Canadian Investment Review

Why Solvency Reform Won’t Make It Better

Written by Gerry Wahl on Thursday, December 22nd, 2016 at 7:28 am

band-aidOntario is undertaking a review to attempt to ‘improve’ Defined Benefit (DB) plan solvency funding rules. Will this be more successful than past attempts or will it just lead to more confusion and complexity? In my view, it will as I explain in this blog post.

First, however, a bit of background.

DB sponsors’ concerns about defined benefit (DB) solvency funding requirements were common in times of financial stress e.g. the current low interest rate environment and slow economic growth in Canada. Ontario is undertaking a study on this topic, the Review of Ontario’s Solvency Funding Framework. The review states that solvency reform is desirable and should focus on sustainability, affordability and benefit security and it should consider the interests of DB pension stakeholders (members, retirees, unions etc.).

The point of DB pension funding on both a going concern and solvency basis has always been to protect members in the event of the financial failure of the sponsor. Current legislation favours members’ interest over those of the sponsors in certain situations. But it is also understood that onerous funding requirements during times of financial stress can contribute to or accelerate the financial demise of an organization and its DB plan. Some argue that the current solvency and going concern funding and accounting liability requirements are too complicated. But according to the review, it has also been effective:

 “Solvency valuations and going concern valuations tend to alternate as the driver of pension costs… dual valuations may explain why DB pension plans have performed better in Canada than their counterparts in other countries. Is it advisable to change this dual approach for the sake of improving sponsor affordability but eroding the current level of DB member security?”

The downside of change

It is up to employers to decide the level of benefits in a DB plan and they are, therefore, accountable for the costs and funding risk. Since they made the promise to DB members, I’m not clear why those same sponsors feel that government legislation is needed or appropriate that allows them to circumvent that promise.

Some sponsors argue that Pension Benefit Guarantee Fund should also be eliminated as part of reform.

Companies buy insurance to mitigate risks – it’s part of the cost of doing business. The PBGF is insurance policy which provides limited protection of an employee’s DB benefit. Pensions are a valuable employer benefit that play a role in attracting employees to an organization: PBGF fees are simply part the cost of offering a DB plan and doing business.

The current PBGF fees are no more onerous than the recent increases in CPP premiums. In the overall scheme of things, the cost of PBGF to an employer is not significant – moreover, it’s a deductible tax expense.

It is going to be very difficult to justify the level of solvency funding should be reduced and the elimination of PBGF.

Another argument raised against the PBGF is that it’s offensive that taxpayers who are not in DB plans are forced to subsidize DB plan members by funding the PBGF. It may be seen unfair but Ontario taxpayers are already effectively subsidizing/guaranteeing public service pension plan benefits. The $500 million Ontario grant given to PBGF in 2010 covers 3.5 million Ontario DB plan members – that’s not a bad tradeoff.

Have the reasons for solvency funding or the need for PBGF changed? Have the solvency funding requirements been and PBGF protection been effective? Periods of financial stress come and go. Undoubtedly there are times when situations such as the current prolonged low interest rate environment may require regulatory intervention but this should be on a short term, case-by-case basis – not a permanent one (e.g.  Air Canada 2012).

The review also outlines several alternative approaches to DB plans: these all would appear to erode the current level of member protection to a certain degree if implemented. Changes to existing DB funding rules or new forms of DB plans can be introduced but the underlying concept has to be maintain protection of member benefits.

Protection of pension benefits and funding arrangements are frequently discussed but the same approach is never proposed for post-retirement benefits. In the case of flat benefit plans (e.g. union plans), the value of post-retirement benefits for older retirees can almost be as valuable as the pension. If an organization fails financially, the post-benefits are usually lost.

Ultimately, Protection of a pension benefit is special case and should not be undermined for the sake of “affordability”.

A plan administrator has a fiduciary responsibility to act in the best interests of the members. Will arguing for changes to DB solvency funding be in the best interests of DB Members?

The changes to existing funding requirements being discussed shift financial risk to members or reduce their current level of security. Solvency funding reform will be a delicate balancing act but the obligation to protect Members should continue to be foremost rather than being “taken into consideration”.

Rather than eliminating or tweaking solvency funding requirements perhaps it would be better to phase out DB plans in their current form e.g. Bill C27 and move to other types of risk sharing arrangements or CAPs.

 

 

Copyright 2017. Canadian Investment Review. All Rights Reserved.