Pensions &

Benefits
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Pension Pulse
PENSIONS & BENEFITS E-BLAST

Federal Government Tweaks Pension Solvency Funding Rules and

Investment Limits

On May 3, 2010 the federal Department of Finance introduced draft regulatory amendments to the
federal Pension Benefits Standards Act (1985) (“PBSA”), concerning solvency funding requirements and
quantitative investment limits. The draft regulations have been released for public comment up until
May 28, 2010.

The changes to the solvency funding requirements would affect federally-registered defined benefit
pension plans, namely, those pension plans whose funding is subject to the federal PBSA. The changes
to the investment limits would affect most registered pension plans in Canada, the reason being that the
pension legislation in most provincial jurisdictions adopts the federal PBSA investment rules.

Solvency Funding Changes

The primary proposal by the government is to introduce a form of solvency averaging so as to reduce
volatility inherent in the current rules, attributed to market conditions and changes in interest rates.
Under the proposed rules, solvency funding would be calculated based upon a three-year average
solvency deficiency. In this manner, the impact of a spike in a solvency deficiency in a particular year
will be smoothed.

In addition, the government has proposed the use of a 5% solvency margin before a plan sponsor would
be entitled to take a contribution holiday. This means that a plan’s solvency ratio, or the ratio of a plan’s
market value of assets to its solvency deficiency, would have to be at least 1.05 in order for a plan
sponsor to discontinue its current service contributions.

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Investment Limit Changes

The investment regulations under the federal PBSA contain a number of quantitative limits, viewed by
most in the pension investment community as outmoded and unnecessary. There are five such investment
limits on the investment of a pension fund’s assets:

r the number of shares of an entity to which are attached more than 30% of the votes that may be cast to elect the entity’s directors
r 10% of the book value of the pension fund’s assets in any one entity
r 5% of the book value of the pension fund’s assets in a single parcel of real estate or Canadian resource property
r 15% of the aggregate book value of the pension fund’s assets in Canadian resource properties
r 25% of the aggregate book value of the pension fund’s assets in real estate and Canadian resource properties.

The government is proposing to eliminate only the 5%, 15% and 25% limits. The 30% and 10% limits would
remain. While the government announced that it intends to propose further modifications to the 10% rule, it
confirmed that it will not be changing the 30% limit. According to the government’s impact analysis statement,
the 30% rule “remains appropriate at this time for prudential reasons.”

Comments

The proposed changes to the solvency funding rules, through the smoothing of solvency deficiencies, are
salutary. A significant concern with the current regime has been the volatile nature of the solvency funding
requirements, as market returns and prevailing interest rates go up and down.

The government considered extending the five-year funding of solvency deficiencies to ten years, but
decided that this would not fairly balance the interests of plan members and plan sponsors. In the
government’s view, the three-year smoothing would represent a better balancing of interests, which is
always a challenge with pension plan regulation.

The requirement for a 5% “solvency cushion” in order to permit plan sponsors to take contribution holidays
is not unlike other jurisdictions’ concept of a provision for adverse deviation. The 5% cushion would not
have to be factored into solvency funding requirements. A plan sponsor with a pension plan solvency ratio
of at least 1.00 but less than 1.05 would still be required to make current service contributions.

With regard to the pension investment limits, the proposed changes are disappointing. The quantitative
limits are outmoded in a modern investment regime that places more weight on fiduciary duties and the
prudent person standard. While many in the pension investment community had hoped that all of the
quantitative limits would be eliminated, this was perhaps too much to hope for in this round of regulatory
changes.

If you would like assistance with drafting a submission to the federal government on its proposed changes,
please contact any member of the National Pensions and Benefits Group.r

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Mark Newton is a partner in Heenan Blaikie’s Toronto office and chairs its national Pensions & Benefits
practice. He has over 25 years of experience in pensions and benefits.

As a member of our firm’s Labour and Employment group, Mark handles all aspects of pensions and benefits
law, including governance, regulatory compliance, collective bargaining, litigation, due diligence, mergers
and acquisitions, financing agreements, bankruptcy and insolvency, and the tax aspects of compensation,
pensions and benefits.

The National Pensions & Benefits Group Includes:

Toronto
Mark Newton 416 643.6855 mnewton@heenan.ca
John Craig 416 360.3527 jcraig@heenan.ca
Jodi Gallagher 416 360.3555 jgallagher@heenan.ca
Peter Clark 416 360.3543 pclark@heenan.ca

Montreal
Robert Bonhomme 514 846.2260 rbonhomme@heenan.ca
Robert Dupont 514 846.2314 rdupont@heenan.ca
Troy McEachren 514 846.2319 tmceachren@heenan.ca
Frédéric Massé 514 846.2386 fmasse@heenan.ca

Vancouver
Andrea Zwack 604 891.1161 azwack@heenan.ca
Peter Gall 604 891.1152 pgall@heenan.ca
Jillian Frank 604 891.1160 jfrank@heenan.ca

Calgary
Robb Beeman 403 261.3452 rbeeman@heenan.ca

Ottawa
Sébastien Lorquet 613 236.1327 slorquet@heenan.ca
Judith Parisien 613 236.4673 jparisien@heenan.ca