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The rules used by plan administrators and actuaries when calculating commuted values (CVs) for defined benefit pension portability benefits are about to change. In general, the change will lead to lower CVs to better reflect the theoretical value of a pension. This change will also result in immediately decreasing the solvency liabilities of practically every pension plan in Canada.
Summary of Recent History
The current Standard of Practice for Calculating Pension Commuted Values (CV Standard) has been in effect since February 1, 2005. The CV Standard was originally scheduled to expire on February 1, 2008, but was extended to February 1, 2009 by the Actuarial Standards Board (ASB). This extension was granted pending its review of a report, released in March 2008, by the Canadian Institute of Actuaries (CIA) Task Force on Pension Value Consistency.
In March 2008, the ASB issued a notice of intent proposing changes to the CV Standard (although no specific details were provided) and invited comments on the proposal. At the June 19, 2008 CIA General Meeting, and following input from key advisors and stakeholders, the ASB announced its proposed new CV Standard. The resulting Exposure Draft of the new standard was released on June 27, 2008.
Overview of Changes
The Exposure Draft will leave the CV Standard essentially unchanged, except for the following:
The proposed use of lower mortality rates is consistent with trends towards longer life expectancy. The proposed use of a higher discount rate reflects the fact that the deferred pension being commuted is highly illiquid. Therefore, it is important to base the discount rate on yield underlying financial instruments that have a similar level of illiquidity .
The discount rate increase in the Exposure Draft is the range shown above, with the ASB specifically inviting comments on the topic before deciding on a final number.
The ASB noted at the CIA General Meeting that the CV Standard could be amended again in as little as three years to incorporate a generational mortality table. Generational mortality rates vary by age, but also by calendar year, in anticipation of continuing future improvements in longevity.
Effective Date
The ASB expressed a preferred effective date of February 1, 2009 for the new CV Standard, as this will eliminate the need to further extend the application of the current CV Standard. However, finalizing the changes for this date is contingent on the ASB reaching a decision on the contents of the new CV Standard in October 2008, following a two-month window in which submitted comments are encouraged. Whether this is possible will depend on the extent of stakeholder agreement with its content.
There may be opportunities for early adoption in solvency valuations (but not in CV transfers for individual plan members). The ASB memorandum notes that actuaries could potentially use the new standard in solvency valuations with an effective date after the final CIA standard is issued, including in particular December 31, 2008/January 1, 2009 valuations, provided the pension regulators accept this approach.
Impact of Changes - Values
The above changes will generally lead to a decrease in commuted values across all ages and pension plan types. This decrease could be as high as 15 to 20% for younger members terminating from a non-indexed pension plan, if the 50 bps discount rate increase is adopted for non-indexed plans. The decreases would be even larger for members terminating from fully- or partially-indexed plans. The following table shows the approximate percentage drop in CVs for a typical pension plan:
| If the discount rate is increased by 25 bps for non-indexed pensions and by 50 bps for indexed pensions: | ||||
|
Age at termination |
25 |
35 |
45 |
55 |
|
Non-indexed plan |
-9% |
-7% |
-5% |
-2% |
|
Fully indexed plan |
-19% |
-15% |
-11% |
-7% |
| If the discount rate is increased by 50 bps for non-indexed pensions and by 75 bps for indexed pensions: | ||||
|
Age at termination |
25 |
35 |
45 |
55 |
|
Non-indexed plan |
-18% |
-15% |
-10% |
-6% |
|
Fully indexed plan |
-28% |
-23% |
-17% |
-11% |
A portion of solvency liabilities of almost all pension plans is determined with reference to the CV Standard, and this portion would decrease. Thus, the proposed changes would improve the solvency position of most pension plans (all else being equal).
Impact of Changes – Administration
The proposed changes should create minimal disruptions for pension administrators. Systems will have to be modified to include the new mortality table and may need to be modified to reflect the revised method for determining the discount rates. However, since the two-tier floating rate structure and 10-year select period appear likely to be retained, it is very likely that discount rate-related systems changes will be modest. Plan administrators need to ensure that they take the appropriate steps to be ready for the changes before they begin preparing CV estimates with effective dates from February 2009 onward.
Some administrators also use the CV basis to determine actuarially equivalent optional retirement benefits, as well as for the purchase of past service credits, the purchase of optional ancillary benefits in flexible pension plans and other purposes. Administrators will need to consider whether the new lower prices for the purchase of defined benefits remain appropriate.
Administrators should be aware that a more significant systems update may be required if a generational mortality assumption is adopted in a few years.
Risk of Increased Voluntary Terminations
As the new CV Standard will lead to lower CVs, several HR managers we have spoken to are concerned that active members may accelerate their decision to terminate to take advantage of the current, higher values. The extent to which this risk becomes a reality will depend on other movements in interest rates at that time and possible attempts by financial advisors to promote such decisions.
Implementing Changes – Legislative Amendments
Pension regulations must be amended in Ontario, Quebec and New Brunswick to implement these changes. As all other jurisdictions currently have regulatory language that automatically incorporates amendments to the standards, no amendments will be required in those jurisdictions.
Please contact Doug Chandler, Marshall Posner, Dean Taylor or your Watson Wyatt consultant for additional information.
For other information about Watson Wyatt research and services: call 1-866-206-5723 or email infocanada@watsonwyatt.com.
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