PENSION FUNDING REGULATIONS
2015-05-26
Pension Funding Regulations applicable to Air Canada
Can you remind me what the 2014 Regulations are about?
In December 2013, the Government of Canada approved the Air Canada Pension Plan Funding Regulations, 2014 (the “2014 Regulations”) effective January 1, 2014. Instead of contributing amounts that could vary from one year to another under the normal funding rules, the 2014 Regulations required Air Canada to make solvency deficit payments of $200 million per year, on average, from 2014 to 2020 inclusively. In connection with these regulations, Air Canada and the Government of Canada entered into an agreement that contained several restrictions, including a prohibition on dividends and share repurchases; however it allowed Air Canada to opt out at any time.
Why did Air Canada opt-out of the 2014 Regulations?
Air Canada has elected to opt-out of the 2014 Regulations as following a detailed risk assessment, it believes it has largely eliminated the funding risk associated with the solvency of its pension plans. Also, under normal funding rules the annual solvency payments for 2015 are $91 million, almost $110 million less than the $200 million required under the 2014 Regulations. The originally committed deficit funding contributions over the next six years of approximately $1.1 billion may be redeployed to further improve the competitive position of Air Canada and create substantial value for shareholders and employees.
Why did Air Canada need the 2014 Regulations if it is opting out only one year after it became effective?
At a time when Air Canada was discussing special arrangements with the federal government, the solvency deficit in the Air Canada pension plans was in the range of $4B and Air Canada’s 2009 Special Regulations were set to expire at the end of 2013. Based on the level of the solvency deficit, Air Canada would have been required to make substantial special payments to repay the deficit in 2014 and well into future years. These amounts would have significantly impeded Air Canada’s transformation and the solid foundation we have set which will benefit all of us including our pension plans.
Why does Air Canada believe that a future significant deficit is unlikely to re-occur and that payments will remain below $200M under normal funding rules?
Defined benefit pension plans are very sensitive to variations in long-term interest rates and return on pension plan assets. Since 2009, Air Canada has been gradually implementing a new investment strategy in an effort to reduce these risks. In fact, 75 per cent of Air Canada’s pension liabilities are now immunized with duration-matched fixed income products, significantly reducing the interest rate risk associated with all pension plans.
As part of its due diligence and risk mitigation strategy, Air Canada, with the assistance of its professional actuaries, simulated 1,000 different economic scenarios to determine what combination of economic factors would have to occur to cause Air Canada to contribute an aggregate of more than $1.2 billion to its pension plans under normal funding rules, over the next six years. With respect to these 1,000 economic scenarios, less than 2 per cent would result in payments of over $1.2 billion; however, none of these scenarios has ever actually occurred.
Air Canada also simulated the past three economic crises (the 2009 financial crisis, the 2001-2002 technology crisis and the 1970 oil crisis) to assess the effect each would have on the pension plan assets. None of those three economic crises would result in payments exceeding an aggregate amount of $1.2 billion over the next six years.
What were the payments required under the 2014 Regulations?
The 2014 Regulations required Air Canada to make payments of at least $150 million annually with an average of $200 million per year, to contribute approximately $1.2 billion over seven years (2014 to 2020) in solvency deficit payments, in addition to its pension current service payments.
What will the payments be effective January 1, 2015?
Based on the financial position of the plans as of January 1, 2015, showing an increase of the surplus from $89 million as of January 1, 2014 to $660 million, Air Canada’s pension solvency payment will be $91 million for 2015 under normal funding rules, compared to $200M under the 2014 Regulations.
Based on pension plan solvency surplus as at January 1, 2015 of $660 million and assuming similar market conditions to the current environment and given its immunization strategy, Air Canada expects its pension solvency payments in 2016 to be zero, saving $200 million in that year.
Under normal funding rules, Air Canada will be required to make annual current service contributions as well as past service contributions determined in accordance with the Pension Benefits Standards Regulations, 1985. Past service contributions will be determined by a specified calculation based mostly on historical deficit performance. Contributions for future years will be determined by future actuarial valuations.
How specifically is the past service contribution determined under normal funding rules?
The annual past service contribution is equal to one fifth of an average deficit reflecting the solvency position of the plan over the last three years, adjusted for special payments made and to reflect amendments.
For example, the 2015 past service contribution will be based on an average deficit reflecting the solvency position of the plan as of January 1, 2015, January 1, 2014 and January 1, 2013, adjusted for special payments made in 2013 and 2014 and to reflect the benefit reductions effective January 1, 2014. This means that based on the financial position of the plans as of January 1, 2015, showing an increase of the surplus from $89 million as of January 1, 2014 to $660 million, Air Canada’s pension solvency payment will be $91 million for 2015 under normal funding rules, compared to $200M under the 2014 Regulations.
Did Air Canada require the consent of the Office of Superintendent of Financial Institutions (OSFI), the government, the unions or plan beneficiaries to opt-out?
No, following the agreement reached with the Government of Canada and based on the 2014 Regulations, Air Canada could alone elect to opt out of the 2014 Regulations at any time and make payments according to normal funding rules.
Were there restrictions applicable to Air Canada while it was subject to the 2014 Regulations?
Yes – as long as Air Canada was subject to the 2014 Regulations, the company was subject to certain restrictions including a prohibition on dividends and share repurchases, as well as limitations on executive compensation arrangements.
Isn’t it safer to make pre-determined annual payments of $200M rather than not knowing how much payments will be from year to year?
The decision to opt out of the 2014 Regulations was made after very careful consideration. Air Canada’s pension plans are very healthy. The aggregate solvency surplus as at May 20, 2015, based on management estimates, is $1.2 billion, 82 per cent above the $660 million surplus level at January 1, 2015, and 13.5 times greater than the $89 million surplus level as at January 1, 2014. The money that we expect to save can be used to further invest in and strengthen Air Canada, something that will benefit all of us.
Is this decision really in the best interest of all pension plan members?
The financial health of the company and its growth benefits all employees, including pension plan members. With regards to its pension plans, Air Canada had three primary pension objectives: secure our employees’ and retirees’ pensions, eliminate the pension solvency deficit and ensure the costs associated with maintaining the pension plans remain affordable, predictable and stable. We have, over the past six years, achieved all three objectives.
The company is taking all aspects into account in its decision-making process; it would not make this decision if there was concern about risk for plan members or for the company.
Pension Funding Regulations applicable to Air Canada
Can you remind me what the 2014 Regulations are about?
In December 2013, the Government of Canada approved the Air Canada Pension Plan Funding Regulations, 2014 (the “2014 Regulations”) effective January 1, 2014. Instead of contributing amounts that could vary from one year to another under the normal funding rules, the 2014 Regulations required Air Canada to make solvency deficit payments of $200 million per year, on average, from 2014 to 2020 inclusively. In connection with these regulations, Air Canada and the Government of Canada entered into an agreement that contained several restrictions, including a prohibition on dividends and share repurchases; however it allowed Air Canada to opt out at any time.
Why did Air Canada opt-out of the 2014 Regulations?
Air Canada has elected to opt-out of the 2014 Regulations as following a detailed risk assessment, it believes it has largely eliminated the funding risk associated with the solvency of its pension plans. Also, under normal funding rules the annual solvency payments for 2015 are $91 million, almost $110 million less than the $200 million required under the 2014 Regulations. The originally committed deficit funding contributions over the next six years of approximately $1.1 billion may be redeployed to further improve the competitive position of Air Canada and create substantial value for shareholders and employees.
Why did Air Canada need the 2014 Regulations if it is opting out only one year after it became effective?
At a time when Air Canada was discussing special arrangements with the federal government, the solvency deficit in the Air Canada pension plans was in the range of $4B and Air Canada’s 2009 Special Regulations were set to expire at the end of 2013. Based on the level of the solvency deficit, Air Canada would have been required to make substantial special payments to repay the deficit in 2014 and well into future years. These amounts would have significantly impeded Air Canada’s transformation and the solid foundation we have set which will benefit all of us including our pension plans.
Why does Air Canada believe that a future significant deficit is unlikely to re-occur and that payments will remain below $200M under normal funding rules?
Defined benefit pension plans are very sensitive to variations in long-term interest rates and return on pension plan assets. Since 2009, Air Canada has been gradually implementing a new investment strategy in an effort to reduce these risks. In fact, 75 per cent of Air Canada’s pension liabilities are now immunized with duration-matched fixed income products, significantly reducing the interest rate risk associated with all pension plans.
As part of its due diligence and risk mitigation strategy, Air Canada, with the assistance of its professional actuaries, simulated 1,000 different economic scenarios to determine what combination of economic factors would have to occur to cause Air Canada to contribute an aggregate of more than $1.2 billion to its pension plans under normal funding rules, over the next six years. With respect to these 1,000 economic scenarios, less than 2 per cent would result in payments of over $1.2 billion; however, none of these scenarios has ever actually occurred.
Air Canada also simulated the past three economic crises (the 2009 financial crisis, the 2001-2002 technology crisis and the 1970 oil crisis) to assess the effect each would have on the pension plan assets. None of those three economic crises would result in payments exceeding an aggregate amount of $1.2 billion over the next six years.
What were the payments required under the 2014 Regulations?
The 2014 Regulations required Air Canada to make payments of at least $150 million annually with an average of $200 million per year, to contribute approximately $1.2 billion over seven years (2014 to 2020) in solvency deficit payments, in addition to its pension current service payments.
What will the payments be effective January 1, 2015?
Based on the financial position of the plans as of January 1, 2015, showing an increase of the surplus from $89 million as of January 1, 2014 to $660 million, Air Canada’s pension solvency payment will be $91 million for 2015 under normal funding rules, compared to $200M under the 2014 Regulations.
Based on pension plan solvency surplus as at January 1, 2015 of $660 million and assuming similar market conditions to the current environment and given its immunization strategy, Air Canada expects its pension solvency payments in 2016 to be zero, saving $200 million in that year.
Under normal funding rules, Air Canada will be required to make annual current service contributions as well as past service contributions determined in accordance with the Pension Benefits Standards Regulations, 1985. Past service contributions will be determined by a specified calculation based mostly on historical deficit performance. Contributions for future years will be determined by future actuarial valuations.
How specifically is the past service contribution determined under normal funding rules?
The annual past service contribution is equal to one fifth of an average deficit reflecting the solvency position of the plan over the last three years, adjusted for special payments made and to reflect amendments.
For example, the 2015 past service contribution will be based on an average deficit reflecting the solvency position of the plan as of January 1, 2015, January 1, 2014 and January 1, 2013, adjusted for special payments made in 2013 and 2014 and to reflect the benefit reductions effective January 1, 2014. This means that based on the financial position of the plans as of January 1, 2015, showing an increase of the surplus from $89 million as of January 1, 2014 to $660 million, Air Canada’s pension solvency payment will be $91 million for 2015 under normal funding rules, compared to $200M under the 2014 Regulations.
Did Air Canada require the consent of the Office of Superintendent of Financial Institutions (OSFI), the government, the unions or plan beneficiaries to opt-out?
No, following the agreement reached with the Government of Canada and based on the 2014 Regulations, Air Canada could alone elect to opt out of the 2014 Regulations at any time and make payments according to normal funding rules.
Were there restrictions applicable to Air Canada while it was subject to the 2014 Regulations?
Yes – as long as Air Canada was subject to the 2014 Regulations, the company was subject to certain restrictions including a prohibition on dividends and share repurchases, as well as limitations on executive compensation arrangements.
Isn’t it safer to make pre-determined annual payments of $200M rather than not knowing how much payments will be from year to year?
The decision to opt out of the 2014 Regulations was made after very careful consideration. Air Canada’s pension plans are very healthy. The aggregate solvency surplus as at May 20, 2015, based on management estimates, is $1.2 billion, 82 per cent above the $660 million surplus level at January 1, 2015, and 13.5 times greater than the $89 million surplus level as at January 1, 2014. The money that we expect to save can be used to further invest in and strengthen Air Canada, something that will benefit all of us.
Is this decision really in the best interest of all pension plan members?
The financial health of the company and its growth benefits all employees, including pension plan members. With regards to its pension plans, Air Canada had three primary pension objectives: secure our employees’ and retirees’ pensions, eliminate the pension solvency deficit and ensure the costs associated with maintaining the pension plans remain affordable, predictable and stable. We have, over the past six years, achieved all three objectives.
The company is taking all aspects into account in its decision-making process; it would not make this decision if there was concern about risk for plan members or for the company.