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The process of calculating pension plan deficits

Every three years, the McGill University Pension Plan (MUPP) undergoes an actuarial valuation by an independent actuarial firm. This valuation is required by law. The valuation of the MUPP, conducted by Eckler Inc., as of December 31, 2009, found that the current contributions were not enough to maintain the long‐term health of the plan, given the level of retirement benefits being paid out.

The firm performed a solvency valuation and a funding valuation, two tests commonly used to determine the health of a pension plan:

1) Solvency deficiencies/surpluses:

A solvency valuation examines whether the plan would be in deficit or surplus if it were closed as of the valuation date. It compares the actual assets (funds in the plan) to the actual liabilities (the amount it has to pay to plan members, plus wrap‐up expenses) at a moment in time.

As of December 31, 2009, the MUPP had a solvency deficiency of $114,841,000, meaning that the plan had nearly $115 million less than it would need to meet its immediate obligations if it ceased operations on that date.  Although this figure may seem alarming, the MUPP is in no immediate danger of winding up, as the University does not face closure.

To ensure that pension obligations can be met and members are protected, the Quebec Government requires most organizations to pay off their solvency deficiencies within a five‐year period. Fortunately, McGill does not have to meet this requirement as universities and municipalities were exempted from this law commencing January 2007. However, the magnitude of the solvency deficit indicates the need for McGill to act quickly to make the plan sustainable.

The valuation also determines the “degree of solvency”, which establishes the ratio of the pension plan’s assets to its liabilities for those in a defined benefit minimum position.  This figure is important in determining the level of funds available for transfer to terminating and retiring members of the MUPP who are in a defined benefit minimum position.

The degree of solvency as of December 31, 2009 stands at 84%. This means that under pension legislation in the province of Quebec, the MUPP is required to withhold 16% of the funds from plan members in a defined benefit minimum position who are settling their pension plan holdings after December 31, 2009. In order to allow members to obtain 100% of their account holdings, rather than enforcing the measure prescribed in pension legislation which would provide members with only 84% of the value, with the remaining 16% paid within 5 years, the University has opted to make additional contributions to the MUPP thus maintaining 100% payment to such members.

2) Funding deficiencies/surpluses:

In a funding valuation, the actuarial firm takes factors such as expected future contributions, anticipated return on investment, estimated life expectancy, and interest rates into account to project the future health of the plan. The valuation estimates the funds needed to cover anticipated pension payments to members versus the anticipated funds available based on the projected value of the pension plan.  A funding deficiency (also called a funding deficit) means that the funds projected to be available in the future are less than the estimated pension payments to departing members. The 2009 actuarial review found that the MUPP had a funding deficiency or deficit of $46,313,000. Pension plans are given 15 years to resolve a funding deficiency.

The previous valuation of the MUPP as of December 31, 2006 reported a funding surplus of $33,597,000 (compared to a funding deficiency of $46,313,000 in 2009) and a solvency deficiency of only $11,058,000 (compared to a solvency deficiency of $114,841,000) respectively. These figures show how dramatically the return on investment and interest rates changed following the global financial crisis that began in 2008. Indeed, the funding deficiency reported as of 2009 is the most significant funding deficiency in MUPP history.