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Ottawa International Airport Authority Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:
August 19, 2005
Financial Sector Policy Branch,
Department of Finance
20th Floor, East Tower
140 O'Connor Street
Ottawa, Canada K1A 0G5
By email: email@example.com
Dear Ms. Lafleur:
This letter is to provide comments on the funding proposals included in the Department of Finance consultation paper on "Strengthening the legislative and regulatory framework for Defined Benefit Pension Plans" dated May 2005.
I find it unfortunate that part B of the consultation paper, in its focus on the requirements for funding, blindly seems to accept the assumption that the existing solvency test is an appropriate measure for determining the risk of plan termination. One needs to go back to first principles and ask these questions: What is the risk that needs to be detected and mitigated with a solvency test? What is the desired outcome? Does the solvency test mitigate these risks with the desired outcome?
Is the solvency test serving the basic principles as intended? Or is there something basically wrong with a test that, when the circumstances really warrant some extra protection for plan members (such as the sponsor's potential business failure), the regulator looks to relaxing the requirements?
Relaxing requirements for funding solvency deficits when there truly is a high risk of termination makes a mockery of the test. Such mockery is well deserved. Changing and improving the test to a meaningful test or sequence of tests that realistically assesses the risk of termination would be a better first step. There is an urgent need to move to a risk-based assessment of solvency.
Extending relief to less solvent sponsors is counter-intuitive to mitigating the risk. When the rubber hits the road and a plan sponsor does in fact face a higher risk of failure, the Finance paper contemplates extending the funding period for a longer period (ala Air Canada). This is counter-intuitive to what would happen in the commercial world. In the commercial world, most creditors would respond to such a risk by tightening credit, and not by allowing for payment over even longer terms. However, in certain industries, it is not uncommon to ask a customer that is a poor credit risk to provide a standby letter of credit to guarantee future payment. But one would certainly not relax payment terms. This tells me that the solvency test is not an adequate measure and device to protect plan members.
The Act requires that pension funds be funded based on both "going-concern valuations" and "solvency valuations" of plan assets and plan liabilities. Many company pension plans meet the going concern tests, but in 2004 54% of these plans found themselves with solvency deficits. 54%! Solvency valuations are meant to reduce the risk of a loss of benefits in the event that a plan is terminated, including as a result of the failure of the plan sponsor. Can the economy of Canada be in such a poor state that 54% of businesses are at risk of failure, including failure to maintain their pension plans on a going concern basis?
The question of companies in good financial condition continuing to perform solvency valuations is a bit of a contradiction – much like asking solvent going concern public companies to periodically value their assets on a forced liquidation basis and asking shareholders to respond. Or like asking homeowners to value their homes on a forced liquidation basis in a down-market, and asking these homeowners to immediately come up with the shortfall from their mortgage.
What are the solutions? Without pursuing the technical, legal, and administrative questions related to the following, I would suggest that the following suggestions merit further study and consideration:
1. Establish a multi-step process of evaluating, first of all, the risk of failure or plan termination. If there is a higher than acceptable risk of failure, it would then be appropriate to determine the outcome of such a failure with a solvency calculation.
- As a first step, evaluate the financial vulnerability of the plan sponsor. For example, if a plan sponsor is a crown corporation or a debt issuer with an A credit rating or better from Standard & Poors, Moody's, or DBRS, it is unlikely that this sponsor will fail in its obligations to continue funding its pension plan in the medium term.
- Enquire as to the sponsor's future plans to terminate the plan. If the sponsor intends to terminate the plan, irrespective of the sponsor's financial strength, this may lead to an immediate course of action with regards to solvency payments. If the sponsor intends to continue the plan and the sponsor meets the criteria of strong financial footing, then a course of action regarding solvency payments would not be necessary.
- Determine a course of action regarding solvency payments if the sponsor is experiencing financial difficulty or is otherwise highly financially vulnerable, depending on the severity of this situation. For example, if the solvency ratio is 90 % or higher, no payments would be required. If the ratio is between 80 % and 90 %, payments might be required over a ten year period. If the solvency ratio is below 80 %, payments might be made over a 5 year period.
2. The Government of Canada should provide an alternative vehicle for investing and managing assets of terminated pension plans (as it now successfully does with Canada Pension Plan (CPP) assets). In the stress of plan termination, the prudent plan member should not be investing his locked-in pension assets in long-term fixed income securities or insurance companies providing suboptimal returns, but should be investing in a suitable balanced mix of assets that suits his situation. Perhaps this is where the Government of Canada needs to step in, and provide special guidance or assistance, or perhaps it needs to establish and manage a special investment fund for all of these assets (as it now successfully does with CPP assets).
3. Revise the criteria for calculation of solvency valuations. Low interest rates are the problem – in the short history of solvency calculations, we have never ever seen interest rates as low as they are today. Actuaries are given no flexibility to consider the circumstances. Instead, they are driven to make assumptions for the solvency valuation of pension liabilities based today's requirement that existing assets will be invested in long-term fixed income assets (life insurance policies). Long term interest rates are the lowest they have been in over 40 years. What happened in the 1960's, the last time that interest rates were this low? My actuaries tell me that pension plans were generally in their infancy in the 1960's, and for that matter, the solvency test did not come into existence until the late 1980's, early 1990's. There are alternative investment vehicles for terminated pension plan assets, and these should be considered in determining rates of return for calculating NPV of pension liabilities.
4. Allow sponsors other means to guarantee pension plan solvency deficits when appropriate (that is, when it is necessary to do so because the plan sponsor does not meet the financial vulnerability test). This could be done with instruments such as letters of credit. Such letters of credit should contain appropriate terms and conditions to ensure the protection of pension plan benefits for the duration of time that a solvency deficit exists.
5. If solvency conditions prevail or deteriorate, consider solvency payments into the plan to amortize the shortfall, but this should not be done over an extended 10 year basis. Rather, if these conditions are truly serious, the amortization of the deficit should be done over as short a period of time as possible. I oppose extending the solvency funding period to 10 years. Even 5 years to fund a solvency deficit is not consistent with the premise that the plan may be terminated in the short term.
I attach to this letter a letter that I wrote on March 22, 2005 to OSFI outlining my concerns with regards to one-size-fits-all solvency test requirements. Any test which requires the exceptions that are proposed in the consultation paper must be flawed in its basic application.
If you have any questions on this letter, please do not hesitate to contact me at 613-248-2000 extension 1107. I hereby also give my express permission to post these comments on the Department of Finance website.
John G. Weerdenburg, CA
Vice-President and CFO
Ottawa International Airport Authority
Chair, Pension Committee