InfoPensions – Issue 26 – May 2022

Estimated solvency ratio results

OSFI regularly estimates the solvency ratio for federally regulated pension plans with defined benefit provisions. The Estimated Solvency Ratio (ESR) exercise assists OSFI in identifying solvency issues that could affect the security of pension benefits promised to members and beneficiaries before a plan files their actuarial report. The ESR results also help identify broader trends.

The ESR is calculated using the most recent actuarial, financial and membership information filed with OSFI for each plan before the analysis date. Assets are projected based on either the rate of return provided on the Solvency Information Return (SIR) or an assumed rate of return for the plan when no SIR has been filed. Solvency liabilities are projected using relevant commuted value and annuity proxy rates prescribed by the Canadian Institute of Actuaries. Expected contributions, benefit payments, and expenses are taken into account and an ESR based on the estimated adjusted market value of the fund and estimated liabilities is then calculated for each plan.

The solvency position of pension plans improved significantly in 2021. The median ESR for the 333 plans included in the exercise (down from 342 last year) increased to 1.09 as at December 31, 2021, up from 0.97 at the end of 2020. The liability weighted average ESR for all plans is also 1.09 as at December 31, 2021, up from 1.00 at the end of 2020. The main drivers of the increase in the ESR are higher solvency discount rates and strong investment returns in 2021. The three-year estimated average solvency ratio (EASR), on which funding requirements are based, has increased to 1.03 as at December 31, 2021, up from 0.99 at the end of 2020. The graph below shows the current and previous ESRs, median ESRs, and the three-year EASRs dating back to December 2012.

The most recent ESR results show that around three-quarters of defined benefit plans are fully funded – the first time that most pension plans have been fully funded in a number of years! There was a significant reduction in the percentage of plans that were underfunded (23% in 2021 versus 61% in 2020). The number of plans that were significantly underfunded (ESRs below 0.80) also decreased (7% in 2021 down from 15% in 2020). It should be noted that these plans are all designated plans and therefore their funding is limited by the Income Tax Regulations. The graph below illustrates the distribution of the ESR results as at December 31 of each year since 2012.

Actuarial reports – Items warranting review

Actuarial reports submitted to OSFI are generally reviewed by each plan’s Relationship Manager, who may refer the report to the actuarial team for a more detailed review.

The Instruction Guide for the Preparation of Actuarial Reports for Defined Benefit Pension Plans (Guide) sets out the reporting requirements for actuarial reports filed with OSFI. Based on the Standards of Practice of the Canadian Institute of Actuaries, it is expected that plan actuaries provide sufficient details in their actuarial report to enable another actuary to assess the reasonableness of the data, assumptions, and methods used.

OSFI would like to share with plan actuaries its expectations relating to the following item that warranted a more detailed review in some actuarial reports:

Going concern valuation – Adjustment of OSFI’s maximum going concern discount rate

In accordance with the Guide, the actuary should adjust the maximum rate for a plan using an asset mix expected to generate a lower return and may adjust the maximum rate for a plan using an asset mix expected to generate a higher return, than that obtained by using a 50% fixed-income allocation. The actuary should disclose the adjusted maximum rate in the actuarial report calculated based on the asset mix and expected return for each asset class of the plan.

Some pension plans use a target asset mix in accordance with their investment policy that includes derivative instruments for implementing risk management strategies to limit exposure to various risks related to assets and liabilities. This approach is different than a contingent immunization strategy where part of the pension fund is actively managed to potentially obtain higher returns over the immunized bond portfolio.

Generally, one of the objectives pursued by a pension plan when managing risks is to match more closely the interest rate sensitivity of the plan’s assets to that of its liabilities. A common approach is to increase the interest rate exposure of the assets by extending their duration. An overlay strategy allows a plan to achieve this objective without otherwise changing its investment holdings, including the fund’s exposure to return seeking assets such as equities.

For the purpose of adjusting the maximum rate, some actuaries use the plan’s allocation to fixed-income investments net of the overlay financing. However, this approach does not appear appropriate, as it effectively ignores the additional exposure of the plan to bonds through the overlay.

As an example, consider the following asset mix, which includes an overlay strategy used by the plan to manage duration exposures. For the purpose of adjusting the maximum rate, the allocation of 20% related to the overlay financing would not be reflected. Rather, the maximum discount rate would be based on a fixed-income allocation of 50% (60% / 120%).