On August 24, 2010 the Ontario government announced the second stage of a multi-step process to reform the province’s pension system – the first being the passage of the Pension Benefits Amendment Act, 2010 (Bill 236) on May 5, 2010.

The proposals outlined by the Ontario government build upon the principles announced in Bill 236 and the recommendations proposed by the Expert Commission on Pensions. Please see our May 20, 2010 post for a summary of the first stage of pension reform outlined in Bill 236.

Here is a summary of the proposed reforms with some initial thoughts on some of the key provisions:

  1. Strengthening funding contribution rules through smoothing restrictions and limitations on excluded benefits
  • The use of smoothing (averaging) methods to value going concern assets would be limited to no more than the last five years.
  • Current interest rates, as opposed to the average of solvency interest rates, will have to be used to value plan liabilities.
  • The actuarial value of pension assets will be required to be within 20% of market value so that contributions better reflect current market conditions.
  • Indexing benefits will continue to be permitted exclusions from solvency liabilities, but will be required to be included in going concern valuations.
  • Plans with a funding threshold below 85% (currently 80%) will be obliged to undertake annual valuations to address “solvency concerns”. This matches federal requirements.
  1. Employer Contribution holidays
  • Contribution holidays are to be expressly permitted (subject to prohibitions in plan documents) provided they do not reduce the plan’s transfer ratio below 105%. What is not addressed is whether parties can rely on the current plan documents, or whether it will still be necessary to do an analysis of historical plan provisions, to determine whether or not the plan documents prohibit or restrict contribution holidays.
  • Contribution holidays will trigger enhanced member disclosure obligations, as well as the requirement to file annual statements with the regulator.
  1. Accelerate the funding of benefit improvements
  • Benefit improvements will be required to be funded over no more than eight years on a going concern basis, in contrast to the current 15-year amortization rules.
  • Where benefit improvements would result in a plan having a transfer ratio of less than 85% or the plan being less than 85% funded on a going concern basis, two new requirements will be imposed in conjunction with implementing the improvement:
  1. A lump sum contribution will be required to prevent a reduction of either the transfer ratio or the going concern funded ratio below 85%; and
  2. Any remaining cost of the improvement must be amortized over no more than five years.
  1. Clarify surplus entitlement
  • In addition to continuing to allow surplus to be paid to an employer where surplus entitlement can be demonstrated by the employer or a surplus sharing agreement has been reached, a binding arbitration process will be created to address surplus distributions on plan wind up. The scope of this arbitration provision remains to be seen, i.e. will it cover all disputes that arise in the context of negotiation or just surplus entitlement?
  • Payments of surplus to an employer from an ongoing plan will be permitted where there is either employer entitlement or appropriate consent has been obtained (2/3rds of members or bargaining agent and retireds and deferreds). However, for ongoing withdrawals, the surplus remaining in the plan must be no less than the greater of 25% of the wind up liabilities; or twice the current service cost plus 5% of wind up liabilities.
  • For plan splits and mergers, surplus sharing agreements will be required if the importing and exporting plan surplus provisions differ, to protect member surplus rights. This recommendation is surprising given the recommendations surrounding plan mergers from the Expert Commission and the Bill 236 changes to the PBA, and could be a significant impediment to plan mergers and other plan asset transfers, especially if a historical analysis of plan terms is required.
  1. Increased funding flexibility for MEPPs and JSPPs
  • “Target benefit” MEPPs that meet certain criteria are to be exempt from solvency funding requirements. These MEPPs will also be permitted to reduce benefit levels to the greater of the transfer ratio or going concern ratio when individual members exercise portability and the plan is underfunded.
  • Current JSPPs would be exempt from solvency funding requirements provided that certain criteria (e.g., enhanced disclosure to members and retired members) are met.
  • “Target benefit” MEPPs or JSPPs would have five years to fund a benefit improvement if that improvement causes the plan to become less than 85% funded (on a going concern basis).
  1. Create financial stability in the PBGF
  • Assessment levels for PBGF covered plans would be increased by creating a minimum assessment level of $250 for each pension plan covered by the PBGF; raising the base fee per plan member from $1 to $5; raising the maximum fee per plan member in underfunded pension plans from $100 to $300; and eliminating the overall assessment cap for underfunded pension plans.
  • New plans, and benefit improvements under existing plans, will be excluded from PBGF coverage for a period of five years (formerly three years).
  1. Temporary solvency funding relief for certain broader public sector plans
  • This proposal is expected to be utilized by certain universities in Ontario, but its potential application to other pension plans in the broader public sector is not yet clear.
  • The criteria plans must meet to participate are not yet clear. “Participating” defined benefit and hybrid plans that are less than 90% funded would be able to receive temporary solvency funding relief. To qualify, a proposal must first be submitted to the Ministry of Finance, outlining how sustainability will be achieved. These plans would be given a three-year window where a lower solvency threshold would be applied. Plans that have demonstrated progress towards stability at the end of the three-year period would then be permitted to enter “stage two” of the process. Plans that are not permitted to enter “stage two” are to be transitioned back into the normal pension funding rules.
  • “Stage two” would facilitate negotiations between plan members and their representatives by providing up to 10 years to implement the proposed changes and liquidate solvency deficits. During this period, contribution holidays and benefit improvements would be restricted.
  1. Encourage flexibility and opportunities for plan innovation
  • Employers will be permitted to use irrevocable letters of credit from a financial institution to cover up to 15% of solvency liabilities.
  • Defined contribution plans will be permitted to pay variable (life income fund-like) benefits.
  • Flexible defined benefit plans will be allowed (subject to Income Tax Act requirements)
  • Defined benefit plans will be permitted to amortize going concern and solvency special payments over a period beginning up to one year following the valuation date.
  • The recent federal investment rule changes will be adopted (Ontario currently applies the federal investment rules as they read on December 31, 1999), and Ontario will continue to review the appropriateness of the 30 percent rule for pension investments.
  • Require the PBA to be reviewed every 5 years.

An Observation

These proposed measures are directed to strengthening the retirement income system in Ontario, but in fact do little to encourage employers to establish or maintain defined benefit pension plans which, for the most part, will continue to be expensive to administer and risky to fund beyond minimum requirements. One additional way in which benefit security might have been enhanced in a sponsor-friendly fashion would have been through the adoption of a dedicated pension security fund, as suggested by the Alberta/British Columbia Joint Expert Panel on Pension Standards. This would be a balanced way of addressing sponsor “trapped capital” concerns associated with more aggressive pension plan funding and would encourage better benefit security without jeopardizing member rights. Perhaps it is not too late for the Ontario government to consider this as it would go a long way to achieving a better balance between member security and sponsor funding interests.  

Next Steps

The government will continue to consult with various stakeholder groups and has asked that any comments with respect to these reforms be submitted by September 14, 2010. Moreover, the provincial government continues to welcome feedback on how regulatory oversight of Ontario’s pension system can be improved. Legislation concerning these reforms can be expected around the middle of Fall 2010, with any accompanying Regulations to follow at a later date.