Canadian HR Reporter

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Visit www.carswell.com or call 1.800.387.5164 for a 30-day, no risk evaluation The standard will increase solvency liabilities that will lower funded status. PENSIONS More than meets the eye New mortality asumption could significantly impact pension plan administration By Paul Christiani and Paul Migicovsky R ecent updates to the actu- arial Standards of Practice published by the Canadi- an Institute of Actuaries (CIA) introduced a new mortality as- sumption with respect to com- muted value calculations. While this change is important from an actuarial point of view, it may also significantly impact pen- sion plan administration. So or- ganizations need to be prepared. Members of defined benefit pen- sion plans in Canada have the right to transfer the value of their pension as a lump sum amount into some form of tax-sheltered arrangement. is right gener- ally applies upon termination of employment prior to eligibility for an early retirement pension, although some plans have extend- ed this right to retirements that occur from the active workforce after the eligibility conditions for an early retirement pension have been satisfied. e lump sum payment repre- sents the commuted value of the monthly pension payments oth- erwise owed to the plan member, and the rules for calculating com- muted values are determined by referencing the standards. In 2015, the actuarial stan- dards board of the CIA changed the standards applicable to com- muted value determinations by announcing a new mortality as- sumption should be used. The new assumption is based on stud- ies that revealed two key facts: • Current mortality rates are low- er than the rates used under the prior assumption (meaning plan members are living longer). • Mortality rates are improving faster than had previously been anticipated (meaning future generations of plan members are expected to live even longer than current generations). By reflecting this increase in the current and future life expectancy of plan members, commuted val- ues will be higher under the new standard than they were before; and these higher commuted val- ues will have several implications for defined benefit plan sponsors. e change will increase com- muted values by about four per cent to seven per cent for mem- bers terminating employment be- fore retirement, according to the Actuarial Standards Board (ASB); and since plan actuaries must take these forecasted higher payments into account when performing ac- tuarial valuations, plan sponsors can therefore expect to see: • increased solvency liabilities of one per cent to two per cent • increased going concern liabili- ties and service costs for fund- ing purposes of just under one per cent, although plans cover- ing primarily active members or plans with high lump sum take-up rates might experience a higher impact • increased accounting liabilities and service costs for financial reporting purposes of about one per cent (keeping in mind that the previous comment about plan demographics would apply here as well and the accounting standard adopted by the organi- zation could also affect the size of the change). In addition, there are adminis- trative implications. First, some jurisdictions, such as Ontario, require a plan administrator to suspend lump sum payments un- til certain documents are filed and approved by the regulator if the administrator "knows or ought to know" a plan's funded status has fallen since the last filed actuarial report by more than a threshold amount. The new commuted value standard will increase solvency liabilities that will, in turn, lower funded status, all other things being equal. As a result, plan ad- ministrators need to be vigilant in monitoring these sorts of regula- tory requirements if their last filed actuarial report was prepared un- der the old standard. Second, the mortality assump- tion under the new standard is more technically complex than the one under the old standard; there- fore, some plan administrators who are exposed to possibly dated technology — either internally or from their external supplier — may have difficulty complying with the new standard immediately. e ASB has acknowledged this concern by allowing a two-year phase-in to give administrators time to revise systems if necessary. Finally, for plan members, al- though the higher commuted value payment is a "sunny ways" development for those who are terminating employment (as well as those who are retiring, where the plan permits commuted val- ue payments to them), there is a cloud in the forecast. e Income Tax Regulations place a limit on the portion of the commuted value payment that can be tax- sheltered; and the limit has not been updated to reflect Canadi- ans' increasing life expectancy as captured by the new standard. Under the applicable regula- tion, when a plan member re- ceives a commuted value greater than the prescribed limit, the excess portion of the commuted value is to be treated as taxable income (unless the plan member chooses to make use of any avail- able personal registered retire- ment pension plan (RRSP) room). As a result, the higher com- muted values could result in more taxable income being received. Whether the federal government will update (meaning raise) the limit to reflect our increased lon- gevity — and thereby allow for greater tax-sheltering of CV — payments is not known. Recent Ontario decision serves as example e increased commuted values resulting from the change to the standards may lead to greater interest by members and former members in commuted values. A recent decision by Ontario's su- perintendent of financial services serves as an example of the effect that fluctuating assumptions can have on commuted values and the benefit of explaining this possibil- ity to members. In that case, a member's pen- sion plan membership terminat- ed and she was sent a termination statement and an election form dated Aug. 15, 2013. e member was permitted to elect to receive a deferred pension or transfer the commuted value of her pension to a registered retirement savings arrangement. e statement in- dicated the commuted value was valid for six months, following which it would be recalculated using current interest rates, which could result in a lower value. Almost eight months later, the member completed the form, electing a commuted value trans- fer. She was informed by the ad- ministrator that because it was received after the six-month pe- riod, the commuted value had been recalculated and was lower. e member claimed she did not receive the statement until af- ter the expiration of the six-month period and asked the superinten- dent to order the administrator to pay the original amount. e superintendent denied the request, finding that the admin- istrator had complied with the Pension Benefits Act when it pro- vided the statement, and the time period within which options must be exercised. e superintendent noted that the six-month period exceeded the 90-day period set out in the act and although the pension plan text provided that a failure to make an election would result in the default option of a deferred pension, the administra- tor had permitted the member to make the election despite being past the required time period. e superintendent also stated the Pension Benefits Act requires commuted value calculations to be made using actuarial assump- tions consistent with accepted ac- tuarial standards of practice. Un- der the standards, actuaries have discretion to determine the pe- riod for which a commuted value will remain valid, and commuted values computed after the end of the period should be recalculated. Accordingly, a time period for the original commuted calcula- tion had been established and had elapsed, and the re-calculated val- ue the member received was de- termined in accordance with the requirements under both the act and the terms of the pension plan, found the superintendent. Although the member claimed she received the statement fol- lowing the expiration of the six- month period, the superintendent held that the member was still only entitled to the re-calculated commuted value, calculated on the date of the transfer. e super- intendent held that the member was entitled to a commuted value calculated in accordance with the Pension Benefits Act and the plan terms, not the date most "advan- tageous" to her. This case demonstrates the importance of not only having a clear and consistent policy and plan provisions on when a com- muted value must be recalculated, and whether requests for a com- muted value transfer after the election deadline has passed will be granted, but communicating that policy to members. Clear communication is par- ticularly important if, as part of a de-risking initiative, a window is opened to permit existing de- ferred vested members to take a lump sum. As outlined above, there is more to the change in standards than meets the eye. While increased costs to the pension plan may be the most immediate impact, there may be other consequences for both plan administrators and members. Paul Christiani is a senior partner at Mercer in Toronto and Paul Migi- covsky is an associate at Hicks Morley Hamilton Stewart Storie in Toronto.

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