frozen nest egg

This story, which was originally published May 1 in the May issue of Investment Executive, has been updated to incorporate May 7 policy changes by OSFI.

The decision by the office of the Superintendent of Financial Institutions (OSFI) to freeze transfers out of federally regulated defined-benefit (DB) pension plans is likely to lead to confusion among plan members, experts say. However, the regulator’s move was not surprising, given the stress put on these plans by the Covid-19 crisis.

Canadian DB pension plans have been battered by the decline in global equities market values and bond yields in response to the Covid-19 pandemic, according to a report by London, U.K.-based Aon PLC released in April. According to the report, the median solvency ratio for Canadian DB plans stood at 89.1% at the end of March, a drop of 13.4 percentage points since the end of 2019, when the ratio stood at 102.5%.

“In the short term, [the freeze] helps prevent a run on pensions and helps maintain their health,” says Jason Heath, managing director and certified financial planner with Objective Financial Partners Inc. in Markham, Ont. “In the medium or longer term, the risks of a pension not being able to pay future monthly benefits have increased.”

Says Trevor Parry, president of TRP Strategy Group in Ancaster, Ont., and a tax and estate planning specialist: “Some [plan members] will be greatly and adversely inconvenienced [by the freeze]. For others, there will be some anxiety, but they will get through it.” He adds that OSFI’s move is “the right thing” for the regulator to do.

On March 27, OSFI implemented a “full freeze” on portability transfers and annuity purchases in relation to federally regulated DB plans. The office said the move was meant “to protect the benefits of plan members and beneficiaries, given that current financial market conditions have negatively affected the funded status of pension plans.”

When a DB plan member’s employment ends before they retire, they typically are given the opportunity to remain in the plan or to receive the commuted value of their pension. If the member chooses not to remain in the plan, they can transfer the maximum transfer value (MTV) of their commuted value pension into a locked-in RRSP and receive the amount in excess of the MTV in cash. The member may also buy an annuity with the commuted value. DB pension providers typically set an age threshold above which a member may no longer transfer out of the plan or buy an annuity.

OSFI’s freeze, which does not affect pensions being paid to retirees, is meant to be temporary, but an end date was not announced. OSFI’s website indicates that the office “will need a better understanding of the solvency position of pension plans and evidence of some level of financial market stability before considering adjustments to the freeze.”

On March 27, OSFI also froze portability transfers and annuity purchase requests already underway, stating: “We expect plan administrators to make best efforts to keep the money in the fund and cancel payment authorizations. However, we understand that in some cases, administrative processes may be difficult to reverse, and recognize that some payments may have been processed in the days following the freeze.” (Editor’s note: The Superintendent loosened this restriction on May 7; see below.)

Lea Koiv, president of Lea Koiv & Associates Inc. in Toronto and a tax, pension, and retirement planning specialist, says OSFI should have allowed deals in progress to go ahead. “[If I had] handed in my documents, and now they say, ‘Nope, this whole thing is put on hold,’ I think that’s unjust,” she says, speaking in late April.

OSFI is permitting plan administrators to request OSFI’s consent to a transfer or annuity purchase, but such consent is contingent on the administrators demonstrating “that the proposed transfer(s) or buyout annuity purchase(s) do not unduly impact the security of the benefits of the remaining members and other beneficiaries of the plan.”

The May 7 update

On May 7, OSFI updated its guidance, announcing it would automatically consent to portability transfers to locked-in vehicles for members within 10 years of pensionable age — i.e., those eligible for early retirements — as long as the amount transferred out of the pension plan does not compromise the plan’s financial position.

“Some plans allow members who are within 10 years of pensionable age […] to transfer the value of their pension benefit out of the plan. Therefore, the portability freeze has resulted in individuals not having expected access to funds that they had planned on using for their retirement,” the OSFI website states.

OSFI also says the updated directive “will help accommodate plan members who were counting on being able to access funds, while at the same time guarding against transfers out that would impair plan solvency.”

The updated directive applies only to transfers to locked-in retirement vehicles, such as LIRAs or LIFs. Transfers to other pension plans or to purchase an annuity still require the consent of the Superintendent.

As part of the May 7 update, OSFI also indicated that any transfers to locked-in vehicles that were in process on March 27, 2020 for members who were within 10 years of pensionable age at the time their plan membership ended would be processed. However, OSFI said it expected any amounts in a plan on March 27 to continue to be subject to the freeze, save for transfers allowed with the consent of the Superintendent.

Finally, OSFI also indicated that plan administrators must process transfers on behalf of members who are eligible for early retirement.

Still entitled to benefits

Pension plan members affected by the freeze still are entitled to their pension benefits, which are calculated as of their termination date. Those members can select a commuted value option, but the transfer can’t be made during the freeze without the consent of OSFI. Once the freeze ends, a plan’s administrator can transfer the member’s commuted value pension, plus interest, out of the plan.

An OSFI spokesperson was asked in an email from Investment Executive if the office would extend commutations for members younger than the pension threshold age if those plan members are terminated from their job, yet will be older than the threshold age once the freeze lifts. An OSFI spokesperson replied: “Entitlement to benefits [is] determined as at the date of the cessation of [plan] membership. If the member was entitled to a commuted value at that time, they will remain entitled to take their commuted value once the portability freeze has been lifted.”

OSFI made other moves to support pension plan administrators, including extending deadlines for certain filing requirements. And in early April, the Actuarial Standards Board, a body set up by the Canadian Institute of Actuaries, announced that a new commuted value calculation standard, which was to be effective on Aug. 1, would be delayed to no earlier than Dec. 1.

So far, none of the provinces except Saskatchewan has announced a similar temporary freeze on transfers from provincially regulated DB plans. However, provincial pension legislation typically includes rules relating to plan solvency that limit amounts that may be transferred out.

For example, the Financial Services Regulatory Authority of Ontario (FSRA) issued guidance in March indicating that if the “transfer ratio” of a plan falls by 10% or more, the plan administrator “shall not transfer any part of the commuted value of a pension, deferred pension or ancillary benefit to which a member or former member is entitled without obtaining FSRA’s prior approval.”

“It’s getting exceedingly difficult to commute a pension,” Koiv says.

Heath suggests that there are three probable factors that contributed to OSFI’s decision to impose the freeze.

The first is the low interest rate environment, which means that commuted values’ calculations are relatively high. “[As a pension plan member], you need to get a larger [commuted value] payment in order to replicate your future pension,” Heath says. “Right now, arguably, interest rates are artificially low, and commuted value payouts are artificially high.”

The second factor is the drop in equities markets’ valuations, which means plan administrators would have to sell assets that have fallen significantly in value to pay out the larger commuted value transfers. Administrators would then face the prospect of having to top up shortfalls in the pension plan, all while the plan sponsor may be undergoing financial difficulties itself.

(On April 15, the federal government announced a moratorium for the rest of 2020 on solvency payment requirements for federally regulated DB plans.)

Finally, with potentially more employees losing their jobs or taking early retirement, a freeze on pension plan withdrawals decreases the likelihood of a run on the plan.

“I can see why pension plans would be hesitant to write big cheques to people who want to take money out of the pension [plan],” Heath says.

OSFI’s decision may cause difficulty for members leaving the plan who would have received a partial cash payout as part of commuting their pension, particularly if these people are facing immediate liquidity challenges.

“I’d hate to be in that situation,” Koiv says. “But hopefully [the economic fallout of] Covid-19 won’t last so long that people [are] making decisions based on a ‘black swan’ event.”

Says Parry: “We’ll come out of this. But how long [will it be] until the pension [solvency ratios] are back to where they need to be?”

Koiv says that in general, she’s “not a big fan” of taking a commuted value of a pension in cash, which is taxable as income in the year it’s received.

“By taking the amount out, you have a phenomenal tax bill,” Koiv says, “and when you look at longevity and the volatility of investments, you might not have enough money to get you [through retirement].” De- pending on the circumstances, purchasing an annuity or remaining in the plan may be better options, she says.

Parry says that while he agrees with OSFI’s decision to temporarily freeze transfers, he believes the current difficulties faced by plan administrators and members should ignite a policy debate once the crisis passes about the role of DB plans in the broader Canadian pension landscape.

“Demographics and the simple metrics that govern pensions on the plan member side [aren’t] positive for the long-term survival of DB plans,” Parry says.