1. Stephen Butterfield, FSA, CIA André Choquet, FSA, FCIA 2006 General Meeting Assemblée générale 2006 Chicago, Illinois 2006 General Meeting Assemblée générale 2006 Chicago, Illinois Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Agenda Educational Notes New Standards of Practice for Pension Funding Valuations

3. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes

4. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Educational notes are covered under Section 1220 of the Standards of Practice. – “The actuary should be familiar with relevant educational notes and other designated educational material.” – “practice which the notes describe for a situation is not necessarily the only accepted practice for that situation and is not necessarily accepted actuarial practice for a different situation.” – “educational notes are intended to illustrate the application (but not necessarily the only application) of the standards, so there should be no conflict between them.”

5. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes PPFRC will very shortly be issuing two Education Notes – Recognition of Expenses in Funding Valuations – Events Occurring After the Calculation Date of an Actuarial Opinion for a Pension Plan (i.e., interim actuarial opinions)

6. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Developed on the recommendation of the Pension Review Project – Observed many instances with seemingly inadequate provision for expenses – Observed many instances of inadequate disclosure of the provision for expenses i.e., “discount rate is net of all expenses” Consistent with the intent of Educational Notes, the purpose is to: – Remind members of need to include adequate provision for expenses in funding valuations – Provide members with advice on best practices for: Estimating future expenses that may be paid from the fund How to include appropriate provision for these expected expenses Disclosure of allowances for future expenses

7. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Going Concern Valuations Two key references in our Standards of Practice: – SOP 3300.04: “The actuary should make provision for any expenses that are expected to be paid from the plan’s assets.” – SOP 3200.07: “No provision is needed for expenses to be paid by the employer. In case of doubt, it would be prudent to assume that the expenses are paid from the plan’s assets.”

8. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Determination of expenses expected to be paid from the pension fund: – It is not the role of the actuary to determine whether or not it is appropriate to pay expenses from the pension fund – The actuary should consider all types of expense charged to the pension fund, including both investment expenses and administration expenses

9. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Fundamental actuarial equation should be considered: PVF(Benefits + Expenses) = Accrued Actuarial Liability + PVF (Normal Costs) Therefore, provision for expenses may be included in either the accrued actuarial liability or in the future normal costs (or a combination of both)

10. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Provision for expenses are typically made through either: – A reduction in the discount rate – An explicit provision in the normal cost Note that a reduction in the discount rate results in a provision in not only the accrued actuarial liability, but also in the normal actuarial cost – Provision for future expenses associated with accrued benefits – Provision for the future expenses associated with current year’s accruals

11. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Observations on reflecting expenses through a reduction in the discount rate: – Provision varies over time in relation to the liabilities If plan is approximately fully funded, this approach tends to work well for asset related expenses May not be appropriate for expenses that are not related to asset size Best practices suggest that the provision included in the discount rate be explicitly disclosed

12. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Inclusion of allowance in normal cost Care should be taken if the expenses are not expected to vary in relation to the normal cost For example: – Expenses that are asset-related – Recognition of expenses in a closed plan, where the normal cost is expected to decline over time

13. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Other methods of recognizing expenses are of course permissible If possible, the actuary should include an explicit gain / loss analysis for expenses

14. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Windup / hypothetical windup / solvency valuations – SOP 3720.02 “The actuary should either select and report an explicit assumption regarding the expenses of wind-up and offset the resulting expense provision against the plan’s assets, or justify the expectation that expenses will not be paid from the plan’s assets.” – SOP 3720.28: “Windup expenses usually include fees related to the actuarial wind-up report, fees imposed by a pension supervisory authority, legal fees, administration expenses, and custodial and investment management expenses” – SOP 3720.29: “The actuary should net wind-up expenses against the plan’s assets in calculating the ratio of assets to liabilities as a measure of the financial security of the benefit entitlements. However, an exception may be made for future custodial and investment management expenses, which may be netted against future investment return in the treatment of subsequent events.”

15. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Windup / hypothetical windup / solvency valuations – SOP 3720.06 “The actuary should report any explicit assumption of expenses payable from the plan’s assets required to wind- up the plan, including any assumptions with respect to the solvency of the employer in deriving the expense assumption.” – SOP 3740.13: “Since the actuary would assume that the plan has neither a surplus nor a deficit, wind-up expenses related to the resolution of surplus or deficit issues need not be considered.”

16. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Considerations in hypothetical windups / Solvency valuations: – EN lists types of expenses to consider – Actuary may rely on historical data of other plan terminations – For large plans, an annuity purchase may not be possible. The actuary should postulate a windup scenario and consider all expenses associated with such a scenario

17. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Recognition of Expenses in Funding Valuations Considerations in actual windups – Similar considerations, but actuary must be more meticulous – Actuary should consider the circumstances of the wind- up and the expected expenses to be incurred: – For example: If the plan is in deficit and registered in Ontario, then fees associated with an application to the PBGF should be considered If the plan is in a surplus position, then fees related to resolution of any surplus ownership issues should be considered

18. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date It was “suggested” by a member that an Educational Note on “Interim Actuarial Opinions” would be helpful PPFRC agreed that such an Educational Note would be valuable, but Our Standards of Practice make no mention of Interim Actuarial Opinions Thus, the reason for the long and technical name for this Educational Note

19. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date Three important definitions: 1. “Calculation Date” is the effective date of a calculation 2. “Report Date” is the date that a report is completed 3. “Subsequent event” is an event that occurs after the calculation date, but before the report date Two distinct situations: 1. event occurs before the report date (i.e., a subsequent event); and 2. event occurs after the report date An event is considered to have “occurred” when it is “definitive or virtually definitive”

20. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date Our Standards do not provide for secondary type of opinion All actuarial opinions must state: – The data are sufficient and reliable; – The assumptions are, in aggregate, appropriate; and – The methods are appropriate as at the CALCULATION DATE Therefore, it is NOT acceptable to prepare an opinion about financial position where the assets are valued at one date and the liabilities are valued at another date

21. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date Situation 1- event occurs before report date… …and after the Calculation Date→ subsequent event 1. Take the Event into account in the calculations; or 2. Disclose the Event in the report, but don’t take it into account in the calculations – must state that the Event will be taken into account in a subsequent report

22. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1. event occurs before report date (cont’d) Event is taken into account in the calculations → three approaches: a) One Actuarial Opinion @ calculation date b) Two Separate Actuarial Opinions – Reflecting the Financial Positions at Two Dates c) Two Separate Actuarial Opinions – One Reflecting the Financial Position at the First Calculation Date and one Reflecting the Financial Impact of the Subsequent Event

23. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1. event occurs before report date (cont’d) In describing the three approaches, we will refer to the following simple example: – Flat dollar pension plan – Calculation Date of January 1, 2006 – Flat dollar benefit rate is increased effective June 1, 2006 (the Event Date) – Report Date is September 30, 2006

24. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1 a) One Actuarial Opinion Financial position at Calculation Date includes effect of Event using data, assumptions and methods appropriate at such date In our example: – The going concern liability, windup liability, solvency liability and normal cost at January 1, 2006 would include provision for the future increase in the flat dollar benefit rate – The “financial impact” of the increase in the flat dollar benefit would be disclosed within the report Subject to regulatory / legislative considerations, it would be permissible to delay the funding of the Event until the effective date of the Event

25. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1 b) Two Opinions of the Entire Plan Two completely separate valuations, at two distinct Calculation Dates combined in one report may be based on the same membership data second opinion must use assets and assumptions that are appropriate at the second Calculation Date – In general, it would not be appropriate to project liabilities or assets from the first Calculation Date to the second Calculation Date

26. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1 b) Two Opinions of the Entire Plan (cont’d) In our example, in undertaking the 01/06/06 opinion: – collect revised membership data at June 1, 2006 or – use the membership data effective January 1, 2006 (projected in some manner to June 1, 2006) must use actual asset values at June 1, 2006 liabilities to be determined using assumptions that are appropriate at June 1, 2006

27. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1 c) Opinions on whole Plan & Event only The first opinion would completely exclude the financial effects of the Event Second opinion only to value effect of the Event – Calculation Date = Event Date – membership data to be appropriate at the Event Date – assets are generally immaterial – The liabilities must be determined using assumptions appropriate at the Event Date Disclosure should clearly differentiate two opinions

28. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1 c) Opinions on whole Plan & Event only (cont’d) financial position of the whole of the plan is unknown at the Event Date → – not possible to opine on the financial position of the whole plan – The opinion would merely state the financial effects of the Event and the contributions required to fund the Event approach not appropriate if the Event was expected to be funded with surplus revealed in the first opinion

29. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date 1 c) Opinions on whole Plan & Event only (cont’d) In our example: – The valuation at January 1, 2006 would completely exclude the effects of the plan amendment – A second opinion would be prepared at June 1, 2006: Only valuing the increase in the going concern liability, windup liability, solvency liability and normal cost resulting from the increase in the benefit rate Membership data may be recollected or projected Assumptions must be appropriate at June 1, 2006

30. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 Educational Notes Events Occurring After the Calculation Date Situation 2 - event occurs after report date The actuary need not seek out information on Events occurring after the Report Date However, if the actuary becomes aware of an Event, then the actuary must determine whether the Event invalidates the report: – If Yes: the actuary is required to either amend or withdraw the report – If No: the actuary is under no obligation to report on the Event Nevertheless, the actuary may be engaged to reflect the financial implications of the Event in which case the actuary must choose either 1b) or 1c) above

31. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Standards of Practice for Pension Funding Valuations

32. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Where Have We Been? New PPFRC issued a Statement of Principles in March 2005 – Proposed changes to the Standards of Practice for funding valuations of pension plans We received submissions from various sources – Actuaries – Plan sponsors / trustees – Regulators – Other professionals (accountants, lawyers, etc.) Issued subsequent discussion documents in the Fall of 2005

33. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Where Are We Going? We have digested the submissions received We have had considerable internal discussions / debates We have rethought the direction we are taking – On some issues: We remain convinced that our suggested approach is correct – On other issues: We are moving in other directions Our current thinking is summarized in a document that we are intending on making public very shortly – We will be welcoming further feedback on this document Next step is the preparation of an Exposure Draft

34. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Roles and Responsibilities We remain convinced that we have the roles and responsibilities appropriately defined Plan sponsors / administrators (Funders) – Set the funding policy – Set the investment policy Pension regulators – Define the minimum funding requirements – Set investment constraints Tax authorities – Define maximum funding constraints – Establish certain investment constraints

35. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Roles and Responsibilities Actuaries – Measurement and reporting of liabilities and costs – Disclosure of pertinent risks It is NOT the role of the actuary: – To establish acceptable levels of risk – To establish how a plan should be funded Risk cannot be eliminated and the actuary’s role is not to eliminate risk, but to report on it – Public Policy dictates the acceptable levels of risk

36. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Roles and Responsibilities Nevertheless, we acknowledge many of the submissions received which advocated a greater role for the actuary In many cases, we envision the Standards of Practice encouraging certain practices, subject to: – The Funder’s Funding Policy; and – Regulatory considerations More details to follow

37. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Objectives of Pension Plan Funding We continue to believe that there are two primary objectives: – Benefit security Promoted primarily through a windup valuation – Stability of cost recognition / budgetting Promoted primarily through a going concern valuation But … – We acknowledge that benefit security is all that really matters Short-term Long-term

38. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Windup Valuation – Almost Always Required Requirement to disclose the financial position on a true windup basis – Market value of assets – Full provision for all benefits payable upon windup Limited exceptions – E.g., public sector plans with no windup provisions Incremental windup cost must be reported – Including for years 2 and 3 if the valuation is intended to be a triennial valuation Simplified windup gain/loss required

39. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Risk Analysis for Windup Valuation – Almost Always Required Must disclose windup position under specified adverse situations – To enable readers of the report to understand the risks and potential volatility in the windup position Variability of the windup incremental cost would also need to be reported CIA Task Force on the Determination of Appropriate Provisions for Adverse Deviation in Hypothetical Windup and Solvency Valuations is currently working on defining these scenarios Important to note that the PPFRC is not advocating the funding of a windup liability with margins, but disclosure of the variability of the windup financial position

40. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Going Concern Valuation – Usually Required Much debate about the need for going concern valuations – Valuable budgetting tool? – Is windup all that is really needed? Going concern valuation must be undertaken, unless not required by the funding policy Currently, all jurisdictions require going concern valuations – Most RPPs would be required to undertake going concern valuations Other than the manner in which the actuarial assumptions are selcted, we envision little changes to the existing Standards of Practice

41. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Going Concern Valuation – Selection of Assumptions Currently, our Standards of Practice require that going concern valuations include provision for adverse deviation – This would no longer be the case The actuarial assumptions would be developed by the actuary based on the Funding Policy – If the Funding Policy specifies the use of best-estimate assumptions, then the actuary could use est-estimate assumptions Note that some Funding Policies may be very prescriptive and others may be very vague – In any event, the actuary must interpret and the Funding Policy and develop the assumptions accordingly

42. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Going Concern Valuation – Selection of Assumptions Two important caveats: – Our Standards will require that each assumption should be no more aggressive than the best-estimate assumption – If there is no Funding Policy, then the assumptions must include provision for adverse deviation In a manner similar to the current Standards PPFRC does NOT intend on issuing guidance with respect to determining best-estimate assumptions – Best-estimate assumptions are already being developed for accounting valuations, so there should be no barriers to also developing such assumptions for funding

43. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Going Concern Valuation – Selection of Assumptions One important exception – the discount rate The Standards of Practice will require that the discount rate be developed in a reasonable manner taking into account the investment policy of the plan Further, periodic guidance would be published providing both upper limits and lower limts on the discount rate Work will be needed to flesh out this concept further

44. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Going Concern Valuation – Selection of Assumptions Illustration of possible approach to developing limits for the discount rate: – Lower limit would be the discount rate applicable under a minimum risk portfolio – Upper limit would be the discount rate applicable using a building block approach with prescribed maximum risk premiums for specific asset classes We believe that this approach is one that provides flexibility for Funders and actuaries, but satisfies the concerns of regulators who currently have little ammunition to challenge what they perceive as being excessively high discount rates

45. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Funding Our Standards of Practice would provide the Funder and the regulators with information to assist in developing funding requirements – True windup position – Windup position, under some forms of adverse conditions (i.e., with margins) – Going concern valuation Usually with form of provision for adverse deviation Asset smoothing would be permitted – But would specifically be disclosed in the contribution section of the report NOT in the statement of financial position It is not up to actuaries to say whether these amounts should be funded or how fast they should be funded

46. 2006 General Meeting Assemblée générale 2006 2006 General Meeting Assemblée générale 2006 New Pension Funding Standards of Practice Next Steps Jointly (with ASB) issue discussion document Continue to solicit feedback Work on preparation of Exposure Draft Continue work on “filling in the details”