Accounting for guaranteed buy-in annuity contracts by pension plans subject to the Supplemental Pension Plans Act
Pension plans are increasingly using annuity contracts offered by insurers to reduce their exposure to risks related to pension benefits. Accounting for this investment vehicle has raised many questions in the last few years.
Until recently, the only retirement option available under Quebec law was buy-in annuity contracts. An Act to amend the Supplemental Pension Plans Act mainly with respect to the funding of defined benefit pension plans, which was adopted on November 26, 2015, introduced the possibility of purchasing buy-out annuity contracts for certain plans subject to the Supplemental Pension Plans Act (the SPP Act), under conditions to be provided for by the Regulation respecting supplemental pension plans (the Regulation). The Regulation was amended on January 4, 2018 to provide for these conditions.
Accordingly, pension plans can now enter into guaranteed buy-in or buy-out annuity contracts, with the exception of municipal and university sector pension plans, for which the SPP Act prohibits the purchase of buy-out contracts.
What are guaranteed buy-in and buy-out annuity contracts?
With a buy-in annuity contract, the pension plan administrator is required to ensure that the benefits covered by the contract are paid to the annuitants even when the insurer fails to make the payments provided for under the terms of the contract. The SPP Act does not consider such a contract a final settlement of plan obligations, nor does it allow the link between the pension plan and the retirees to be severed when the pension fund acquires group annuities from an insurer. Should the employer declare bankruptcy, the annuities purchased from an insurer could be reduced, since the link is not severed.
A buy-out annuity is another type of contract where the annuitant is no longer a plan member or beneficiary, and the plan administrator does not have to intervene in the event of default by the insurer. When such an agreement is entered into, under certain conditions, the SPP Act provides for the link between the plan and the annuitants to be severed, in a going concern context, and for a final payment to be made to the plan members covered by the agreement.
The conditions prescribed by the SPP Act include a requirement that an annuity purchasing policy, the content of which is set out in the SPP Act and the Regulation, be put in place for the purchase of buy-out annuities. Furthermore, the SPP Act requires an actuarial valuation at the buy-out date and written consent from the plan sponsor to make any special payments required as part of the buy-out. The SPP Act also specifies that, if the plan is terminated within three years of the annuity purchase, the surplus assets at the time of termination may be allocated to members for whom an annuity has been guaranteed, if provided for under the plan. On the other hand, their annuities could be reduced if there is a deficit at the time of termination. This last requirement, however, is not a pension obligation if the plan is funded on a going concern basis.
What do the accounting standards say?
Buy-in annuity contracts
Section 4600, Part IV of the CPA Canada Handbook, which contains the standards that apply in preparing pension plan financial statements, defines investment assets and specifies that “insurance contracts related to the plan's pension obligation of which the plan is the beneficiary” are included in these investments.
What is the appropriate accounting treatment?Guaranteed buy-in annuity contracts must be recognized as investments in the pension plan’s statement of financial position. This applies to financial statements prepared in accordance with Section 4600, i.e. by reporting the pension obligations as a liability. This also applies in cases where the statement of net assets is presented in accordance with Retraite Québec’s alternative accounting framework, which excludes pension obligations in financial reports.
As with any investment, these contracts must be measured at fair value. Fair value measurement is more complex, since there is no active market for this type of investment. Reference should be made to IFRS 13, Fair Value Measurement, and to the definition of Level 3 inputs. The measurement is normally performed in collaboration with the actuary in charge of the pension plan valuation.
In financial statements where the plan presents pension obligations, the obligation corresponding to the annuity purchase must be measured in accordance with the accounting policy applied by the plan. With respect to the plan’s going concern and the insurer’s solvency, once the contract has been entered into, the asset value often equals the obligation, but exceptions may apply.
Preparing the annual information return (AIR) for Retraite Québec
Reporting guaranteed buy-in annuity contracts on the statement of financial position is required under accounting standards. The SPP Act requires that a plan’s financial report be audited (unless part of the exceptions) by an accountant, and the AIR guide specifies that the financial report must be prepared in accordance with accounting standards for pension plans or the alternative Retraite Québec framework, which is the same as the accounting standards for pension plans where assets are concerned.
Guaranteed buy-in annuity contracts must be reported on line 345.1 of the AIR, Annuity contracts guaranteed by an insurer. The variation in the fair value of guaranteed buy-in annuity contracts is reported on line 301, Investment income and Variation in the fair value of investments.
Buy-out annuity contracts
A guaranteed buy-out annuity contract is considered a settlement of the pension obligation to members with a guaranteed annuity.
What is the appropriate accounting treatment?When the financial statements are prepared in accordance with the standards in Section 4600, Pension Plans, and the plan purchases a guaranteed buy-out annuity, the plan assets must be reduced by the premium that was paid to the insurer for the annuity purchase, and the pension obligations must be reduced by the obligations linked to members for whom an annuity was purchased. This also applies in cases where the financial statements are presented in accordance with the special purpose basis of accounting allowed by Retraite Québec, which excludes pension obligations. In the latter case, only the plan’s assets are reduced by the premium paid.
Guaranteed buy-out annuity contracts must not be reported in the statement of financial position in accordance with accounting standards. Therefore, they will not be included in the AIR either. Furthermore, in the year during which the annuity contract is entered into, the payment associated with the contract must be reported on line 323, Other transfers and refunds (Locked-in amounts and Non locked-in amounts).
The Order’s Sector-specific working group on pension plans