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6 | INVESTMENT EXECUTIVE NEWS May 2020 Freeze is meant to be temporary, but no end date was announced
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given the stress put on these
plans by the Covid-19 crisis. Canadian DB pension plans have been battered by the decline in global equities mar- ket values and bond yields in response to the Covid-19 pan- demic, according to a report by London, U.K.-based Aon PLC released in April. According to the report, the median sol- vency ratio for Canadian DB plans stood at 89.1% at the end of March, a drop of 13.4 percent- age points since the end of 2019,
when the ratio stood at 102.5%. “In the short term, [the freeze] helps prevent a run on pensions and helps maintain their health,” says Jason Heath, managing dir- ector and certified financial planner with Objective Financial Partners Inc. in Markham, Ont. “In the medium or longer term, the risks of a pension not being able to pay future monthly bene-
fits have increased.”
Says Trevor Parry, president of
TRP Strategy Group in Ancaster, Ont., and a tax and estate plan- ning specialist: “Some [plan members] will be greatly and adversely inconvenienced [by the freeze]. For others, there will be some anxiety, but they will get through it.” He adds that OSFI’s move is “the right thing” for the regulator to do.
On March 27, OSFI imple- mented a “full freeze” on port- ability transfers and annuity purchases in relation to federally regulated DB plans. The office said the move was meant “to pro- tect the benefits of plan members and beneficiaries, given that cur- rent financial market conditions have negatively affected the funded status of pension plans.”
When a DB plan member’s employment ends before they retire, they typically are given the opportunity to remain in the plan or to receive the commuted
value of their pension. If the member chooses not to remain in the plan, they can transfer the maximum transfer value (MTV) of their commuted value pension into a locked-in RRSP and receive the amount in excess of the MTV in cash. The member may also buy an annuity with the com- muted value. DB pension provid- ers typically set an age threshold above which a member may no longer transfer out of the plan or buy an annuity.
OSFI’s freeze, which does not affect pensions being paid to retirees, is meant to be tem- porary, but an end date was not announced. OSFI’s website indi- cates that the office “will need a better understanding of the sol- vency position of pension plans and evidence of some level of financial market stability before considering adjustments to the freeze.”
On March 27, OSFI also froze portability transfers and annu- ity purchase requests already underway, stating: “We expect plan administrators to make best efforts to keep the money in the fund and cancel payment authorizations. However, we understand that in some cases, administrative processes may be difficult to reverse, and rec- ognize that some payments may have been processed in the days following the freeze.”
Lea Koiv, president of Lea Koiv & Associates Inc. in Toronto and a tax, pension, and retire- ment planning specialist, says OSFI should have allowed deals in progress to go ahead. “[If I had] handed in my documents, and now they say, ‘Nope, this whole thing is put on hold,’ I think that’s unjust,” she says.
OSFI is permitting plan administrators to request OSFI’s consent to a transfer or annu- ity purchase, but such consent is contingent on the adminis- trators demonstrating “that the
proposed transfer(s) or buy- out annuity purchase(s) do not unduly impact the security of the benefits of the remaining mem- bers and other beneficiaries of the plan.”
Pension plan members affected by the freeze still are entitled to their pension bene- fits, which are calculated as of their termination date. Those members can select a com- muted value option, but the transfer can’t be made during the freeze without the consent of OSFI. Once the freeze ends, a plan’s administrator can trans- fer the member’s commuted value pension, plus interest, out of the plan.
An OSFI spokesperson was asked in an email from Investment Executive if the office would extend commutations for members younger than the pension threshold age if those plan members are terminated from their job, yet will be older than the threshold age once the freeze lifts. An OSFI spokesperson replied: “Entitlement to benefits [is] determined as at the date of the cessation of [plan] member- ship. If the member was entitled to a commuted value at that time, they will remain entitled to take their commuted value once the portability freeze has been lifted.”
OSFI made other moves to support pension plan admin- istrators, including extending deadlines for certain filing requirements. And in early April, the Actuarial Standards Board, a body set up by the Canadian Institute of Actuaries, announced that a new commuted value cal- culation standard, which was to
be effective on Aug. 1, would be delayed to no earlier than Dec. 1. So far, none of the provinces has announced a similar freeze on transfers from provincially regulated DB plans. However, provincial pension legislation typically includes rules relating to plan solvency that limit amounts
that may be transferred out.
For example, the Financial Services Regulatory Authority of Ontario (FSRA) issued guidance in March indicating that if the “transfer ratio” of a plan falls by 10% or more, the plan adminis- trator “shall not transfer any part of the commuted value of a pen- sion, deferred pension or ancillary
benefit to which a member or for- mer member is entitled without obtaining FSRA’s prior approval.”
“It’s getting exceedingly diffi- cult to commute a pension,” Koiv says.
Heath suggests that there are three probable factors that con- tributed to OSFI’s decision to impose the freeze.
The first is the low interest rate environment, which means that commuted values’ calcu- lations are relatively high. “[As a pension plan member], you need to get a larger [commuted value] payment in order to repli- cateyourfuturepension,”Heath says. “Right now, arguably, inter- est rates are artificially low, and commuted value payouts are artificially high.”
The second factor is the drop in equities markets’ valuations, which means plan administra- tors would have to sell assets that have fallen significantly in value to pay out the larger commuted value transfers. Administrators would then face the prospect of having to top up shortfalls in the pension plan, all while the plan sponsor may be undergoing financial difficulties itself.
(On April 15, the federal
government announced a mora- torium for the rest of 2020 on sol- vency payment requirements for federally regulated DB plans.)
Finally, with potentially more employees losing their jobs or taking early retirement, a freeze on pension plan withdrawals decreases the likelihood of a run on the plan.
“I can see why pension plans would be hesitant to write big cheques to people who want to take money out of the pension [plan],” Heath says.
OSFI’s decision may cause dif- ficulty for members leaving the plan who would have received a partial cash payout as part of commuting their pension, par- ticularly if these people are facing immediate liquidity challenges.
“I’d hate to be in that situa- tion,” Koiv says. “But hopefully [the economic fallout of] Covid- 19 won’t last so long that people [are] making decisions based on a ‘black swan’ event.”
Says Parry: “We’ll come out of this. But how long [will it be] until the pension [solvency ratios] are back to where they need to be?”
Koiv says that in general, she’s “not a big fan” of taking a com- muted value of a pension in cash, which is taxable as income in the year it’s received.
“By taking the amount out, you have a phenomenal tax bill,” Koiv says, “and when you look at longevity and the vola- tility of investments, you might not have enough money to get you [through retirement].” De- pending on the circumstances, purchasing an annuity or remaining in the plan may be better options, she says.
Parry says that while he agrees with OSFI’s decision to temporarily freeze transfers, he believes the current difficulties faced by plan administrators and members should ignite a policy debate once the crisis passes about the role of DB plans in the broader Canadian pension landscape.
“Demographics and the sim- ple metrics that govern pensions on the plan member side [aren’t] positive for the long-term sur- vival of DB plans,” Parry says. IE
None of the provinces has announced a similar freeze on transfers from provincially regulated DB plans
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