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Solvency Pendulum Swings Too Far

The Association of Canada Pension Management (ACPM) says the current defined benefit pension plan funding requirements do not represent an appropriate balance between member benefit security and the sustainability and affordability of DB pension plans. In its response to the Alberta Treasury Board and Finance Consultation Paper on the Private Sector Pensions Review, it says the extreme decrease in interest rates and resulting increase in solvency liabilities means the solvency pendulum has swung too far towards benefit security at the expense of the wellbeing of the plans and plan sponsors themselves. By taking a longer-term view of DB plan funding, pension legislation has been adapted in other pension jurisdictions (British Columbia, Manitoba, Ontario, Quebec, Nova Scotia, and New Brunswick) to reflect the important role of those few plan sponsors who continue to provide DB plans. It suggests that funding rules should facilitate a reasonable and appropriate level of risk sharing between plan sponsors and plan members. However, when solvency funding rules were first designed in the 1980s, co-incidental with the introduction of portability rules in pension legislation, their primary objective was to protect plan members’ benefits in the event of plan termination. This benefit security was to be achieved by requiring additional employer contributions to the plan (over a five-year horizon) if a solvency test, required to be conducted at each actuarial valuation, revealed a deficit. Unfortunately, the theory behind solvency funding rules has not turned out as well in practice as was hoped. When solvency funding rules came into effect, it was probably never contemplated that solvency valuations could result in a measurement of liabilities that far exceeds the going-concern liabilities, but that is what has occurred. Corporate plan sponsors with otherwise healthy balance sheets are being put into difficult financial situations because of the higher capital and the shorter-term funding requirements of their pension plans, resulting in repeated rounds of solvency relief granted by governments. As DB pension plans mature in a low interest rate environment, ‘as and when needed’ exemptions and ‘temporary’ funding relief measures have become a band-aid solution. ACPM believes that this situation presents an opportunity to re-think solvency funding – a funding measure from which ‘relief’ has been granted at the bottom of nearly every economic cycle and market shock since its inception in the 1980s, in economic circumstances that differ greatly from the current persistent low long-term interest rate environment (despite the recent uptick in interest rates). Key measures would include funding based on a going-concern ‘plus’ model and eliminating solvency requirements except for a minimal solvency ratio floor.

Deadline Extended To Comment On Risk Guidelines

The Canadian Association of Pension Supervisory Authorities (CAPSA) has extended its deadline for submissions on an ‘Approach to Risk Management Guideline’ and guidelines on ‘Environmental, Social and Governance ESG) Considerations;’ ‘Leverage;’ and ‘Cyber Risk’ to October 14, says a Stewart McKelvey ‘Client Update.’ The risk management guideline is intended to help plan administrators fulfill their fiduciary obligations including, but not limited to, appropriate consideration of their standard of care. Based on stakeholder input on the approach, CAPSA may develop an inclusive risk management guideline that will contain sections on ESG, leverage, and cyber risk or publish three stand-alone guidelines, plus a separate principles-based guideline relating to risk management practices. The ESG draft guideline outlines how pension administrators may consider some ESG factors when making investment decisions, while still meeting their fiduciary obligation to plan beneficiaries. Administrators could incorporate ESG factors through portfolio limits on exposure to greenhouse gas emissions; setting investment targets for the portion of green assets in a portfolio; or setting standards related to executive compensation, diversity, labour, or cybersecurity practices in target companies. While the draft guideline does not state that the consideration of ESG factors is mandatory, it says that ignoring or failing to consider ESG factors that may be potentially material to the fund’s financial performance could be a breach of fiduciary duty. The draft leverage guideline provides guidance on practices for managing risks associated with the use of leverage in pension plan investments, while the draft cyber risk guideline reviews integrating cyber risk into a plan's general governance and risk management framework; delegating to third-party service providers; and developing incident reporting and response procedures.

For details on these stories, visit www.bpmmagazine.com

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