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Stikeman Elliott LLP Barristers & Solicitors' Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:

Direct: 
(416) 869-5250
(416) 869-5245

E-mail: 
gnachshen@stikeman.com
aboctor@stikeman.com

By Electronic mail

September 15, 2005

Department of Finance
Ottawa, Ontario
pension@fin.gc.ca

Dear Sirs:

Re: Defined Benefit Pension Plans Consultation Paper

We are pleased to offer the following submissions on the issues raised in your May 2005 consultation paper entitled Strengthening the Legislative and Regulatory Framework for Defined Benefit Pension Plans Registered under the Pension Benefits Standards Act, 1985 (the "Consultation Paper"), on the legislative and regulatory framework for defined benefit pension plans registered under the Pension Benefits Standards Act, 1985 ("PBSA"). As counsel to a number of corporations which sponsor pension plans registered under the PBSA, we would like to offer our thoughts on certain legal, as opposed to actuarial or quantitative, aspects of some of the Consultation Paper proposals. We appreciate the opportunity to put forward these thoughts.

We would like to begin by stating our views on the importance of defined benefit pension plans in Canada. In our experience, defined benefit plans are a unique and valuable component of the compensation environment for many employers and employees, which permit a dignified retirement for members who participate in such plans. Unfortunately, as a result of some of the legal principles which have developed over the past two decades and various other factors, it has become increasingly difficult for many plan sponsors to justify the continuation of their defined benefit plans, let alone establish new plans. In our view, the present juncture is a tipping point for the future of defined benefit plans. We are hopeful that the Consultation Paper will lead to reforms that will encourage the maintenance of defined benefit plans, and our specific comments and suggestions below should be read with that overarching objective in mind.

We have addressed the issues in the order in which they appear in the Consultation Paper.

Issues For Discussion

A. Surplus

The Government of Canada is seeking views as to whether there are any disincentives or obstacles preventing plan sponsors from adequately funding their plans and building up a funding cushion.

Although we cannot speak to any particular situation, we suspect there is considerable truth to paragraph 4 of this section of the Consultation Paper. That paragraph states that, as a result of the surplus distribution rules currently enforced on termination or partial termination of a defined benefit pension plan, many plan sponsors are discouraged from making contributions above those specifically required by law.

The state of the law on this issue has reached a point where the present generation of defined benefit plan members both enjoy the upside of pension fund performance through surplus distribution rights and are protected from the downside of such performance through a defined benefit. That is, they effectively get the best of both defined contribution and defined benefit schemes, and plan sponsors effectively get the worst of both. In many cases, we are concerned that future generations of plan members will suffer the consequences of this phenomenon, either through reduced benefit security or no defined benefits at all.

Accordingly, we respectfully advocate the adoption of clear surplus entitlement rules that reflect the true nature of the defined benefit pension "bargain", to the exclusion of a mechanistic application of ancient trust law principles which do not reflect the reality of ongoing pension plans with constantly changing memberships. The adoption of such rules would redress some of the imbalance in the present environment, thereby removing an important obstacle to continued conservative funding of defined benefit plans.

The Dispute Settlement Mechanism for Surplus Distribution

The Government of Canada is seeking views on whether the dispute settlement mechanism for surplus distribution contained in the PBSA requires improvement or clarification.

We are unaware of the general consensus, if any, on the surplus dispute resolution mechanism under the PBSA. We do, however, feel that any mechanism that results in a plan sponsor being required to share surplus with plan members where the language in the plan text does not so stipulate is a derogation of a plan sponsor's property rights. This constitutes a further legal impediment to the long-term maintenance of defined benefit plans by private sector employers in Canada.

Distribution on Partial Termination

The Government of Canada is seeking views on whether there should be partial plan terminations under the PBSA and if so, should there be a requirement to distribute surplus at the time of the partial termination.

We suspect that an employer will be reluctant to pour funds into a pension plan so as to build a funding cushion to weather a potential economic storm, if the regulatory regime requires the funding cushion, or a part thereof, to be distributed to members should a partial termination event occur. This is particularly so given that the criteria for a partial termination are not always clear and often become evident only years after the fact. To require a distribution out of a plan based on economic circumstances that no longer exist could have the result of weakening the plan's funded position, thus reducing benefit security for the remaining members.

Due to the legal and administrative complexities surrounding partial plan terminations, it is our view that such concept should be deleted from the PBSA. We would support its replacement with immediate vesting, as is provided under the Quebec regime. Alternatively, we would support what we understand to be OSFI's current interpretation of the PBSA, i.e. that the rights assigned to persons affected by a partial plan termination do not include the distribution of surplus at the time of a partial termination.

B. Funding

Letters of Credit

The Government of Canada is seeking views on whether there are alternative financial vehicles, such as letters of credit, that could allow for greater funding flexibility.

What types of conditions or rules should be required if greater funding flexibility is given to plan sponsors, to ensure that the risk to benefit security is minimized?

At first blush, the posting of letters of credit ("L/Cs") in lieu of cash contributions would seem to be an attractive alternative for plan sponsors trying to plug solvency gaps without cutting unduly into needed capital spending. However, the experience to date with L/Cs in the retirement compensation arrangement ("RCA") context suggests that it might be difficult to define all the events of default which would trigger the calling of the L/C. And it is precisely those events of default which are the key to ensuring the benefit security the L/C would be designed to provide.

Even if the events of default can be properly defined, it is not obvious who would be charged with determining that such an event had in fact occurred and taking the requisite action in any particular situation. The plan custodian is one possibility, but in our experience most trust companies and insurance companies are extremely reluctant to exercise discretion on much less contentious matters relating to the pension funds they hold, let alone make decisions of this magnitude. It is one thing for the custodian to adopt a passive stance with regard to L/Cs in an executive RCA; it would be quite another if that were to happen in a broad-based registered plan. On the other hand, a kneejerk decision by a custodian to call an L/C where other alternatives remained available could have catastrophic consequences for the plan sponsor. We believe that detailed consultations with the pension custodian sector would thus be necessary to determine if this were truly a viable option.

As is the case with so many of the issues facing plan sponsors and regulators, we believe the use of L/Cs is a much more complex issue than it appears at first blush. As such, at present we are somewhat sceptical that L/Cs would prove a practical solution to the short-term solvency funding crisis currently being experienced by many plans.

Extending Solvency Funding Period to 10 Years

The Government of Canada is seeking views on what the appropriate amortization period is and whether it is different for financially vulnerable and financially strong companies.

The Government of Canada is seeking views on what types of conditions or rules should be attached to any extended amortization period for solvency funding for companies under CCAA or BIA.

Given the dramatic and unexpected decline since 2001 in long-term interest rates and the corresponding spike in defined benefit pension plans' solvency liabilities, we believe that extending the solvency amortization period to ten years would constitute an eminently sensible reform. Unfortunately, the Consultation Paper somewhat prejudges the outcome of the consultation process by asserting that any extension "must" have conditions attached to "recognize the potential increase in risk".

With respect, we do not agree that plan sponsors should be required to give something up in order to qualify for a longer amortization period. Rather, we are of the view that sponsors are already sufficiently burdened and that an across-the-board amortization period of ten years would be a proper reflection of the realities at play in today's economic environment. We respectfully submit that access to such extension should not be accompanied by placing further restrictions on defined benefit plan sponsors.

Alternatives to Relaxing Funding Requirements

The Government of Canada is seeking views on whether there are alternatives to address funding issues other than relaxing funding requirements. For example, would special accounts for pension plans be feasible?

We do not believe that special accounts would be a feasible solution to the funding issues facing defined benefit plan sponsors, in the absence of watertight legislative guarantees of sponsor entitlement to recover the funds in such accounts should those funds prove not to be needed. With the uncertainty currently surrounding the trust aspect of pension plans, sponsors would likely be unmoved by the opportunity to pour money into yet another account over which members and former members might later lay claim.

Disclosure of Funding Information

The Government of Canada is seeking views on whether there should be greater disclosure provided to plan members regarding a plan sponsor's financial condition, funding decisions and contribution holidays and how this may be done.

With respect to the sponsor's financial condition, this information is already available in respect of public companies, and we believe it need not be duplicated for plan members. The imposition of additional disclosure requirements might also have securities laws implications, which could raise provincial jurisdiction issues.

With respect to funding decisions and contribution holidays, this information, too, is available for interested members to view should they so choose, in the actuarial valuation reports filed with OSFI. On balance, and with a view to encouraging the maintenance of defined benefit plans, we are not convinced that the incremental value to members of enhanced disclosure would outweigh the burden of adding yet another disclosure document to the already onerous obligations plaguing plan sponsors.

C. Void Amendments

The Government of Canada is seeking views on its proposal to implement the void amendments of the PBSA based on a prescribed solvency ratio level of 85 per cent, and to reduce the priority of claims against pension plan assets for recent benefit improvements that have not been fully funded. Specifically:

Is an 85 per cent solvency ratio an appropriate threshold for applying the proposed controls and conditions on plan improvements?

Should pension plans with solvency ratios below 85 per cent be permitted to make plan improvements provided that offsetting funding is provided at the time that the improvement comes into effect?

Would the proposed priority scheme improve security of longer-established benefits?

We have no comment with respect to this proposal.

D. Full Funding on Plan Termination

The Government of Canada is seeking views on full funding on plan termination, and in particular how it should be applied to financially vulnerable sponsors.

Full funding of any deficit existing as of the date of plan termination is another idea that might seem more attractive at first blush than on closer scrutiny. When OFSI floated a similar idea midway through the Air Canada restructuring in 2003, creditors reacted very negatively. Other lenders could have the same reaction to what would constitute a fundamental new threat to the interests of those extending credit to defined benefit plan sponsors. It is not difficult to foresee what those lenders might then do, meaning that this reform might ultimately backfire on the very employees and plan members it would ostensibly be designed to assist.

Accordingly, we would respectfully submit that no change to the rules in this area should be made now or for the foreseeable future.

E. Pension Benefit Guarantee Fund

The Government of Canada is seeking views on the viability of a federal pension guarantee fund including any comments on its possible design, operation, and powers.

The possibility of establishing a federal pension benefits guarantee fund is not an idea we would support. The vast majority of benefits paid out of federally-registered pension plans are funded by a handful of plan sponsors, meaning that the proposed guarantee fund could never operate as a true pooling of risks. Rather, in the event of a material default, the fund would effectively have to be financed by taxpayers. With respect, we can see no public policy justification for having taxpayers backstop the retirement income of a relatively small group of persons who already enjoy pension benefits far superior to those available to most Canadians.


Once again, we would like to express our appreciation for the opportunity to make these submissions. We hope that the ensuing reforms will restore some balance to the rules governing defined benefit plans.

Yours very truly,

Gary Nachshen
Andrea Boctor

AB/MF