Five Years Later: Annuity Buy-Out Transactions under the Ontario Pension Benefits Act
This Sidebar updates our June 20, 2018 Sidebar, “Ontario Pension Benefits Act Amended to Provide a Discharge for Buy-out Annuity Purchases Effective July 1, 2018”
After years of significant and prolonged funding deficits, many single employer defined benefit (“DB”) pension plans are now well funded. As a result, de-risking of DB plans has become an important topic for Canadian employers and pension plan administrators, and the use of “buy-out annuities” has become an attractive de-risking strategy. In this Sidebar, we provide an overview of the statutory discharge rules that apply to Ontario registered pension plans when they complete buy-out transactions covering Ontario former members, retirees, and surviving spouses. We also set out below a number of factors that are important to consider when preparing for and proceeding with a buy-out annuity transaction.
Background
Very generally, a buy-out annuity purchase is a transaction where an authorized insurance company assumes the obligation to provide pensions to certain former members, retired members or surviving spouses from an ongoing DB pension plan in exchange for a premium payment from pension fund assets.[1] Although the Ontario Pension Benefits Act (the “PBA”) has permitted plan administrators to purchase buy-out annuities for ongoing plans for many years, a statutory discharge regime has only been in effect since July 1, 2018.
Once a discharge is obtained by the plan administrator, the relationship between the plan and the former members, retired members and/or surviving spouses for whom annuities were purchased, is essentially severed. The plan administrator is no longer required to treat these underlying pension obligations as a continuing plan liability for purposes of actuarial valuations, plan financial statements and Pension Benefits Guarantee Fund assessments. Furthermore, the pension plan administrator is released from the obligation to make future benefit payments to these individuals. Plan administrators for single employer pension plans registered in Ontario are eligible for the statutory discharge in respect of a buy-out annuity purchase if the conditions set out in section 43.1 of the PBA and O. Reg. 193/18 (the “Annuity Regulation”) are satisfied. Notably, no discharge is available under the PBA in respect of annuity purchases for active plan members. Plan participants included in the buy-out transaction also benefit from the security provided by Assuris, which is a compensation body that provides protection to Canadian policyholders in the unlikely event that a covered insurance company fails. In 2023, Assuris enhanced its coverage and now protects up to $5,000 per month or 90% of monthly annuity payments, whichever is higher. Annuity transactions may be structured to maximize Assuris coverage.
Discharge for Buy-Out Annuity Purchases made on or after July 1, 2018
The PBA and Annuity Regulation set out specific detailed criteria that must be met in order for a plan administrator to obtain a discharge for a buy-out annuity purchase that is made on or after July 1, 2018. A high-level summary of these requirements is set out below.
- Notice to Affected Individuals
The administrator must provide former members, retired members and spouses[2] for whom annuities were purchased with notice of the annuity purchase in accordance with the requirements of the Annuity Regulation. Advance notice prior to completing the annuity purchase is not required. The content of the notice varies depending on whether the annuity purchase is in respect of a former member, retired member or a spouse. Notice requirements include, among other things:
- a statement that the administrator has purchased the individual’s pension and ancillary benefits, if applicable, from an insurance company and that benefits will remain the same;
- basic information about the insurance company from which the annuity was purchased, including contact information, the policy number, the date of the purchase, and the annuitant’s individual certificate number;
- for former members, the amount of the pension and ancillary benefits a former member is entitled to receive upon early, normal and postponed retirement dates;
- a statement that the administrator intends to file a certificate prepared by an actuary pursuant to the PBA to seek a discharge in respect of the buy-out annuity purchase (discussed below);
- a statement that, if the administrator is discharged, the annuitant will no longer be a former member or retiree under the plan, as applicable, except in certain circumstances where the plan is wound up and has a surplus; and
- a statement regarding the rights of the former member or retired member to surplus in the event that the plan is wound up.
The administrator’s statutory notice obligations are in addition to welcome/onboarding communications provided by the insurer.
- Same Benefit
The annuity purchased from the insurance company must provide the same benefit as the former member, retired member, or spouse (as applicable), would have received from the pension plan had the annuity purchase not been made.
In its November 2023 pension update, the Financial Services Regulatory Authority of Ontario (“FSRA”) noted that it has identified errors when reviewing annuity contracts (e.g., contracts not including portability rights for former members at wind-up or the ancillary benefits and indexation provisions (if any) not matching the plan terms). To help identify compliance issues, FSRA announced that starting in 2024, it will be requesting a copy of the Request for Proposal (“RFP”) or Request for Quotation (“RFQ”) document provided to the insurer as part of the annuity purchase process so that it can assess whether the plan terms are properly reflected in the annuity purchase.[3] The RFP or RFQ allows an insurer to determine its pricing for the annuity. FSRA notes that if the filed annuity contract sets out the plan provisions that must be adhered to, there is no need to file a separate copy of the RFP or RFQ.
- Content of the Annuity Contract
The annuity contract must, among other things, incorporate provisions of the PBA in respect of non-alienation of benefits, spousal priorities, division of pensions on marriage breakdown, portability at wind-up and death benefits. The annuity contract must also require the insurer to issue to each annuitant a certificate of insurance confirming the annuity purchase.
- Funding Requirements
The Annuity Regulation imposes minimum funding requirements, which are designed to ensure that a buy-out annuity purchase does not erode the security of benefits for the pension plan members, retirees and spouses for whom no annuity purchase is made. In short, these funding requirements are to ensure that:
- if the most recently filed actuarial valuation report before the buy-out annuity purchase shows the plan’s solvency ratio[4] is at least 1.0, then it must be at least 1.0 after the annuity purchase; and
- if the most recently filed actuarial valuation report before the buy-out annuity purchase shows a plan’s solvency ratio is less than 1.0, then it must be the greater of 0.85 or the solvency ratio in the report after the annuity purchase.
If the solvency ratio of the pension plan on the day after the date of the buy-out annuity purchase is less than the required solvency ratio, the employer has 90 days to top up the pension fund to meet the requisite funding status.
- Maintenance of Records
The Annuity Regulation also imposes record retention requirements relating to the purchase. The administrator must retain certain information including: the date of the purchase, details about the insurance company, the name and address of all annuitants, and all records necessary to determine the pension, deferred pension and ancillary benefits, if any, that would have been payable to each annuitant under the pension plan.
Discharge for Buy-Out Annuity Purchases made prior to July 1, 2018
Buy-out annuity contracts that were entered into prior to July 1, 2018 will also qualify for a discharge under section 43.1 of the PBA provided that the requirements of the PBA and Annuity Regulation are met.
In relation to past transactions, the PBA and Annuity Regulation generally require that the old transaction be brought into compliance with the new rules in order for the administrator to benefit from a statutory discharge. Annuities must provide the same benefits that were provided for under the plan, notices that meet prescribed requirements must be distributed to affected retirees, former members and spouses, and specified funding criteria must be met. The annuity contract is also required to satisfy all of the same content requirements that apply to buy-out annuities purchased after July 1, 2018. If an annuity contract is amended to meet the requirements of the Annuity Regulation and requires an additional premium, the funding requirements outlined above must be met after the date of the amendment; if no amendments to the annuity contract are required, the solvency ratio of the plan must be at least equal to 0.85 in the most recently filed actuarial valuation report before the date the annuity certification from the actuary is filed.
Filings to Obtain a Discharge under the PBA
There is no formal approval process for obtaining a discharge after purchasing buy-out annuities. Instead, the plan administrator is provided a discharge under the PBA upon filing with FSRA a certificate prepared and signed by an actuary certifying that the administrator has complied with the requirements of the PBA and Annuity Regulation. The administrator must also file a copy of the annuity contract, and a listing of the affected former members, retired members and spouses, as applicable.
Once the discharge is obtained, the individuals for whom the purchase was made are no longer considered former members, retired members or spouses, as applicable, for any purpose under the PBA, except in respect of surplus entitlement. If the pension plan is later wound up and has a surplus, the individuals for whom the annuity purchase was made will have the same rights to payment of surplus as they would have had if the pension plan was wound up on the date the purchase was made.
Transaction Considerations
The following points are important to consider when preparing for and completing a buy-out annuity transaction:
- Data Hygiene
When a buy-out annuity purchase is being considered it is important to ensure that the administrator has current and accurate data for the individuals for whom annuities are being purchased. Accurate data is critical to a smooth completion of the buy-out transaction.
- Corporate Accounting Implications
How the buy-out annuity transaction will be reflected in accounting financial statements of the company is important to understand. In jurisdictions where a discharge is available (and in some cases even where a discharge is not available), a buy-out transaction will have profit and loss (“P&L”) implications.
- Timing and Resources
The pricing of annuities depends on a variety of factors and it is important to engage an annuity purchase consultant early in the process. An annuity purchase consultant will typically assist with obtaining attractive annuity purchase pricing. A plan administrator should also consider the process for making the premium payment to the insurer (e.g., do any investments need to be liquidated?), and build this process into the transaction timeline. Transferring the obligation to make benefit payments involves a significant amount of work by the plan administrator, including the transfer of data on annuitants’ pension entitlements, contact information, payment details, spouses, and beneficiary designations.
- Multi-Jurisdictional Considerations
For buy-out annuity transactions that involve former members, retired members and spouses who were employed in provinces other than Ontario, plan administrators (i) need to consider whether multi-jurisdictional considerations will impact their ability to obtain a full discharge, and (ii) ensure all applicable legislative and regulatory requirements are met. In addition to Ontario, the provinces of British Columbia, Quebec, New Brunswick and Nova Scotia also provide a statutory discharge for annuity purchases made in connection with ongoing pension plans, which are similar to the PBA but, of course, include differences on a jurisdiction-by-jurisdiction basis. Buy-out annuity discharge rules have been introduced under the Federal and Saskatchewan pension standards legislation but are not yet in force.
- Indexing
Indexing can complicate the annuity purchase process and a plan administrator should understand the indexing provisions in its plan and how they may impact the transaction.
- FSRA Guidance
FSRA has released new or updated guidance for plan administrators in a number of areas relevant to annuity buy-out transactions. For example, FSRA’s [soon to be updated] guidance on Pension Plan Administrator Roles and Responsibilities discusses a plan administrator’s fiduciary duties and FSRA’s guidance on Information Technology (“IT”) risk management addresses information technology considerations when outsourcing. When read together, these two guidance documents are informative as to the diligence and contractual protections that a plan administrator should consider when selecting a service provider, including an insurance company in the context of an annuity buy-out transaction.
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While the focus of this Sidebar is on compliance with the PBA requirements for a buy-out annuity discharge, pension plan administrators also need to ensure that the requirements of the Income Tax Act are satisfied and that the administrator’s general fiduciary obligations are met through the annuity purchase process.
If you have any questions regarding this update, please do not hesitate to call any of us – we’re here to help.
[1] A “buy-in annuity” is an arrangement under which the insurer makes guaranteed payments to the pension plan and the pension plan retains administration and payroll responsibility. The purchase of a buy-in annuity is considered an investment of the pension plan. There is no discharge available to plan administrators for the purchase of a buy-in annuity.
[2] Spouses include surviving spouses in receipt of a pension for whom annuities are purchased, and spouses entitled to a payment from a plan due to a division of property on a marriage breakdown for whom annuities are purchased.
[3] The RFP or RFQ is a document prepared at the beginning of the annuity transaction process that outlines the pension plan provisions and anonymized data on the group of members for whom the annuities will be purchased.
[4] To determine the solvency ratio for the purpose of the funding threshold, solvency assets include letters of credit held in trust for the pension plan.
This Sidebar client update provides general information and should not be relied upon as legal advice. This publication is copyrighted by Brown Mills Klinck Prezioso LLP and may not be reproduced in whole or in part in any form without the express written consent of Brown Mills Klinck Prezioso LLP. ©
