Underfunded Defined Benefit Pension Plans

  1. Are defined benefit pension plans allowed to operate in an underfunded (or deficit) position?

    Yes. Federal pension legislation allows a defined benefit pension plan to operate in an underfunded or deficit position. Being in an underfunded position means that the plan’s liabilities (i.e. the present value of all current obligations to pay benefits to members) exceed the plan’s assets.

    Administrators of defined benefit pension plans must submit actuarial reports to OSFI indicating the funded status of the plan under two different assumptions:

    1. that the plan will be ongoing (this is called a going concern valuation) and
    2. that the plan terminated on the date of the actuarial report (this is called a solvency valuation).

    OSFI has the authority to ask for actuarial reports at any time and most underfunded plans are required to file actuarial reports annually.

    If either the going concern valuation or the solvency valuation indicates that a plan is underfunded, the employer must fund the shortfall by making special payments into the plan. The going concern shortfall must be paid to the plan by making equal annual payments over no more than 15 years. Required solvency special payments may be offset by the use of Letters of Credit, which are held in trust for the pension plan, subject to a maximum of 15% of the plan’s solvency liabilities.

  2. Why are defined benefit pension plans allowed to operate in a deficit position?

    The Pension Benefits Standards Act, 1985 (PBSA), recognizes that defined benefit pension plans may, at times, find themselves in deficit positions as a result of a variety of factors such as benefit increases, changes in actuarial assumptions resulting in actuarial losses to the fund, a decrease in long-term interest rates and downturns in the financial markets. These deficits may be very large and difficult for employers to absorb at once. The PBSA allows a defined benefit plan to operate in a deficit position but requires employers to make special payments aimed at making up this deficit.

  3. When a plan’s solvency ratio is less than 1, can a top-up contribution, made for purposes of transferring out a member’s full transfer value, be considered as one of the adjustments detailed in subsection 9(8) of the Pension Benefits Standards Regulations, 1985 that increase the average solvency ratio?

    No. A top-up contribution that an employer remits for the purpose of paying out a member’s full transfer value restores the solvency ratio to its level prior to the payout. Conversely, a special payment contributes to improving the plan’s solvency and may legitimately be counted as a positive adjustment to the average solvency ratio.