The revisions affect important issues such as interest rates and commencement age.

By Ed McCarthy

Assumptions about interest rates and pension commencement dates are key factors in calculating a defined benefit plan’s commuted value (CV) — the present value of the expected benefit payments to participants. Modifying these assumptions can significantly change the CVs and the plan’s funding status. Effective Aug. 1, 2020, the Canadian Institute of Actuaries revised its standards of practice for calculating CVs. Here are the highlights:

Interest Rates

The interest rate assumption is currently calculated monthly by adding a 0.9% spread to Government of Canada bond yields.

The new spread will be capped at 150 basis points (but not less than zero) and will be based on prevailing provincial and corporate bond yields.

This change’s impact will vary, but in the current environment of low rates, the new method generally would have led to higher rate assumptions, which in turn would reduce CVs.

Assumed Pension Commencement Age

The CV calculation requires an assumption about when the participant’s monthly pension would have started if the participant started receiving the pension at the optimal retirement age.

Optimal in this definition is the date that maximizes the commuted value.

The revised standard calculation modifies that formula by assuming:

  1. There is a 50% chance the pension starts at the optimal date (the previously assumed date);, and
  2. There is a 50% chance the pension starts at the first date when the participant is eligible for a full benefit.

According to a report from actuarial firm Eckler Ltd., a plan’s early retirement provisions will determine how the changes affect commuted values: “For plans without early retirement subsidies, the change could have no impact on CVs.

“However, CVs will generally be lower under the new standards for plans with early retirement subsidies; the more generous the early retirement subsidies provided by a plan, the greater the decrease this change in assumption will have on CVs,” the report states.

“For example, if the same 45-year-old we considered above belongs to a plan with a 3% reduction to the pension for each year their retirement age precedes age 65, the revised standards could lower their CV by a further 4% to 7%,” it explains.

Implications for Plans

Analysis by Willis Towers Watson Client Advisory lists several potential implications resulting from the changed assumptions.

Besides updating pension administration systems to reflect the changes, the firms suggests sponsors should consider:

  • The new assumptions will affect the CVs paid to former plan participants. Also, the change may affect plans that use the CV basis for actuarial equivalence calculations in the administration of the plan. These calculations could include the determination of optional forms of pension, early retirement reductions and the conversion of flex accounts to defined benefit ancillary benefits.
  • The changes may reduce the solvency liabilities for pension plans with valuation dates on or after Aug. 1, 2020. There could also be an effect on funding going-concern and accounting obligations, but the impact will likely be smaller than the effect on solvency liabilities.
  • The implications for pension communications, including any disclosure of CVs in participant statements, termination estimates for active participants, and the use of the CV assumptions in retirement modeling tools.
  • Supplemental employee retirement plans (SERPs) often use the CV assumptions to calculate lump sum payouts. The CV assumptions are also sometimes used to determine SERP funding amounts or the face amounts of letters of credit used to secure SERP obligations.

Ed McCarthy is a longtime financial writer and author of three books, including “Foundations of Computational Finance with MATLAB.”