Update: second Exposure Draft of new rules for pension commuted value calculations
On November 23, 2018, the Actuarial Standards Board (ASB) of the Canadian Institute of Actuaries released the second Exposure Draft of proposed changes to the actuarial standards applicable for the calculation of pension commuted values (CVs). The second Exposure Draft includes some noteworthy updates that will affect both defined benefit (DB) and target pension arrangements (TPAs) across Canada. The previous Exposure Draft was released in July 2017 and summarized in the July 2017 edition of News & Views.
Updates affecting DB pension plans
Consistent with the July 2017 Exposure Draft, the interest rate spread over the Government of Canada bonds will be a market-linked spread rather than a fixed 90 basis points (bps) spread. The first Exposure Draft’s proposed approach of adding a spread to Government of Canada bonds of 67% provincial bonds and 33% investment-grade corporate bonds is retained.
The second Exposure Draft proposes that a floor of 0 bps and cap of 150 bps be applied to the spread added to the Government of Canada bond yields used for determining commuted values (CVs). The purpose is to mitigate large interest rate spreads during unusual financial market conditions.
Depending on market conditions, the proposed approach could lead to a reduction (or increase) in CV amounts compared to the current standard. However, current market spreads indicate a much smaller impact on CVs than would have been seen 10 years ago during the financial crisis of 2008 and the years after. The introduction of the minimum and maximum spread will serve to mitigate impacts to CVs during times of extreme market fluctuations and instability.
In addition to the changes respecting interest rate spreads, the second Exposure Draft would permit, but not require, the use of an alternate approach for the assumed age of pension commencement used in determining the commuted value. Historically, the assumed member retirement age to calculate CVs has been equal to the age that maximizes the CV.
The second Exposure Draft proposes this assumption be changed to a blend of 50% of the age that maximizes the CV, and 50% of the member’s earliest unreduced retirement age. A pension plan could continue to use the current approach, as long as it produces a higher CV amount than the new approach.
Updates affecting TPAs
The definition of a TPA remains unchanged compared to the July 2017 Exposure Draft. A TPA is defined as “a pension plan for which applicable legislation contemplates the reduction to the accrued pensions of plan members while the pension plan is ongoing as one of the available options for maintaining the funded status of the pension plan, and where the reduction in accrued pensions is not necessarily caused by the financial distress of the plan sponsor or sponsors.”
However, the second Exposure Draft notes that policy makers should consider whether pension legislation in their jurisdiction should permit the use of this section by other plans, such as jointly sponsored pension plans.
The proposed methodology for calculating CVs for TPAs has been updated in the second Exposure Draft from a proportionate share of plan assets to the going-concern liability. The assumptions for the most recently filed going-concern valuation must be used, including margins for adverse deviations. However, in the case of determining the CVs of deferred members, some of these assumptions could be modified if deemed unreasonable for the purpose of calculating CVs.
It will be possible, if permitted by plan terms or legislation, to adjust a member’s CV up or down to reflect the plan’s funded status. If the going-concern funded ratio is used for this purpose, the calculation date of this ratio should be no earlier than the valuation date of the most recently filed actuarial funding valuation report or cost certificate.
Feedback on the second Exposure Draft must be submitted by January 31, 2019. Unless the feedback submitted results in significant revisions to the second Exposure Draft, it is expected that the changes to the standard will be finalized in early 2019, with an effective date no earlier than mid-2019. Changes to the standard are automatically adopted in most jurisdictions in Canada, but would require regulatory changes in Ontario. The ASB is considering allowing TPA plan administrators to implement the final version of the standard prior to the effective date.
For both TPAs and traditional DB plans, the updates included in the second Exposure Draft do not change the fact that these proposed changes will impact CV amounts, solvency liabilities and potentially required contributions, and will require plan sponsors to review and potentially make changes to existing pension asset immunization strategies.
For TPAs, the change in proposed CV calculation methodology will likely be less administratively onerous than the changes proposed in the July 2017 Exposure Draft; however the current proposed changes could result in comparatively higher CV amounts. For traditional DB plans, the optional update to the retirement age assumption could result in lower CV amounts, and could therefore be viewed as an advantageous change by some plan sponsors.