cia annual meeting assemblée annuelle de l’ica

PEN-22 SERP Pension Session

CIA Annual MeetingAssemblée annuelle de l’ICA

June 29 & 30, 2006 Ÿ Les 29 et 30 juin 2006Ottawa, Ontario

• SERP Commuted Values• Other SERP Actuarial Issues

Doug Chandler


CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

Typical Situation – Commuted Value

• only monthly income is specified• scanty documentation• both parties want a lump sum settlement• sponsor and member trust actuary



Standards of Practice• Commuted Value standard does not apply

(3810.03)• don’t say it does (3850.06)• CSOP does apply:

– unbiased calculations (1740)– assume a tax rate (1710.06)– disclose stipulated assumptions (1720.03)– disclose alternative to extreme assumption (1720.06)



All the Usual CV Issues…• mortality• discount rate • future retirement age• marital status at future retirement

And a Couple of Others…• tax adjustment• integration with Registered Pension Plan


CIA Annual Meeting Ÿ Assemblée annuelle de l’ICAAdjusting for tax can be a big deal!

Example:• $100,000 per year annual pension• payable immediately at age 60• Joint and 50% Survivor, UP94@2015• $1.4 million without tax adjustment (5% discount rate)• $1.8 million with 40% tax adjustment (3% discount rate)• Even bigger difference for indexed or deferred pensions

$-

$500,000

$1,000,000

$1,500,000

$2,000,000

No Tax Adjustment With Tax Adjustment



Employer Perspective• corporate tax deduction for lump sum• cost is after-tax cost of capital (or debt)

Employee Perspective• tax on lump sum• tax on interest, dividends and capital gains • no tax on withdrawals from after-tax funds• broader range of tax strategies



Non-Registered Funds First

$0

$50,000

$100,000

$150,000

60 63 66 69 72 75 78 81 84

RPP net of tax Tax on RPP

SERP net of tax Tax on SERP

$0

$50,000

$100,000

$150,000

60 63 66 69 72 75 78 81

RRIF net of tax Cash net of tax

Tax on RRIF Tax on Cash



Effective Tax Rate on aNon-Registered Investment Fund

EarningsMost Efficient

Investment Strategy

Least Efficient Investment

StrategyLess than $35,000 7% 22%$35,000 to $70,000 13% 31%$70,000 to $120,000 17%* 39%*Over $120,000 20% 46%

* plus OAS clawback after 65

Be sure to validate your assumption with current tax rules and province of employment, e.g. www.kpmg.ca/en/services/tax/taxratesPersonal.html

http://www.kpmg.ca/en/services/tax/taxratesPersonal.html



Commuted Values and Tax AdjustmentAvoiding the Issue

• Specify commuted value basis in plan document• Take direction from client (stipulated

assumption)• Explain the effect of taxes and report a range



Commuted Values and Tax AdjustmentExamples of Specified Basis

• same basis as RPP (no tax adjustment)• purchase price of prescribed annuity• discount rate reduced by a tax rate of x%• commuted values at y% fixed



Commuted Value Assumptions Required for Explicit Tax Adjustment

• Asset mix• Equity turnover rate• Tax rates (for lump sum, monthly pension, and

income on various asset classes)



• Annual normal retirement benefit is $5,000 per year of service

• Plan reduction is 5%/yr from 65

• Plan indexing is ad hoc

• RPP pays ITA maximum

• Retirement at 60 in 2009

Example – Integration with RPP

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

60 62 64 66 68 70 72 74

Age

Ann

ual P

ensi

on p

er Y

ear o

f Ser

vice

SERPRPP



Other Types of SERP “work”

• funding valuations – Retirement Compensation Arrangement

• determining the face amount of a Letter Of Credit

• plan design cost studies

• corporate accounting – CICA3461, FAS87, IAS19



50% RCA Tax Rate intended to prevent tax advantage (at 1986 rates) does not reflect recent changes in corporate and personal tax rates, capital gains tax inclusion rate, dividend tax credits a neutral rate today would be about 30% many more employers would fund RCA’s if the tax rate were lowered

http://www.watsonwyatt.com//canada-english/news/pdf/WW_Submission_2005_Federal_Pre-Budget.pdf





Retirement Compensation Arrangements

Reason for Funding Valuation Basis

Eliminate Balance Sheet Liability Accounting Basis

Stable Contribution Rate Going Concern

SERP is part of a registered plan Going Concern and Solvency

Tax Deduction for Employee Contributions Matching

Benefit Security Settlement Cost



Letters of Credit can be a tax-effective alternative to RCA funding

require actuarial report to determine face amount same problems as commuted values:

- no specified basis for settlement

- optimal tax adjustment depends on plan member



Letter of Credit Valuation be aware of annual cycle deadlines and roles:

- sponsor- trustee- bank- Administrator

you’re telling them how much insurance to buy face amount must cover triggering event any time in the year

- fluctuations in interest rates

- mid-year cliff vesting

- new members

- bonuses that boost final average pay



Letters of CreditDon’t forget about the Refundable Tax Account

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

40

45

50

55

60

65

70

75

80

85

90

95 10

0 10

5

Age

Amount required to Settle

Face amount of LC



Letter of Credit Valuations:Integration with RPP

typical SERP combines with RPP to pay “whatever the RPP would pay without tax limits” hypothetical wind-up scenario – both plans

- does legislated grow-in increase or decrease SERP obligation?

- if surplus in the RPP is distributed through indexing or other improvements, do those improvements increase or decrease the SERP obligation?

Doug Chandler



Approach to security Additional cost

RCA for actives 80%

LOC for actives 40%

RCA for retirees 33%

LOC for retirees 15%

Lump Sum Settlement with 50% marginal tax 33%

Lump Sum Settlement with 20% marginal tax 15%Prescribed Annuity 33%

Cost Comparisons

Figures are for illustration only – do your own calculations and sensitivity testing

Doug Chandler



Questions about Cost Comparisons1. Should the LOC fee be expensed on a cash basis or an accrual

basis?

2. What about trustee and administration fees?

3. What is the going concern value of an RTA balance that will never be recovered?

4. How do you factor in corporate tax costs?

5. What about life insurance products?

6. What is the actuary’s role in conflicts between the interests of executives and the interests of the company?

Doug Chandler



Questions about Corporate Accounting1. What retirement age should you use?

• most likely (earliest unreduced)• most expensive (could be 65)•scale from 55 to 65

2. Should you discount for forfeiture on early termination?

3. How do you account for an increase in the tax limits?

5. Should SERP and RPP assumptions be the same?

6. Should you disclose the sensitivity to salary and bonus changes?

7. Do you need to measure the extra SERP liability arising from individual salary variations?

cia annual meeting assemblée annuelle de l’ica

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