Legal Issues for Plan Sponsors in the Current Round of Pension Reform

April 28, 2012Paul Litner

The Canadian Retirement Income System

Canada’s retirement system as a “three pillar” model Government-sponsored programs

(CPP/OAS) Personal savings (RRSPs/TFSAs) Employer sponsored retirement plans (Group

RRSPs and RPPs)

Most common form of RPPs: Defined benefit (“DB”) pension plans Defined contribution (“DC”) pension plans

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Trends in the Canadian Retirement Income System

Declining participation in private sector DB plans Private sector membership in DB plans declined

3.6% in 2009 (Statistics Canada, 2011)

Overall participation in any private sector employer sponsored pension plan declining number of workers in the private sector with

pension coverage has declined by 2.1% (Statistics Canada, 2011)

DC plans failing to deliver? Expected retirement age of Canadian workers

has increased from 60 (in 2007) to age 67 (2011) (Towers Watson, “Pension Freedom Index”, 2011)

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The Need for Pension Reform in Ontario

Pension reform long overdue in Ontario and in many other Canadian jurisdictions

Societal/economic changes further reinforce need for pension reform

Pension stakeholders call for reforms to pension laws to save a “failing” system

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Pension Reforms & Asymmetry of Risk

Key issue for employers related to “asymmetry of risk” (driven by issues over access to surplus in DB plans)

Important context in assessing reforms: (a) Pre-2008 context: access to surplus

predominant issueSurplus entitlementContribution holidays

(b) Trust law requirements as a result of Schmidt and subsequent jurisprudence

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Background to Reforms: Schmidt Schmidt v. Air Products of Canada Ltd (SCC)

“The first step is to determine whether or not the pension fund is in fact a pension trust... A pension trust is a “classic” or “true” trust and not a mere trust for a purpose. If there is no trust created under the pension plan, the wording of the pension plan alone will govern the allocation of any surplus remaining on termination. However, if the fund is subject to a trust, different conclusions may govern.”

“When a pension fund is impressed with a trust, that trust is subject to all applicable trust laws.”

Consequences of Schmidt: Trust law analysis required in order to demonstrate

entitlement to surplus Application of trust law to pension trusts

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Pension Reform in Ontario

OECP formed in November 2006 Public consultations held in October 2007 OECP final report in November 2008 Pension reform:

Bill 236 (Royal Assent on May 18, 2010) Bill 120 (Royal Assent on December 8, 2010) Bill 135 (Royal Assent on December 8, 2010) Bill 173 (Royal Assent on May 12, 2011) Bill 55 (first reading on March 27, 2012) Regulations to the PBA in conjunction with above-

mentioned reforms

Majority of reforms not yet in force7

Pension Reform: Surplus Withdrawal

Pre-Reform: Superintendent’s consent required

Ongoing plan: 100% member consent Wound up plan: lower member consent

requirement but requirement to demonstrate legal entitlement

Legal entitlement pursuant to Schmidt: (a) employer made a beneficiary to the trust from

the trust’s inception; or (b) employer expressly reserved the power to

revoke the trust at the trust’s inception; or (c) employer is entitled to the surplus by operation

of a “resulting trust”

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Pension Reform: Surplus Withdrawal

Post-Reform: Surplus can now be paid pursuant to:

(a) consent regime or (b) court order

Consent regime:Employer must reach agreement with 2/3 of

plan members (or union) and % of former members/others determined by Superintendent

In force December 8, 2010

Reforms to permit arbitration re: surplus to follow

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Pension Reform: Surplus Withdrawal

Impact of reforms from an employer’s perspective? No legislative override to trust law analysis

requirement Few plans currently with ongoing surplus –

new surplus sharing regime “too little, too late”

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Pension Reform: Contribution Holidays

“Contribution holiday”: ability to use surplus to suspend/reduce normal cost contributions

Pre-Reform: No clear statutory guidance Schmidt: distinction between actuarial

surplus in ongoing plan and actual surplus on plan wind-up

Contribution holidays do not encroach on trust

Kerry: confirmed Schmidt approachEmployer entitled to take contribution holidays

unless plan documents preclude it

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Pension Reform: Contribution Holidays

Post-Reform Employer/employee contributions can be

reduced/suspended if: (a) plan has a surplus (b) documents that create and support the

pension plan or pension fund do not prohibit it

(c) other prescribed requirements are met

Amendments not yet in force Falls short of legislative override to

requirement for trust law review

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Pension Reform: Partial Wind-Ups

PWU either (i) voluntarily declared by employer, or (ii) ordered by the Superintendent

PWU by the Superintendent: Broad interpretation of power by the courts No time limitations

Two main issues: (a) Entitlement to surplus on PWU (b) “Grow-in” benefits

Reforms to eliminate PWUs (likely effective July 1, 2012)

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Pension Reform: Partial Wind-Ups – Surplus Entitlement

Pre-Reform: Monsanto: SCC concludes that PBA requires

distribution of surplus attributable to PWUSCC did not make any conclusions with respect

to who was entitled to such surplusPWUs declared in 1980s and 1990s revisited –

distribution of surplus forced

Post-Reform: 2012 Ontario Budget – commitment to

eliminate PWUs by July 1, 2012 However: PWUs prior to July 1, 2012:

Monsanto will continue to apply14

Pension Reform: Partial Wind-Ups –Grow-In Benefits

Pre-Reform: Entitlement to grow-in benefits on PWU (or full wind

up) if age + service > 55 Increases the value of an employee’s pension and can

result in employee being entitled to enhanced early retirement benefits (where not otherwise eligible)

Post-Reform: Expansion of grow-in benefits to all terminations (other

than where wilful misconduct, disobedience or wilful neglect of duty that is not trivial nor condoned)

Expansion of grow-in benefits contrary to trends of encouraging later retirement and the reduction (or elimination) of grow-in benefits in other jurisdictions

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Pension Reform: Asset Transfers, Plan Mergers & Plan Splits

Currently the PBA divides asset transfers into 2 categories: (a) asset transfer pursuant to the sale of

business (b) where assets are transferred to a new

pension plan

Superintendent consent required for asset transfer Can refuse asset transfer where transfer “does

not protect the pension benefits and any other benefits of the members and former members”

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Pension Reform: Asset Transfers, Plan Mergers & Plan Splits

Transamerica Sale of business included reps and warranties

that a merged pension plan was fully funded Merged plan required to keep assets separate

and apart as condition of merger – one of predecessor plans underfunded

Court of Appeal: “exclusivity language” in trust of predecessor plan prevented trust funds from one part of the plan being used to meet obligations in the other part

FSCO response to Transamerica: Employer required to demonstrate no trust law

impediments to merger or asset transfer17

Pension Reform: Asset Transfers, Plan Mergers , and Plan Splits

Post-Reform: Aim of reforms to clarify rules Creation of “overarching” rules for all asset

transfers Removal of requirement for employers to

demonstrate that there are no trust law impediments?

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Pension Reform: Plan Funding & Solvency

Pension plans required to be funded on: (a) “going concern basis” (b) “solvency basis”

FSCO 2011 Annual Report conclusions: 52% DB plans less than fully funded on

going concern basis; 88% less than fully funded on a solvency basis

Median solvency funded position of pension plans would “deteriorate significantly”

Demand by employers for solvency funding relief and for more funding flexibility

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Pension Reform: Plan Funding and Solvency

Solutions? Letters of credit to fund solvency deficiencies

Potentially prohibitively expensive?Not yet in force

Temporary Solvency Funding ReliefThree solvency funding relief options for

valuation dates between September 30, 2008 and September 29, 2011

2012 Ontario Budget: commitment to extend temporary solvency funding relief

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PRPPs: Background

Majority of employees in Ontario/Canada do not participate in employer sponsored retirement savings plans

Improvement of retirement security requires pension innovation

Pooled Registered Pension Plan (“PRPP”) to address fact that fewer Canadians have access to workplace pension

Intended to provide a new “low cost” and accessible retirement savings vehicle to those who do not currently participate in employer sponsored plans (i.e., self-employed and small-medium sized businesses)

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PRPPs: Legislative Status

Federal Bill C-25 – November 17, 2011 Only applies to employers/employees in

“included employment” under federal PBSA Each province to pass own enabling

legislation

Draft legislative proposals to the Income Tax Act

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PRPPs: Main Features

Bill C-25 as general rules – Regulations to provide additional details

PRPP to be a DC plan, administered by a licensed third party (as opposed to employer)

Licensing requirement for administrators Licenses to be extended to corporations,

regulated financial institutions and public pension plans?

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PRPPs: Main Features

Responsibilities of Administrator Fiduciary duties and most responsibilities employers

have under RPPs

Responsibilities of Employer Employer participation voluntary Once elect to participate have limited responsibilities:

Select plan and enrol employees Contract with administrator Collect and remit contributions Provide administrator with information required to

comply with terms of plan

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PRPPs: Main Features

Contributions Employers not required to contribute (but are entitled to) Rates of member contributions set by administrator Members may set contribution rates at 0% Employers may deduct member contributions (auto-

enrolment)

Tax Treatment Similar treatment to DC multi-employer pension plans Additional application of some RRSP rules Creation of separate category of plan known as “pooled

registered pension plan”

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The Future of PRPPs in Canada? Will the provinces adopt PRPPs?

Ontario – pension innovation should be tied to CPP enhancements; has not embraced PRPPs

Quebec – mandatory VRSPs to be offered effective January 1, 2013

Will employees and employers embrace PRPPs? Need to facilitate participation by self-employed Financial institutions willingness/ability to sell

the concept

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Target Benefit Plans: The Way of the Future?

Jury still out on PRPPs—can they provide the desired retirement income security?

Target benefit plans: aim to provide DB benefits but funded through fixed employer contributions If contributions not sufficient to provide

“target” DB benefits, accrued benefits can be reduced

TBP = “middle ground” between DB and DC plan models—the way forward?

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