New mortality asumption could significantly impact pension plan administration
Recent updates to the actuarial Standards of Practice published by the Canadian Institute of Actuaries (CIA) introduced a new mortality assumption with respect to commuted value calculations. While this change is important from an actuarial point of view, it may also significantly impact pension plan administration. So organizations need to be prepared.
Members of defined benefit pension 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. This right generally applies upon termination of employment prior to eligibility for an early retirement pension, although some plans have extended this right to retirements that occur from the active workforce after the eligibility conditions for an early retirement pension have been satisfied.
The lump sum payment represents the commuted value of the monthly pension payments otherwise owed to the plan member, and the rules for calculating commuted values are determined by referencing the standards.
In 2015, the actuarial standards board of the CIA changed the standards applicable to commuted value determinations by announcing a new mortality assumption should be used. The new assumption is based on studies that revealed two key facts:
• Current mortality rates are lower 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 values will be higher under the new standard than they were before; and these higher commuted values will have several implications for defined benefit plan sponsors.
The change will increase commuted values by about four per cent to seven per cent for members terminating employment before retirement, according to the Actuarial Standards Board (ASB); and since plan actuaries must take these forecasted higher payments into account when performing actuarial valuations, plan sponsors can therefore expect to see:
• increased solvency liabilities of one per cent to two per cent
• increased going concern liabilities and service costs for funding purposes of just under one per cent, although plans covering 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 organization could also affect the size of the change).
In addition, there are administrative implications. First, some jurisdictions, such as Ontario, require a plan administrator to suspend lump sum payments until 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 administrators need to be vigilant in monitoring these sorts of regulatory requirements if their last filed actuarial report was prepared under the old standard.
Second, the mortality assumption under the new standard is more technically complex than the one under the old standard; therefore, 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.
The 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, although 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 value payments to them), there is a cloud in the forecast. The 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 Canadians’ increasing life expectancy as captured by the new standard.
Under the applicable regulation, when a plan member receives 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 available personal registered retirement pension plan (RRSP) room).
As a result, the higher commuted values could result in more taxable income being received. Whether the federal government will update (meaning raise) the limit to reflect our increased longevity — and thereby allow for greater tax-sheltering of CV — payments is not known.
Recent Ontario decision serves as example
The 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 superintendent of financial services serves as an example of the effect that fluctuating assumptions can have on commuted values and the benefit of explaining this possibility to members.
In that case, a member’s pension plan membership terminated and she was sent a termination statement and an election form dated Aug. 15, 2013. The member was permitted to elect to receive a deferred pension or transfer the commuted value of her pension to a registered retirement savings arrangement. The statement indicated 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 transfer. She was informed by the administrator that because it was received after the six-month period, the commuted value had been recalculated and was lower.
The member claimed she did not receive the statement until after the expiration of the six-month period and asked the superintendent to order the administrator to pay the original amount.
The superintendent denied the request, finding that the administrator had complied with the Pension Benefits Act when it provided the statement, and the time period within which options must be exercised. The 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 administrator had permitted the member to make the election despite being past the required time period.
The superintendent also stated the Pension Benefits Act requires commuted value calculations to be made using actuarial assumptions consistent with accepted actuarial standards of practice. Under the standards, actuaries have discretion to determine the period 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 calculation had been established and had elapsed, and the re-calculated value the member received was determined 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 following 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. The superintendent 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 “advantageous” to her.
This case demonstrates the importance of not only having a clear and consistent policy and plan provisions on when a commuted value must be recalculated, and whether requests for a commuted value transfer after the election deadline has passed will be granted, but communicating that policy to members.
Clear communication is particularly important if, as part of a de-risking initiative, a window is opened to permit existing deferred 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 Migicovsky is an associate at Hicks Morley Hamilton Stewart Storie LLP in Toronto.
Members of defined benefit pension 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. This right generally applies upon termination of employment prior to eligibility for an early retirement pension, although some plans have extended this right to retirements that occur from the active workforce after the eligibility conditions for an early retirement pension have been satisfied.
The lump sum payment represents the commuted value of the monthly pension payments otherwise owed to the plan member, and the rules for calculating commuted values are determined by referencing the standards.
In 2015, the actuarial standards board of the CIA changed the standards applicable to commuted value determinations by announcing a new mortality assumption should be used. The new assumption is based on studies that revealed two key facts:
• Current mortality rates are lower 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 values will be higher under the new standard than they were before; and these higher commuted values will have several implications for defined benefit plan sponsors.
The change will increase commuted values by about four per cent to seven per cent for members terminating employment before retirement, according to the Actuarial Standards Board (ASB); and since plan actuaries must take these forecasted higher payments into account when performing actuarial valuations, plan sponsors can therefore expect to see:
• increased solvency liabilities of one per cent to two per cent
• increased going concern liabilities and service costs for funding purposes of just under one per cent, although plans covering 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 organization could also affect the size of the change).
In addition, there are administrative implications. First, some jurisdictions, such as Ontario, require a plan administrator to suspend lump sum payments until 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 administrators need to be vigilant in monitoring these sorts of regulatory requirements if their last filed actuarial report was prepared under the old standard.
Second, the mortality assumption under the new standard is more technically complex than the one under the old standard; therefore, 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.
The 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, although 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 value payments to them), there is a cloud in the forecast. The 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 Canadians’ increasing life expectancy as captured by the new standard.
Under the applicable regulation, when a plan member receives 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 available personal registered retirement pension plan (RRSP) room).
As a result, the higher commuted values could result in more taxable income being received. Whether the federal government will update (meaning raise) the limit to reflect our increased longevity — and thereby allow for greater tax-sheltering of CV — payments is not known.
Recent Ontario decision serves as example
The 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 superintendent of financial services serves as an example of the effect that fluctuating assumptions can have on commuted values and the benefit of explaining this possibility to members.
In that case, a member’s pension plan membership terminated and she was sent a termination statement and an election form dated Aug. 15, 2013. The member was permitted to elect to receive a deferred pension or transfer the commuted value of her pension to a registered retirement savings arrangement. The statement indicated 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 transfer. She was informed by the administrator that because it was received after the six-month period, the commuted value had been recalculated and was lower.
The member claimed she did not receive the statement until after the expiration of the six-month period and asked the superintendent to order the administrator to pay the original amount.
The superintendent denied the request, finding that the administrator had complied with the Pension Benefits Act when it provided the statement, and the time period within which options must be exercised. The 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 administrator had permitted the member to make the election despite being past the required time period.
The superintendent also stated the Pension Benefits Act requires commuted value calculations to be made using actuarial assumptions consistent with accepted actuarial standards of practice. Under the standards, actuaries have discretion to determine the period 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 calculation had been established and had elapsed, and the re-calculated value the member received was determined 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 following 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. The superintendent 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 “advantageous” to her.
This case demonstrates the importance of not only having a clear and consistent policy and plan provisions on when a commuted value must be recalculated, and whether requests for a commuted value transfer after the election deadline has passed will be granted, but communicating that policy to members.
Clear communication is particularly important if, as part of a de-risking initiative, a window is opened to permit existing deferred 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 Migicovsky is an associate at Hicks Morley Hamilton Stewart Storie LLP in Toronto.
