Is it time to develop your funding policy?
By Shawn Wilcox
Insights – March 2021
All views expressed are the author’s own and do not necessarily reflect the official position of any agency, organization, plan sponsor or company.
Atypical, unheard of, unprecedented. We heard these words a lot to describe the past year. It certainly was all of those things for many around the world who struggled with the social and economic impacts of COVID-19. On the business side of things, turbulence in global financial markets caused by the pandemic has resulted in significant volatility in the funded position of many defined benefit pension plans, reminding us of the funding risk inherent in these arrangements. Risk –for single-employer pension plans – is borne by the employers who sponsor them, as they generally assume responsibility for the funding of shortfalls. To add fuel to the fire, ongoing disruptions in day-to-day operations have impacted cash flow for many plan sponsors, leaving them further challenged to meet their funding obligations. While it appears vaccines will get us through our current predicament and bring relief for both people and global economies, we live in a world full of risk and uncertainty, and having a well-planned roadmap to guide us is the best way to manage these risks.
In fact, a growing number of Canadian jurisdictions now require defined benefit pension plan sponsors to adopt a formal funding policy to guide funding decisions and manage risk to ensure that members receive their promised benefits. While Ontario was one of the more recent jurisdictions to adopt the requirement, legislation will not be proclaimed into force until regulations specifying content requirements are released. We know the regulations will be coming eventually, and when they do, your funding policy will need to be filed with the Financial Services Regulatory Authority.
What should be included in your funding policy?
A funding policy is one more brick in the wall, that, along with your other established pension policies, supports the overall governance structure and processes that provide the blueprint for plan operations and safeguard members’ pension benefits.
The funding policy guides the orderly accumulation of assets in the pension fund to pay all pension benefits and related expenses. It is therefore tied closely to a number of your other pension policies including your benefits policy, expense policy and, most important, your investment policy. Your funding policy, which impacts the amount and timing of your contributions, and your investment policy which specifies how your contributions will be invested and your return expectation for the pension fund, should function like two wings, working together to deliver the promised pension benefits.
Your funding policy should clearly articulate your funding objectives and establish a set of guidelines to help you make funding decisions in both good times and bad times. Your funding policy should also provide a risk management framework to assist you in monitoring and managing the risks facing your plan. The level of conservatism incorporated into a funding policy will directly impact the amount and timing of contributions, the plan’s dependency on the financial strength of the plan sponsor and ultimately, the security of members’ pension benefits. Once implemented, your funding policy should be reviewed on a regular basis and updated as necessary to ensure it remains effective and continues to support your funding objectives.
Not all pension plans are the same and the contents of your funding policy should reflect the specific circumstances of your plan. Typically, a funding policy would:
- summarize the plan characteristics that impact funding;
- describe any characteristics of the plan sponsor or of the industry sector in which the plan sponsor operates that may be relevant to funding;
- explain the different funding roles of the plan sponsor and plan administrator;
- document the funding objectives of the plan sponsor and any target funded ratios;
- detail the plan sponsor’s approach to funding deficits and the intended use of funding excess;
- identify the key risks faced by the pension plan, the tolerance to these risks and the tools available to the plan sponsor for monitoring and managing risk;
- provide guidance for the selection of actuarial assumptions and methods, and for the frequency of actuarial valuations; and
- address the review and maintenance of the funding policy itself.
What are the benefits of having a funding policy?
A funding policy is simply a fundamental part of good pension plan governance. A well-documented funding policy will provide clarity to all stakeholders regarding your funding objectives, will promote disciplined decision-making, and increase the likelihood of realizing these objectives. Identifying the key risks facing your pension plan will nurture deeper understanding by decision-makers, leading to better management of risks that might otherwise impair your ability to achieve your funding objectives. Sharing aspects of your funding policy with plan members may foster a greater understanding of the many considerations that go into funding their pension plan. It may also reassure plan members, especially during times of economic uncertainty, that those pension risks are being prudently managed and their pension benefits are secure.
Is this something that should be started on now or would it be better to wait until we know exactly what the Ontario content requirements will be?
From a compliance standpoint this isn’t something that needs to be completed right away. However, depending on how much (or how little) has already been documented about your approach to funding and managing risk, it could take some time to develop your funding policy.
In terms of content requirements, the prescribed content is similar from jurisdiction to jurisdiction for those that already require funding policies, echoing many of the best practices outlined in the CAPSA Pension Plan Funding Policy Guideline (Guideline No. 7).1 As such, it is unlikely that we will see any significant departure in content requirements when the regulations in Ontario are ultimately released.
Now may be a good time to gather any internal documentation that you may have already developed, review the CAPSA Guideline, and begin the process of filling in any gaps. Getting an early start on this process will provide you with an opportunity to develop a well-constructed and useable document that will help you in making those all-important funding decisions – especially in unprecedented times like these.
1 In November 2020, an updated version of the CAPSA Guideline was released for industry consultation. The draft revisions reflect the evolution in pension plan design and minimum standards legislation since the guideline’s original release in 2011.
This issue of Insights has been prepared for general information purposes only and does not constitute professional advice. Should you require professional advice based on the contents of this notice, please contact an Eckler consultant.