Letters of Credit

See also questions related to letters of credits under FAQs for Solvency Funding Relief Regulations, 2009

  1. Can the term of a letter of credit be for a period other than 12 months?

    A letter of credit must expire on the day on which the plan year ends. To accommodate this, the term can be for a period of less than 12 months; however, it cannot be for more than 12 months.

  2. Is the fee payable to the financial institution for securing a letter of credit an acceptable administration expense to be charged to the pension fund?

    OSFI is of the view that fees payable to a financial institution for securing a letter of credit relate to a decision of the employer on how to meet its funding obligations rather than an expense related to the administration of the pension plan. Therefore, we believe it would not be appropriate to charge such fees to the pension fund.

  3. Can the holder of the letter of credit be a different trust company from the trustee or custodian of the pension fund?

    Yes, the holder of the LOC can be different from the Trustee or custodian of the pension fund. However, the holder must be a trust company that is licensed to carry on business in Canada.

  4. Can the trust agreement required for letters of credit be an amendment to an existing trust agreement set up for the pension fund or must it be a separate agreement?

    The trust agreement may be an amendment to an existing agreement or a separate agreement. A separate or new trust agreement would be required where the holder of the letter of credit is not the same institution as the trustee, or where the current custodian for the pension fund is not a trust company that is licensed to carry on business in Canada. Where the employer is not the plan administrator, the plan administrator must be a party to the trust agreement

  5. Can two or more letters of credit be replaced with a single letter of credit with a face value that is at least equal to the total face value of the letters of credit being replaced?

    Yes.

  6. Can letters of credit be used to satisfy solvency special payments?

    Yes. Letters of credit that comply with the conditions prescribed in the Pension Benefits Standards Regulations, 1985 may be used to satisfy solvency special payments, up to a limit of 15% of the solvency liabilities of the plan as determined at the valuation date.

  7. When must a letter of credit that is used in lieu of solvency special payments be provided to the trustee? What must be its effective and expiry dates?

    In accordance with section 9.1 of the Pension Benefits Standards Regulations, 1985, a letter of credit.

    • must be provided to the trustee, on its initial issuance, at least 15 days before the day on which the first instalment of a solvency deficiency payment to which the letter of credit relates is due;

    • is effective no later than the date on which that payment is due; and

    • expires on the day on which the plan year ends.

      If the prior actuarial report's funding recommendation did not include solvency special payments, a letter of credit can be used in lieu of all solvency special payments recommended in an actuarial report filed after April 1, 2011 (up to a limit of 15% of the plan's solvency liabilities ).If the prior actuarial report's funding recommendation included solvency special payments, a letter of credit can be used in lieu of any increase in 2011 solvency special payments recommended in an actuarial report filed after April 1, 2011. Solvency special payments that were recommended in the prior actuarial report and that had to be remitted before April 1, 2011 must be paid in cash.

  8. How should a letter of credit that is included in solvency assets be treated in the calculation of the average solvency ratio?

    Situations where a letter of credit can be included in solvency assets include.

    • where it is used in lieu of solvency special payments; and
    • where the plan sponsor opts out of the solvency funding relief regulations and includes the face value of a funding relief letter of credit as a solvency asset.

    The total face value of all letters of credit included in solvency assets cannot exceed 15% of the solvency liabilities of the plan as determined at the valuation date.

    Where a letter of credit is still being used to fund a plan under the solvency funding relief regulations, it cannot be included as a solvency asset of the plan. There is already a method of considering the letter of credit by allowing the letter of credit to reduce over time by the amount that the solvency payments that were initially delayed through the funding relief regulations are paid to the pension fund.  Including the letter of credit in the solvency assets would effectively result in double-counting of that letter of credit.

    In accordance with paragraph 9(8)(d.1) of the Pension Benefits Standards Regulations, 1985, in calculating the average solvency ratio, the solvency ratios at the prior valuation date (SRt-1) and the second prior valuation date (SRt-2) shall be adjusted

    • to increase the solvency assets at the prior valuation date and the second prior valuation date by the face value of all letters of credit included in the solvency assets on the valuation date; and
    • to reduce the solvency assets by the face value of all letters of credit included in the solvency assets on the prior valuation date or second prior valuation date, as the case may be.

    In practice, this would involve

    • identifying the face value of letters of credit (FVLoC) included in solvency assets at the current valuation date (FVLoCt), the prior valuation date (FVLoCt-1) and the second prior valuation date (FVLoCt-2);
    • adjusting SRt-1 for the difference between FVLoCt and FVLoCt-1; and
    • adjusting SRt-2 for the difference between FVLoCt and FVLoCt-2.

    Cash payments made to reduce the face value of a letter of credit do not impact the previously described adjustments.  These cash payments should be treated as special payments in the calculation of the average solvency ratio, as described under paragraph 9(8)(c) of the PBSR.

    Average Solvency Ratio Calculation – Numerical Example

    The following table illustrates the calculation of the average solvency ratio where letters of credit are used:

      Prior Second Valuation Date Prior Valuation Date Current Valuation Date
      ($000s) 
    Market Value of Assets$8,300$8,300$8,300
    Face Value of Letters of Credit in Effect on the Valuation Date$150$100$200
    Termination Expense Provision($160)($160)($160)
    Solvency Assets (A)$8,290$8,240$8,340
    Calculating Adjustment Due to Special Payments:   
    Payments Made to Reduce LoC Balance Prior to Current Valuation Date (B)   
    Second Prior Year $50 n/an/a
    Prior Year$0$0n/a
    Special Payments (Includes Payments in (B) Above):   
    Second Prior Year $392 n/a n/a
    Prior Year$226Footnote 1$226Footnote 1n/a
    Present Value of Special Payments at Current Valuation Date Footnote 2(C)$618$226 
    Calculating Adjustment Due to Difference in Face Value of Letters of Credit:   
    Face Value of Letters of Credit at Current Valuation Date (D)$200$200$200
    Face Value of Letters of Credit at Valuation Date (E)$150$100$200
    Adjustment Due to Difference in Face Value of LoCs (F) = (D) – (E)$50$100$0
    Adjusted Solvency Assets (G) = (A) + (C) + (F)$8,958$8,566$8,340
    Solvency Liabilities (H)$10,000$10,000$10,000
    Adjusted Solvency Ratio (G)/(H)0.89580.85660.8340
    Average Solvency Ratio  0.8621

    Footnotes>

    Footnote 1

    Special payments required for Prior Year were $326,000. However, letters of credit were used in lieu of making $100,000 of these payments.

    Return to footnote 1

    Footnote 2

    Interest rate assumed to be 0%.

    Return to footnote 2