PEN-22 SERP Pension Session CIA Annual Meeting Assemblée annuelle de l’ICA June 29 & 30, 2006  Les 29 et 30 juin 2006 Ottawa, Ontario SERP Commuted Values Other SERP Actuarial Issues Doug Chandler

PEN-22 SERP Pension Session CIA Annual Meeting  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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Standards of Practice Commuted Value standard does not apply ( ) don’t say it does ( ) CSOP does apply: –unbiased calculations (1740) –assume a tax rate ( ) –disclose stipulated assumptions ( ) –disclose alternative to extreme assumption ( )

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Adjusting for tax can be a big deal! Example: $100,000 per year annual pension payable immediately at age 60 Joint and 50% Survivor, $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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Non-Registered Funds First

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Effective Tax Rate on a Non-Registered Investment Fund Earnings Most Efficient Investment Strategy Least Efficient Investment Strategy Less than $35,0007%22% $35,000 to $70,00013%31% $70,000 to $120,00017%*39%* Over $120,00020%46% * plus OAS clawback after 65 Be sure to validate your assumption with current tax rules and province of employment, e.g.

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Commuted Values and Tax Adjustment Avoiding the Issue Specify commuted value basis in plan document Take direction from client (stipulated assumption) Explain the effect of taxes and report a range

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Commuted Values and Tax Adjustment Examples 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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)

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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 english/news/pdf/WW_Submission_2005_Federal_Pre-Budget.pdfhttp:// english/news/pdf/WW_Submission_2005_Federal_Pre-Budget.pdf

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Retirement Compensation Arrangements Reason for FundingValuation 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Letters of Credit Don’t forget about the Refundable Tax Account

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA 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?

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Approach to securityAdditional cost RCA for actives80% LOC for actives40% RCA for retirees33% LOC for retirees15% Lump Sum Settlement with 50% marginal tax33% Lump Sum Settlement with 20% marginal tax15% Prescribed Annuity33% Cost Comparisons Figures are for illustration only – do your own calculations and sensitivity testing

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Questions about Cost Comparisons 1.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?

PEN-22 SERP Pension Session CIA Annual Meeting  Assemblée annuelle de l’ICA Questions about Corporate Accounting 1. What retirement age should you use? most likely (earliest unreduced) most expensive (could be 65) scale from 55 to 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?