1. Thursday, November 29, 2007 Faisal Siddiqi Task Force on Pension Plan Excess Surplus Issues

2. 2 Agenda Task Force Mandate and History Excess Surplus Issues Review of Submissions to Ontario Expert Commission on Pensions Related to Excess Surplus Summary and Next Steps

3. 3 Task Force Mandate and History The task force was established in 2003 Mandate: With respect to the funding of registered pension plans, to investigate whether there are problems related to the interaction of the maximum funding limitations of the Income Tax Act with the minimum funding requirements of pension benefits laws and, if so, to propose remedies to these problems.

4. 4 Task Force Mandate and History Previous chair of the task force resigned shortly after task force had their initial conference call Remaining members, except one, retired or terminated participation in the task force during 2003/4 New chair appointed in 2005 The Task Force’s mandate was not seen as burning issue by many due to prevalence of unfunded liabilities and solvency deficiencies following 2002

5. 5 Task Force Mandate and History In 2006, CIA requested that some research be done with respect to this task force in any event Revised Mandate: Present this topic at November 2007 CIA meeting and provide feedback to Pension Liason Committee.

6. 6 Excess Surplus – General Idea Currently, the Income Tax Act states that an employer (1) must take a contribution holiday if, at the date of an actuarial valuation, an “excess surplus” exists Employers may commence contributions again only after the excess surplus in the plan has been exhausted There are exceptions to this rule in the circumstances of plans having both an excess surplus and solvency deficiency (1) Employer is being used here in a general sense. It also includes multi-employer plans, jointly sponsored pension plans and other organizations/entities sponsoring a pension plan.

7. 7 Excess Surplus Excess surplus is defined in Income Tax Act Section 147.2(2)(d) Section 147.2(2) discusses what an eligible contribution is under the Income Tax Act towards a defined benefit provision of a registered pension plan

8. 8 Excess Surplus In general, the requirements for an eligible contribution under Section 147.2 are as follows: Valuation report not being more than 4 years old Use of actuarial funding method that matches contributions with benefit accruals Use of reasonable assumptions at valuation date and at time of contribution Use of generally accepted actuarial principles Designated plan rules are followed, if applicable Contributions are apportioned amongst employers, if applicable Ministerial approval in writing

9. 9 Excess Surplus Excess surplus is calculated as the plan’s going concern surplus at the valuation date in excess of the lower of (a) and (b), where: (a) is 20% of the plan’s going concern liabilities (b) is the greater of (i) and (ii), where (i) is 10% of the plan’s going concern liabilities (ii) 2 times the normal cost of the plan Note above calculation excludes any money purchase amounts

10. 10 Excess Surplus For example: Plan’s going concern assets are $900 m, going concern liabilities are $700 m Going concern surplus = $200 million Plan’s normal cost = $30 million Excess surplus limit is min (a) and (b): —(a) is 20% of $700 m = $140 m —(b) is max ( 10% of $700m, 2 x $30m ) = $70 m Excess surplus = $200m - $70m = $130m If normal cost was $60m, then excess surplus would be $80m

11. 11 Excess Surplus The Technical Notes to the Income Tax Act mention that excess surplus can be used as follows: To fund new or improved benefits Offset against the employer’s obligation to fund benefits Refunded to the employer or members

12. 12 Excess Surplus As a practical reality for mature plans, the excess surplus limit is really 110% For mature plans, 2 times their normal cost will be much lower than 10% of going concern liabilities

13. 13 Excess Surplus Slightly different rule for eligible contributions for jointly sponsored pension plans or “shared funding arrangements” Please refer to Income Tax Regulation Section 8516(4)(d) Essentially Uses a layered approach from 10% to 25% and still permits some current service contributions Sets the maximum threshold at 25% instead of 10%

14. 14 Issue 1 Issue 1: Unpredictable cash flows Why? Plan experience, plan changes, or assumption changes, can easily swing a plan’s funded position by more than 10% over a one to three year period Result: Employers go from taking contribution holidays to remitting significant contributions Long term planning is difficult Complex forecasting is required

15. 15 Issue 1 – Current Excess Surplus Rule

16. 16 Issue 1 – Excess Surplus Rule at 30%

17. 17 Issue 1 – Excess Surplus Rule at 40%

18. 18 Issue 2 Issue 2: Benefit security varies Why? Employers forced to take contribution holidays or provide improvements regardless of the long term impact Result: Provisions for adverse deviations (cushions) removed or not available in tougher economic periods

19. 19 Issue 3 Issue 3: Employers concerned with stranded cash Why? Many cases of going concern surplus and solvency/windup deficiencies cause large contributions which may lead to large surplus if economy turns Income Tax Regulation Sections 8516(2) and 8516(3) address funding on a plan termination basis and funding as required by provincial pension legislation

20. 20 Issue 3 Result: Employers/unions frustrated Some have proposed using letter of credit funding Others have proposed establish “contingency accounts”, or “solvency accounts” which are separate and apart from the main pension fund but refundable or usable, as applicable

21. 21 Issue 4 Issue 4: Individual Pension Plans (IPPs) may take advantage of higher contribution limits if excess surplus limit increased Why? Historically IPPs established to tax shelter greater amounts within an RPP versus and RRSP Result: CRA needs to monitor amount of tax assistance it provides while balancing the larger issue

22. 22 Review of Submissions to Ontario Expert Commission What are other organizations’ views? A review was done of some of the submissions made to the Ontario Expert Commission Many submissions have been made and the following will highlight some background on each submission and their specific comments with respect to the excess surplus limit

23. 23 ACPM View Overall view is to provide more flexibility in the operation of DB pension plans while not jeopardizing the benefit security for plan members Encourage change in environment so plan sponsors can fund plans beyond statutory minima Concerned with “stranded” cash issue establish periodic review of legislation

24. 24 ACPM View ACPM encouraging the establishment of: Letters of credit and solvency accounts Inflation protection at the discretion of plan sponsor or agreement of parties involved ACPM has a view to remove the excess surplus limits altogether under the Income Tax Act as they are too low

25. 25 C.D. Howe Institute View If the Income Tax Act (ITA) prohibits sponsors of DB plans from contributing when assets exceed 110%, then it is too low. The limit should be high enough to allow for normal variability in pension fund balance sheets Supports establishment of special trust accounts if current environment of surplus being trapped continues Also supports letters of credit to bridge solvency gaps

26. 26 Bakery Confectionary Tobacco Workers and Grain Millers (BCTGM) View Pension funds are for the owners of these funds: the plan members Affordability is an inherent part of negotiating Expand tax rules to permit carrying of realistic, larger surpluses farther forward Risks can be averaged and tax rules need to change so that surplus is not expended due to forward commitments of the company Objective is always to have fully funded plans

27. 27 Canadian Federation of Pensioners View Would like to encourage the maintenance of surplus in pension plans over the long term Concerned with a legislative environment that discourages accumulation of surplus in good times when it is really needed as a cushion to handle bad times Provisions for adverse deviations need to be maintained Concerned with funding asymmetry issue Encourage removal of the ITA limit on excess surplus

28. 28 Canada Retired Workers Advisory Executive View Does not buy into “asymmetrical” risk argument Argument that employers are responsible for deficits but can not access surplus CRWAE argues that employers include pension costs in collective bargaining. When there are years of high pension contributions, wage and benefit increases are low Also employers do have access to surplus – through contribution holidays No comment on ITA excess surplus issue

29. 29 Canadian Institute of Actuaries View Maximum surplus level allowed under the current tax rules is too low to provide adequate financial protection In order to enhance benefit security, CIA would like the federal government to change the tax rules to allow DB plans to maintain reasonable funding margins Suggest establishing a limit at 25% of going concern liability or 2 times target solvency margin CIA supports letter of credit funding and establishment of solvency accounts

30. 30 Council of Ontario Universities View Most concerned with solvency funding rules. Create a significant cost in their budget. Other provinces have exempted universities from the strict solvency funding rules Given the size of universities’ pension funds the current 10% threshold under the Income Tax Act is too low Would like the Expert Commission to make representations to the Federal Finance Department

31. 31 Ontario Bar Association View The “10%” funding buffer permitted by the ITA is inadequate to ensure long-term pension benefit security Actuarial surpluses can quickly turn into deficits and change funded ratios by more than 10% The limit in effect prevents funding for a rainy day In 2003 the federal government amended the ITA for jointly sponsored pension plans until a surplus of 25% of liabilities is reached

32. 32 Ontario Bar Association View Recommends that ITA be amended to take into account funded-ratio fluctuations that a pension plan can be expected to experience over a long term OBA recommends that the CIA come up with a recommended limit OBA does not recommend establish special trust accounts or contingency reserves. Recommends that legislation allow for more funding flexibility

33. 33 CAW View CAW does not buy into the asymmetrical risk argument since employers enjoy contribution holidays for long periods of time they should contribute in tough times CAW does not believe that greater access to surplus will induce employers to provide improved funding or increase DB coverage. Funding of pension plans is one of many competing priorities for most employers

34. 34 CAAT View Increase the ITA excess surplus limit from 10% to 50%. The current limit is too low and quite variable The strict result of the 10% limit is that employers are forced to take contribution holidays or implement benefit improvements at the cost of removing a provision for adverse deviations in bad times The 10% limit is a major disincentive for employers as it creates unpredictable cash flows – employers going from contribution holidays to significant contribution requirements

35. 35 Larger Consulting Firm Views Recommend: Permitting additional contributions to the pension fund Use of letter of credit financing Establishment of a contingency reserve account to provide funding flexibility Establishing a solvency funding regime under legislation Lengthening solvency amortization periods

36. 36 Larger Consulting Firm Views Towers recommends increases to maximum funding from the current 110% of going concern liabilities or 100% of windup liabilities, perhaps 125% of the greater of these two measures Mercer agrees the limit needs to be increased and analysed further Watson Wyatt suggests a limit around 40%

37. 37 Ontario Secondary School Teachers’ Federation View Contribution holidays created by the Income Tax Act eliminating the ability to contribute to an RPP that has a surplus of more than 10% can undermine a pension plan in times of volatility and should not be allowed The Income Tax Act should be changed to reduce the requirement and opportunity for employers to take contribution holidays Joint sponsors can negotiate what will be put in place and they share surplus and deficits Recommend establishment of an ear-marked contingency reserve

38. 38 Summary and Next Steps The excess surplus limit needs to be increased from 10% to a much higher limit Issues: Unpredictable cash flows Benefit security Stranded Cash IPPs Real issue is overall amount of surplus that a plan can have and how it is treated. Excess surplus rule is a secondary matter

39. 39 Summary and Next Steps CIA needs to consider doing more analysis to recommend a long term approach both in terms of level and structure Pension Liason Committee will be provided with feedback from this session