Flexible Pension Plans

The OSFI policy on flexible pension plans has been developed with two goals in mind. First, we do not want to discourage the introduction of new defined-benefit products. Second, we want to harmonize our policy with the CAPSA Task Force recommendations, developed in co-operation with the Canadian Institute of Actuaries.

Flexible provisions may be defined as:

• an additional voluntary type contribution,
• not necessarily subject to the 50% rule,
• requiring the return of member contributions as necessary under common law fiduciary standards, and
• not necessarily locked-in.

In addition, the plan must specify how the flexible accounts are invested. The actuarial valuation must be done on a reasonable basis that is acceptable to Revenue Canada and to OSFI, and the flexible benefit transfer value payable from the plan should be an amount equal to the lesser of the value of the flexible contributions account and the maximum permitted by Revenue Canada.

Classification - Additional Voluntary Contribution (AVC)

If a pension plan provides for flexible contributions and benefits by allowing optional member contributions that do not give rise to an obligation on the employer to make additional contributions, these contributions may be regarded as AVC-type contributions under the PBSA. Where the employer supplies a portion of the flexible contributions, the plan provisions should clearly specify what is being offered, who carries the costs and under what conditions, if any, and how the flexible contributions and benefits are classified.

50% Rule - Application of Subsection 21(2)

If the plan provides for flexible contributions as AVC-type contributions, no application of the 50% rule would be required under the Act. Clearly, the plan may provide for the application of the 50% rule on the aggregate basic and flexible contributions/benefits.

The intent of subsection 21(2) is to protect members from misrepresentation that the sponsor is providing pension benefits in cases where the benefit in fact may be fully or mostly funded by member contributions. If the flexible benefits are clearly promised only to the extent that the member contributions can buy, or a certain cost sharing arrangement is specified up front before the member chooses the additional flexible pension benefit option, there appears to be no need for the protection of the 50% minimum cost rule.

Forfeitures - Application of Subsection 21(1)

Subsection 21(1) of the PBSA specifies that the value of a defined benefit must be at least "the aggregate of the member's required contributions together with interest" (non-forfeiture rule). Only if the flexible contributions are specified as required contributions in the plan provisions must this subsection of the PBSA be applied. Clearly, the plan may provide for the application of the non-forfeiture rule on the aggregate of basic and flexible provisions. It is the plan sponsor's responsibility to ensure that common law fiduciary standards are met. Here, the plan sponsor may consider options such as a guarantee of the return of member contributions from outside the pension fund.

Also, protection from misrepresentation must be provided through full, up-front disclosure that, in certain circumstances, the members may not receive the full value of their own contributions and that they may end up subsidizing the employer basic benefit costs.

Locking-in

Under the Revenue Canada Newsletter 96-3, flexible contributions are effectively "locked-in" as long as the basic benefits remain in the plan. Since the flexible contributions can be defined as AVC-type contributions under the PBSA, the locking-in requirements do not have to apply to them if that is the way the plan sponsor wishes to provide. In effect, a pension plan may offer a terminating plan member portability for the aggregate benefit (basic + flexible), and the member will have to exercise this portability in order to receive an un-locked flexible benefit. The member will receive the locked-in basic benefit and the flexible benefit, which may be un-locked at that point. If the member chooses to collect his pension directly from the plan, his flexible benefits will be paid directly from the plan in the form of enhanced locked-in pension benefits.

If the plan provides for un-locking of the flexible benefits through portability, members and their spouses must be clearly informed that the un-locked portion of the benefit will then cease to be protected by the PBSA, i.e., the un-locked benefit becomes cash that is accessible to creditors, and will be excluded from spousal claims on marriage breakdown and on member's death.

Investments

The assets connected with flexible contributions may be invested together with the basic plan fund or kept separate with alternative investment strategies as defined by the plan. The plan and member disclosure should specify clearly who makes the investment decisions, who carries the return risks, and return rate implications on the flexible benefit amounts and on potential forfeiture amounts.

Valuation

Funding of a plan, including flexible benefits, must follow the CIA and PBSA standards and guidelines. Revenue Canada also has specific requirements in this regard.

We expect that the valuation of flexible benefits relate closely to flexible contributions, in reference to specific members and the whole plan, to avoid gains to the plan. We also expect plans to design flexible provisions so as to minimize the risk of forfeitures of member contributions, and to allow immediate changes to members' flexible contributions when members' best interests so require.

Flexible contributions and benefits must be identified as a separate item in the actuarial valuation reports and balance sheets, and flexible contributions must be included in the financial statements and AIRs filed with OSFI.

The CIA is currently developing an actuarial basis that can be required for converting flexible contributions to flexible benefits. In the interim, the funding basis, the current CIA transfer value basis, smoothing of the current CIA transfer basis, or other reasonable basis that is acceptable to Revenue Canada, will be acceptable under the PBSA.

Transfer Values

When a member elects a transfer of the basic and flexible benefits, the minimum transfer value in respect of the flexible benefit should be an amount equal to the lesser of the value of the flexible contributions account and the maximum permitted by Revenue Canada.

Full Disclosure

Accurate and clear member disclosure is the responsibility of the plan administrator. Members must be well informed to enable them to make an educated decision whether the flexible plan provisions are beneficial to their own individual circumstances. Plan administrators may wish to make a member specific "contract" with each member who wishes to participate in the flexible plan provisions to demonstrate prudent disclosure. In addition, plan administrators should carefully consider their legal liability in providing information about the flexible pension option versus financial advise and counselling.

The initial member information package/contract and/or member annual statements should specify at least:

• that flexible contributions are optional,
• who pays for the flexible benefits,
• what cost sharing arrangements are provided (if no cost sharing, members must be clearly informed that they carry the full cost of the flexible benefits),
• that in certain circumstances, the members may not receive the full value of their own contributions (include examples), and they may end up subsidizing the employer costs,
• that the protection of the PBSA does not apply where the 50% or the non-forfeiture rules are not applied,
• who makes the investment decisions, who carries the return risks,
• implications of high/low return rates on the flexible benefit amounts and on potential forfeiture amounts,
• members and their spouses must be clearly informed that unlocked flexible benefits will cease to be protected by the PBSA, i.e. the un-locked benefit becomes cash that is accessible to creditors and will be excluded from spousal claims,
• examples of flexible benefit options and their costs to various member profiles,
• the benefit conversion basis, and
• member specific forfeiture risk information annually.

Since flexible pension provisions are new in the market and driven by Income Tax Act considerations, OSFI does not have a clear picture, at this point in time, what these products may entail. This policy has been developed so as not to discourage flexible benefits, but we reserve the right to review and revise this policy if the best interests of plan members and the pension industry so require. OSFI has not seen many plan amendments for flexible provisions and does not contemplate a change to the PBSA or to the regulations to accommodate flexible provisions at this point in time. This policy has been developed with view of harmonizing with the CAPSA/CIA Joint Task Force recommendations to the extent possible without legislative changes.