Most Defined Benefit (DB) pension plans in Canada are subject to provincial or federal pension legislation. This results in the requirement to fund the pension plan on a solvency basis: assets and liabilities are valued on a wind-up basis using current market values of investments and long-term bond rates to calculate liabilities.
Many DB plans in Canada are severely under-funded on a solvency basis today. Since solvency deficits are generally funded over 5 years, required contribution rates for employers and/or plan members have increased significantly.
The initial reason for the solvency test makes sense: ensure that the pension plan is sufficiently funded to cover all earned pension benefits in the event the employer is bankrupt and the plan is wound up. However the solvency test has had a few unintended consequences recently:
- Employers have tried to limit their funding obligations by closing or eliminating DB plans. This has reduced pension coverage in Canada.
- In cost-shared plans members have to share in the extra funding needed to cover current solvency deficits. The consequences are either benefit reductions or high member contributions to cover potential future employer bankruptcy. Members of these plans might question why they are paying the price today for a potential future event (employer bankruptcy) that may or may not impact their pension benefits in future.
Some Canadian pension regulators have allowed relief from the solvency funding test. Typical relief takes different forms and is described below for B.C.-regulated plans:
1) Solvency exemption: BC’s public sector pension plans, such as the Municipal Pension Plan, are exempt from the solvency test. However, many quasi-public sector or Crown corporation pension plans are not exempt from the solvency test, e.g., BC Hydro, ICBC, WorksafeBC or the university pension plans.
2) Solvency moratorium: Negotiated cost multi-employer plans can apply to the Superintendent of Pensions for a 3-year period of relief from solvency payments, if they meet certain restrictions.
3) Extension of solvency payment period: Plans can apply to the Superintendent to extend the payment period from 5 up to 15 years. I understand that these extensions have not been widely granted by the Superintendent.
4) Letter of credit: Single-employer plans in B.C. can use a letter of credit to cover their solvency deficit payments. In this case the employer will pay a bank or credit union a fee to guarantee the payment of solvency contributions in the event that the employer goes bankrupt i.e. the bank back-stops the employer’s solvency deficit funding obligations. Section 35.1 of the PBSA Regulations outlines the restrictions on the letter of credit. One of the key restrictions is that the letter of credit is issued by a bank or credit union with an acceptable credit rating.
For private sector employers, since a solvency exemption or solvency moratorium are not likely, the remaining ways to get relief from solvency funding are:
- Extension of solvency payment period: given the difficulty to obtain this approval, in most cases I don’t feel it is worth the time and expense to pursue this option.
- Letter of credit: in many cases I think this is a good solution. The key issues to consider are the cost of the letter of credit and any restrictions this would place on the employer’s ability to borrow.
- New plan design: Bill 38, once it is law, will result in a new B.C. PBSA and Regulations (expected to be in force in mid-2013). Bill 38 allows for the adoption of target benefit plans (TBPs). Target benefit plans provide a target pension benefit and fixed member and employer contribution rates. Benefits are allowed to vary depending on the plan’s funded position. At this point it is not clear whether TBPs will be subject to solvency funding, but I am optimistic that they will not be required to fund according to the solvency test. This will result in significantly lower current contributions than DB plans for the same benefit levels.
For employers that are quasi-public sector in B.C. (i.e. Crown corporations or universities), there may be another way to get solvency funding relief. If section 35.1 of the PBSA Regulations is amended to allow letters of credit to be issued by the government of B.C., this could provide significant funding flexibility to Crown corporations and universities in B.C. Since these organizations rely heavily on provincial government funding, the B.C. government could back-stop their solvency deficits and reduce the money currently being wasted on letter of credit fees paid to banks.
The current economic environment is forcing plan sponsors to look for new ways to solve their pension funding challenges. The B.C. government is currently working on Regulations for Bill 38 that will shape future pension funding rules, so has an opportunity to help private and public sector plan sponsors deal with their solvency challenges.