While the Pension Investment Association of Canada is generally supportive of British Columbia’s proposed solvency funding framework, when it comes to requirements around funding the provision for adverse deviations, the organization is suggesting B.C. takes a page from Ontario and Quebec.

With many governments across Canada looking to make defined benefit plans more sustainable, the B.C. government launched a consultation on solvency funding reform in October 2018. And in August 2019, it released a report on the stakeholder committee process.

In the report, the provincial government highlighted its proposals, including requiring solvency funding levels of 85 per cent in addition to enhanced going-concern funding through the requirement of a funding cushion, known as a PfAD, which is intended to reduce contribution volatility.

The proposal also included details about how plans can determine their PfAD funding requirements. For example, it suggested the PfAD size should be based on the long-term Government of Canada benchmark bond yield as of the plan’s valuation date.

“A PfAD should be based on the main risk that most DB pension plans are exposed to but cannot control, which is interest rate risk,” the report said. “As this is reflected in long-term bond rate risk, a PfAD should become larger as the LTBR and its associated risks increase and smaller as the LTBR and its associated risks decrease.”

It also highlighted some differences to PfAD funding requirements based on a plan’s asset mix. Specifically, if a plan has less than 30 per cent exposure to asset classes besides traditional fixed income investments, it suggested the PfAD should be adjusted.

The report also recommended the PfAD be simplified to avoid influencing investment strategy. “Plans may choose to take on numerous risks other than interest rate risk, such as market risk, equity risk, duration mismatch risk, fixed income default risk and liquidity risk. Trying to develop factors for a PfAD that take into account these risks would be unwieldy. In addition, many plan sponsors would adopt innovative investment strategies to avoid PfAD funding requirements.”

In a letter sent this week to B.C.’s ministry of finance, the PIAC suggested the PfAD determination be more closely linked to plan asset allocation, as is the case in Ontario and Quebec.

Although B.C.’s proposed approach would work for average plans in normal rate environments, the PIAC said linking this more closely to asset allocation would be more robust for plans with broader asset allocation and in low interest rate scenarios.

“While we appreciate the committee’s desire to have the PfAD adjust with interest rates as a stabilizing mechanism, we do not believe that the regulatory funding requirements should be neutral to asset allocation,” the letter said. “A standardized PfAD based mainly on long-term bond yields at the valuation date may prove be too conservative for substantially de-risked plans in some scenarios (e.g., in higher interest rate environments) and conversely less conservative for plans with a higher allocation to ‘risky assets’ in other scenarios (e.g., very low interest rate environments).”

The letter also noted that linking the PfAD determination more closely to asset allocation would be consistent with the approach to regulatory capital in the financial sector, which usually distinguishes based on overall balance sheet risk.

“In the context of your proposals, a tighter link could potentially be achieved by adjusting the scalar factor on non-fixed income securities across a broader range of allocations, or linking the PfAD to a plan’s going-concern discount rate which implicitly incorporates asset allocation as well as interest rate levels,” it said.

Overall, the PIAC is broadly supportive of B.C.’s proposed solvency funding framework, including its recommendations for funding requirements, contribution holidays, letter of credit usage, amortization periods and the integration with reserve accounts.

In its letter, the association urged the government to move forward as soon as possible. “The decline in the long-term bond yields this year may well lead to greater pressure on solvency funding requirements for plan sponsors in the near-term so timely implementation is critical.”