Funding policy
Development of the funding policy
The person empowered to amend the plan must establish a funding policy. The policy must be reviewed on a regular basis in order to maintain its relevance. Once it has been established or reviewed, the person must sent it to the plan administrator without delay. For the purpose of carrying out its functions, Retraite Québec can, if considered necessary, demand that the policy be sent to their agency.
Plans concerned
A funding policy is required for defined benefit pension plans as well as for defined contribution‑defined benefit pension plans, in both the municipal and university sectors.
One is required particularly for target-benefit pension plans, negotiated contribution pension plans and member-funded pension plans (MFPP).
Fees
The fees related to establishing and updating a funding policy are part of the administrative expenses of the plan. Such fees are assumed by the pension fund, unless the plan text specifies otherwise.
Content of the funding policy
The purpose of the funding policy is to ensure more rigorous funding of pension plans. It provides the various parties with a better understanding of the plan's funding objectives and the risks that can affect funding.
In accordance with the Regulation respecting supplemental pension plans, the funding policy must:
- indicate that its purpose is to establish the principles related to plan funding that must guide the plan administrator in the performance of his or her duties
- describe the type of pension plan, its main provisions and the demographic characteristics that could affect plan funding
- describe the main characteristics of the employer and the employer's sector of activity that could affect plan funding
- describe the funding objectives of the pension plan with regard to variations in and the level of contributions and benefits
- identify the main risks related to funding of the pension plan and the employer's and active members' level of tolerance thereto.
The funding policy may also provide specifications with regard to any question related to the pension plan's investment goals, for example, concerning:
- the smoothing of assets, and the use of an implicit margin
- the circumstances giving rise to the reduction of a letter of credit
- the frequency of actuarial valuations not required under the Supplemental Pension Plans Act
- the measures that could be used to quantify and manage the risks related to plan funding.
The purpose of these specifications is also to provide the plan administrator with information that may be useful in the decision-making process regarding plan funding.
Employer and plan characteristics
In general, the characteristics of the employer will affect the funding of a pension plan. For example, an employer in a highly cyclical industry or in a sector in decline will usually have funding goals adapted to its sector of activity and will have a risk tolerance level lower than other employers.
Furthermore, a small-scale employer's tolerance regarding variations in contributions could be less than that of a large-scale employer due to its financial capacity to absorb a contribution hike.
Lastly, the characteristics of the plan can also affect plan funding. For example, a plan that has a closed defined benefit component or a provision regarding post-retirement indexation will encounter funding challenges that differ from those of a defined benefit plan (i.e., maturity and inflation risk).
Plan funding goals
A funding policy must determine the funding goals while taking into account the plan's characteristics, members, beneficiaries and its employer.
The following goals must be taken into consideration:
- the security and level of benefits
- the stability of contributions
- the level of contributions.
The following goals could also be taken into consideration:
- the plan's financial situation determined on a going-concern or solvency basis
- the limits imposed on the plan under the Income Tax Act
- the increase of benefits payable under the plan.
The administrator must take into account the plan's funding goals during the process of elaborating and reviewing the investment policy. In the event of a discrepancy between the policies, the various parties should discuss the funding and investment policies to ensure coherence.
Tolerance level and risks related to plan funding
The funding policy must outline the main funding risks to which to the plan is exposed. The risks are specific to each plan.
The risks may, in particular, include:
- asset-liability mismatch
- an increase in the inflation rate
- a decline in interest rates
- rising life expectancy
- a significant fluctuation in the value of the plan's assets
- currency risk
- liquidity risk.
The risks selected must be analysed based on the funding goals determined in the funding policy. For example, the employer's and the active members' tolerance level can be defined by their capacity to absorb a contribution hike.
Funding goals and production of actuarial valuations
The funding policy may provide specifications on the measures to be implemented to ensure they are consistent with the determined goals.
In particular, the specifications may refer to certain recommended limits regarding the margin for adverse deviations, the smoothing of assets, the frequency of actuarial valuations, or the circumstances giving rise to the reduction of a letter of credit.
For example, if the parties concerned determine that the stability of contributions is a priority, to ensure consistency, the funding policy could suggest a minimum level for the margin for adverse deviations, the smoothing of assets or the frequency of actuarial valuations. It could also provide details regarding a conservative approach to the potential use of surplus assets.
The funding policy can also provide for circumstances giving rise to the reduction of a letter of credit, given that the latter generates no return.
Risk quantification
The funding policy may specify the method for evaluating the risks related to plan funding.
For example, the funding policy can provide information on the steps that could be undertaken to evaluate the potential materialization of certain risks identified above, such as a stochastic study (assets/liabilities) or the use of any other method to project the plan's financial situation.
In choosing the method, the plan's financial capacity to assume the entailing expenses must be taken into account.
Annual meeting and consultation of funding policy
To ensure better transparency and understanding of the inherent risks to pension plans, the agenda of the annual meeting must contain information on the funding policy, that is, the main risks related to plan funding identified in the funding policy, as well as the measures taken to manage them.
Lastly, pursuant to the Supplemental Pensions Plans Act, eligible employees, members and beneficiaries may consult the plan's funding policy.
Legal references