New Ontario target benefit funding framework a welcomed principles-based approach

Special Notice – September 7, 2023

After over 20 years of lobbying and getting by with temporary funding rules, on September 1, 2023, the Ontario government announced a new funding framework for Target Benefit Plans. After an initial proposal in March 2023 that many in the industry claimed missed the mark, the government has released a more appropriate funding framework based largely on a principles structure that relies on trustee fiduciary duties to properly, and prudently, manage their pension plans (although there are some restrictions for benefit adjustments and detailed prescriptive requirements for the new required policies).

The proposed framework requires trustees to establish a number of policies — funding and benefits, communications, as well as overall governance. Trustees will determine the appropriate level of margins, justified through risk analysis, and which many plans already regularly conduct. The recently released draft Canadian Association of Pension Supervisory Authorities (CAPSA) Pension Plan Risk Management Guideline will be instructive for the risk analysis and plans will be required to implement (if not already in place) a comprehensive member communication program which must include an evaluation of the program.

This principles-based approach goes a long way to achieve the government’s goals of providing certainty, increasing transparency, and improving equity. We have provided more information on a number of the specifics below.

Permanent removal of solvency funding requirement

The proposal permanently removes the requirement to fund a target benefit plan on the solvency basis. Although this requirement has been temporarily gone since 2007, it is reassuring that the government made this a permanent feature of the funding framework.

Eligible plans

Most Specified Ontario Multi-Employer Pension Plans (SOMEPPs) will be eligible to convert to a Target Benefit Plan provided they satisfy all four of the following conditions:

• Employer contributions are fixed;
• Benefits can be reduced;
• No more than 95% of members employed by one employer; and
• There are at least 15 employers or at least 10% of members were employed by two or more employers.

Provision for Adverse Deviation (PfAD)

Trustees will be required to determine the appropriate PfAD based on their plan’s funding and benefits policy and risk management processes. CAPSA’s recently released draft Pension Plan Risk Management Guideline will be helpful for trustees in developing their risk identification, evaluation, mitigation, and monitoring techniques.

This approach will provide trustees with significant flexibility in the financial management of their pension plan. However, it will also require regular (with each actuarial valuation) risk assessments, analysis, quantification, and disclosure (in each actuarial valuation report) to justify the PfAD adopted.

There is also the possibility of greater regulatory oversight on how trustees determine the appropriate PfAD level to ensure it is reasonable given the plan’s funding and benefits policy and objectives. Regulation would require funding and benefits and governance policies to outline risk management objectives for PfADs and how they would be applied.

Valuation frequency

Continuing with the current practice, plans will be required to file a valuation report every three years. However, if the going concern funded ratio falls below 85%, valuation reports will need to be filed annually.

Lump sum benefits

Lump sum benefits (typically for terminated members who elect to transfer their benefits out of the plan, death benefits, and marriage breakdown) will be determined on the plan’s going concern funding basis. This is consistent with actuarial professional standards as well as legislation in other jurisdictions.

Trustees may amend the plan document to adjust the lump sum amount based on the plan’s financial position. This would apply to lump sum amounts for terminated members and marriage breakdown. Plans applying this adjustment will be required to advise members of the amount and impact of the adjustment.

Member communications

Trustees will be required to establish a communications policy to identify, describe and evaluate their effort to engage members in the value and operation of their pension plan. All required member disclosures must also explain the nature of the benefits and that the benefits may be reduced.

Governance

Trustees will also be required to establish a governance policy as well as a funding and benefits policy. The proposed framework provides a lengthy list of items each policy must address. We expect that the Financial Services Regulatory Authority of Ontario (FSRA) will expect trustees to comply with the CAPSA guidelines on these policies.

Use of surplus

Trustees will be able to use a portion of going concern surplus as an offset to contribution shortfalls on a temporary basis to provide flexibility in satisfying the contribution sufficiency test and allow time for the parties to negotiate increases in contributions (or to implement benefit reductions if necessary.) Assets available to be used to offset requirements in the contribution sufficiency test would be, at most, one third of the lesser of:

• Assets in excess of 105% of the going concern liabilities; and
• Assets in excess of 100% plus its PfAD % of the going concern liabilities.

Use of surplus is not allowed in the first valuation report after a new collective agreement has been implemented and is only available to plans where contributions are negotiated in collective agreements.

Benefit adjustments

Benefit improvements will be allowed regardless of the plan’s funded level. Any increase in the going concern liabilities and the PfAD on the increase will need to be funded over 10 years. Surplus can be used to fund benefit improvements provided that, after the improvement, plan assets are at least the greater of:

• 105% of the going concern liabilities; and
• 100% plus the PfAD % of the going concern liabilities of the plan.

We have a number of questions on the technical details of the proposed rules with respect to benefit adjustments (both improvements and reductions). There are proposed restrictions on benefit adjustments, for example, that cause concern and on which we will seek additional dialogue with the Ministry of Finance.

Asset transfers

Regulatory amendments will be made to facilitate target benefit asset transfers on a going concern basis.

Multi-jurisdictional plans

The Ministry has acknowledged that there must be integration of Ontario rules with other jurisdictions. As such, they have advised that this issue will be reviewed to ensure appropriate provisions are implemented.

Conversion

Trustees must apply to FSRA to convert the plan to target benefits within five years from the effective date of the proposed framework. Before applying for consent to convert, trustees are required to engage in good faith consultation with participating trade unions and associations. After conversion, notice of the plan amendment reflecting the conversion must be sent to participating employers, trade unions and associations. The effective date of conversion would be within 12 months of approval from FSRA. All required policies (funding and benefits, governance, and communications) must be filed within one year of the effective date of conversion.

Transition

The first valuation report filed after conversion would not be required to include funding for a PfAD. However, it would be required for all subsequent valuation reports.

Impact:  SOMEPPs have successfully navigated the numerous challenges that pension plans have faced since solvency funding requirements were temporarily removed in 2007. The proposed framework is welcomed news that will provide flexibility and allow trustees of Target Benefit Plans to continue to prudently manage their plan in accordance with their fiduciary duty. Given that SOMEPPs have been operating as target benefit plans for decades, for most plans, there will be no impact on members by moving to the proposed target benefit framework. Although there are details to understand, we believe that the framework will promote long-term sustainability for target benefit plans and will rely on enhanced governance instead of prescriptive rules.