Intent The PPFRC has been asked to consider the comments received for improving the current guidance The improved guidance may require some enabling revisions to the Standards of Practice Removal of requirement that wind-up date, settlement date and valuation date be assumed coincident Allow for possibility that plan amendments, legislative changes or exercise of regulatory discretion may be assumed where there is no practical method of settlement based on current plan provisions and the law 8

9 Key issues to be considered by PPFRC in reviewing current guidance Provide additional guidance on alternative settlement methods Update draft appendix contained in April 2010 EN Consider the use of alternative bond indices Some evidence that annuity prices are better linked to provincial and/or corporate bond indices but lack of publicly available indices are a concern Consider approaches for reducing the time lag in producing the guidance Collection of hypothetical annuity quotes and actual purchase data as of dates prior to quarter ends and/or on a more frequent basis will be considered Further investigation of the market for indexed annuities Consideration of the practicality of refining guidance to reflect liability characteristics 9

10 Accounting Discount Rates: Background Accounting standards generally require that discount rates for pension and post-employment benefit plans be based on high quality corporate bond yields Discount rates suggested by actuarial firms have sometimes diverged significantly, particularly during times of financial market volatility In April 2009, Committee on Pension Plan Financial Reporting established a subcommittee Examine whether guidance related to accounting discount rates could be provided to actuaries In 2010, reporting structure of subcommittee altered such that it became a task force ( Task Force ) reporting directly to the CIA s Practice Council On September 20, 2011, Task Force released an Educational Note summarizing the results of its work ( 10

11 Key Challenge There are very few AA-rated corporate bonds denominated in Canadian dollars with maturities beyond 10 years The long end of a corporate AA yield curve developed for purposes of establishing the discount rate may vary significantly depending on The basic data used The underlying methodology applied The possible third-party provider retained 11

12 Alternatives Considered Task Force decided to focused on three possible alternatives for extrapolating the corporate AA-rated yield curve beyond 10 years A. Supplement AA-rated corporate bonds with maturities greater than 10 years with A-rated bonds, possibly with a spread adjustment to the A-rated bonds to reflect AA corporate risk B. Supplement AA-rated corporate bonds with maturities greater than 10 years with AA-rated US corporate bonds translated to Canadian-equivalent yields C. Use AA-rated provincial yield curve as the benchmark for maturities greater than 10 years with a spread added to reflect AA corporate risk 12

13 Guidance from Technical Partners Committee Task Force wrote to the audit firms Technical Partners Committee ( TPC ) requesting feedback on the following two approaches for developing the yield curve A. Supplement AA-rated corporate bonds with A-rated bonds C. Use AA-rated corporate bonds for maturities less than 10 years. Extrapolate corporate AA curve beyond 10 years using provincial AA-rated bonds, plus a credit spread adjustment to reflect AA corporate risk 13

14 Guidance from Technical Partners Committee Feedback from TPC Preference is for Alternative C (i.e., beyond 10 years use provincial AA-rated bonds, plus a credit spread adjustment) The general approach for extrapolating the AA-rated corporate yield curve beyond 10 years is reasonable Most consistent with Canadian accounting standards (e.g., Q&A 41R), although Q&A 41R refers to government of Canada bonds, not provincials Not based on bonds rated below AA, which is a characteristic of Alternative A 14

15 Educational Note Guidance on Factors to Consider 1. Approach to extrapolating long end of curve 2. Universe of bonds - Minimum size - Excluding bonds with inappropriate features - Quasi-government bonds - Outliers - Mixed ratings 3. Periods of market volatility - Stale pricing - Bid/ask spread and new issue concessions 4. Weighting of individual bonds 5. Curve fitting 15

16 Natcan s CIA Method Accounting Discount Rate Curve CIA has partnered with Natcan Investment Management Natcan to develop monthly spot curve based on approach outlined in the Educational Note Purpose is to provide pension practitioners, plan sponsors, auditors and others with ready access to a monthly spot curve based on an approach the Task Force believes is appropriate Not intended to imply that the approach outlined in Educational Note represents the only appropriate approach for developing discount rates 16

17 Monthly Spot Curve Development Note: The example that follows is illustrative only. 1. Bond selection (corporate AA and provincial AA/AAA) Filter out bonds with Non-standard cash flow structures Explicit callable options Less than $100 million outstanding For corporate bond universe, quasi-government entities are excluded (e.g., Port Authorities) 2. Develop provincial yield curve 17

18 Monthly Spot Curve Development 3. Calculate Base Spread Partition corporate bonds with maturities between 4.5 and 10.5 years into the following 6 maturity bands Band 5: maturity interval [4.5, 5.5) years Band 6: maturity interval [5.5, 6.5) years Band 7: maturity interval [6.5, 7.5) years Band 8: maturity interval [7.5, 8.5) years Band 9: maturity interval [8.5, 9.5) years Band 10: maturity interval [9.5, 10.5) years 18

19 Monthly Spot Curve Development 3. Calculate Base Spread For each Band i (i = 5 to 10), calculate Spread i as average of spread between corporate bond yield and yield at same maturity on provincial curve, for each corporate bond within Band Base Spread = (Spread 5 + Spread Spread 10 ) / 6 19

20 Monthly Spot Curve Development 3. Calculate Base Spread Illustrative example Spread in bps Maturity Band 5 Spread Maturity Band 6 Spread Maturity Band 7 Spread Maturity Band 8 Spread Maturity Band 9 Spread Maturity Band 10 Spread No corporate bonds Base Spread = ( ) / 5 = 108 bps 20

21 Monthly Spot Curve Development 4. Calculate Long Spread as average of spread between corporate bond yield and yield at same maturity on provincial curve, for each corporate bond with maturity of 10.5 years or more 5. Calculate Final Spread Final Spread = (Base Spread + Long Spread) / 2 Illustrative example (continued) Long Spread = 78 bps Final Spread = ( ) / 2 = 93 bps 21

22 Monthly Spot Curve Development 6. Develop observation yields for purpose of curve development Terms to maturity less than 10 years: reference yields on corporate bonds Terms to maturity of 10 years or more: reference yields on provincial bonds + Final Spread 22

23 Yield-to-Maturity (%) Monthly Spot Curve Development Illustrative Example (continued) 6.0 Provincial yields + 93 bps 5.0 Corporate yields Term (Years) Provincial Bond Universe Observation CIA's Yield-to-Maturity Observation 23

24 Monthly Spot Curve Development 7. Fit yield curve to observation yields 8. Develop spot curve 24

25 Rates (%) Monthly Spot Curve Development Illustrative Example (continued) Term (Years) Fitted Semi-Annual Yield-to-Maturity CIA's Yield-to-Maturity Observations Fitted Spot Curve 25

26 Accounting Discount Rates: Going Forward Natcan expects to publish September 30 and October 31 spot curves shortly Audit firms are considering implications of Educational Note and monthly spot curves for year-end audits 26

27 Accounting Discount Rates: Task Force Members Wendy Achoy Gavin Benjamin Sébastien Cliche Martin Cyrenne Douglas Isaac* Uros Karadzic Melissa Kirshenbaum Geoffrey Melbourne Boris Pavlin* Marlene Puffer* Martin Raymond Guillaume Turcotte David Walsh* * Not a member of CIA 27

28 Other PPFRC Projects Q&As on revised pension Standards of Practice Review pension Educational Notes for consistency with revised pension Standards of Practice Guidance on forecast actuarial cost methods Quebec partial valuations 28

29 Questions??? 29

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