“Solvency funding kept things real because that’s what was ultimately promised. However, the last 30 years have proven this line of thinking doesn’t always apply. ” – Faisal Siddiqi, Principal and Senior Consulting Actuary
Effective Jan. 1, 2016, the Quebec government passed Bill 57, which affects the funding and administration of Quebec-registered pension plans as well as members working in Quebec for non-Quebec registered pension plans. This legislation is a welcome change to the pension landscape and will provide a better long-term model for defined benefit (DB) pension plans, as it addresses some key problems with the current legislative framework.
Why Solvency Funding Has Not Worked
Funding has been an onerous burden for DB pension plan sponsors since 1987, and Bill 57 addresses this problem. For a long time in Canada, DB plan sponsors have been required to fund on both a going-concern (or long-term) basis and a solvency/windup (or plan termination) basis. The thinking has always been that it makes sense to fund on both bases because the first approach (going-concern) helps plan sponsors manage their plans over the long term and provides a steady, systematic funding approach, while the second approach (solvency/windup) ensures there are enough funds to pay promised benefits in case the plan winds up. Solvency funding kept things real because that’s what was ultimately promised.
However, the last 30 years have proven this line of thinking doesn’t always apply. Forcing public-sector, quasi-public sector, and large private-sector organizations to fund on a solvency basis has placed a heavy burden on them. Many of these organizations won’t face real scenarios where they would have to wind up their plans because they cover police, firemen and other government services, or they provide essential services (e.g., teachers, nurses, electrical workers, etc.). In the private sector, they tend to be large companies making cars or auto parts, delivering food, etc.
If these organizations or entities don’t face a real likelihood of winding up or closing their DB plans, then it doesn’t make sense to force them to fund them on a solvency/windup basis. Consequently, many have applied for and received exemptions from the solvency funding requirements engrained in the pension legislation of many provinces.
In the private sector, many DB plans have been closed or wound up and replaced with defined contribution plans where the funding is fixed and not subject to interest rate, investment or mortality risks. This is a direct result of having to fund DB plans on a solvency basis and not being eligible to receive exemptions because the organizations are not considered completely essential or too big to fail. Provincial governments implemented solvency funding relief measures in 2009 and 2012, and they’ve now incorporated some type of permanent solvency funding relief measures across the board to address the high burden of solvency funding in the current economic environment.
For multi-employer pension plans (MEPPs), solvency funding rules typically did not apply due to their nature and design; however, these rules have been causing problems in terms of plan administration and optics. On the plan administration side, MEPPs have had to pay out significant lump sums on a solvency basis (as required by law) but have been funding their plans on a going-concern basis. For large MEPPs—and many of them are quite large, at over $100 million or more in assets—this has led to a systematic deterioration of the plan’s funded ratio, causing many MEPP pension committees to adopt a policy to pay out lump sums equal to the full lump sum value multiplied by the plan’s last solvency funded ratio. In terms of optics, all MEPPs communicate their plan’s solvency ratio on member’s annual statements and not necessarily the plan’s long-term funded position. As a result, the solvency ratios make MEPPs look worse funded than they really are.
Is There a Better Approach?
Yes. Quebec has passed legislation that removes the requirement for solvency funding, implementing an approach where members leaving a DB plan receive the solvency funded portion of their lump sum. The province has also established a requirement for a stabilization reserve to help cushion plan sponsors in tough times and encourage plan sustainability.
This is a welcome change, and I expect many plan sponsors and regulators are waiting to see how it unfolds in the near future.