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International Association of Machinists and Aerospace Worker's Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:

September 12, 2005

Diane Lafleur
Financial Sector Policy Branch
Department of Finance
L'Esplanade Laurier
20th Floor, East Tower
140 O'Connor Street
Ottawa, Ontario K1A 0G5

Dear Ms. Lafleur:

I am pleased to have the opportunity to respond to the Finance Department's consultation paper, "Strengthening the Legislative and Regulatory Framework for Defined Benefit Pension Plans registered under the Pension Benefits Standards Act, 1985". I have no objection to the public posting of this response, and hope that the IAM and other unions will be directly consulted on proposals for changes in the legislative and regulatory regime as they come forward.

The consultation paper raises important issues, particularly for unions. Union members make up the majority of registered defined benefit pension plan members in Canada. Most workplace pension plans, while not mandated by law, are not truly "voluntary" on the part of employers (as the "Context" section of the paper says), but are negotiated benefits, negotiated as part of a broad compensation package. The security of the negotiated pension benefit is a central union concern.

This consultation paper is part of a wide range of current activity in Canada dealing with the security of defined benefits in pension plans. CAPSA has issued proposed funding principles for a model pension law. The CIA is considering the proposals of a task force on funding principles. Various provincial jurisdictions have made, or are considering, changes to funding rules, and at the federal level, changes affecting pension plans have been proposed in relation to the Bankruptcy Act and a Wage Earner Protection Fund. I would hope that the federal government is working to coordinate its efforts with those of others.

The federal regulatory framework for registered pension plans is certainly due for review and improvement. There is a need to increase the security of promised defined benefits, and to improve the fairness of the system. The current regulatory system is clearly unbalanced – employers in single employer plans typically have complete control over plan administration, yet have many ways of avoiding responsibility and liability.

Another concern is that the federal regulator, OSFI, does not engage with plan members and the unions that represent them – in fact refuses to communicate directly with them in a substantive way, and is usually more concerned with protecting its bureaucratic behind than protecting the interests of plan members and beneficiaries.

Unfortunately, this distorted regulatory attitude is reflected in many parts of the discussion paper. For example, in the first Issue section, Surplus, the paper presents the ridiculous assertion that "in the absence of contractual clarity, the PBSA has the effect of requiring the plan sponsors to share any surplus while remaining fully responsible for pension plan deficits." This is close to being the exact opposite of the truth.

In an ongoing single-employer defined benefit plan, in the absence of very clear language to the contrary, an employer has an unrestricted right to use surpluses for contribution holidays. Employers have even used this "right" to take contribution holidays based on out-of-date valuations, when it was clear that there was no longer a surplus in the fund.

In an ongoing plan, the use of contribution holidays is offset by the obligation to fund shortfalls. As surpluses have been far more common than shortfalls over the last 30 years, most employers have in fact contributed less, often much less, than the theoretical costs presented in actuarial valuations.

In the last few years, however, as deficits have replaced surpluses, employers have decided that a balanced deal, in which they have to fund deficits as the counterpart to contribution holidays, is unfair, so they pushing to change the rules or wind up their defined benefit plans.

It would have been a useful preparatory exercise for this review for OSFI to analyze the history of surpluses, contribution holidays and deficits in its jurisdiction, so that we might have a more concrete basis on which to assess the real sharing of funding risks.

On pension plan windup in the federal jurisdiction, if the employer has shown clear surplus rights, it can take all of the surplus. Even if the employer has no legal right to any surplus, it is in a strong position, through its control of the windup process, to force members to agree to share surplus with it.

If there is a shortfall on windup, the employer is not required to fund it, even if the employer is solvent. If there is any "asymmetry" in surplus ownership under the PBSA, it is clearly tilted in favour of employer interests.

In relation to the question of obstacles to adequate funding, removing (or substantially increasing) the ITA limits on surplus would be a useful step in allowing pension plans to build up a funding cushion. Limits on employer contribution holidays – perhaps a minimum 10% surplus cushion, or a requirement for union agreement, would more directly improve benefit security.

It is disturbing that the paper says the rules and guidelines for surplus distribution are generally working well, but offers no evidence or data. Here again, some real world analysis is essential. How many surplus distributions have been approved under the provisions of the PBSA over the last 5, 10 or 20 years? How many have been done on the basis of "clear employer entitlement", how many on the basis of a vote or union agreement, and how many through arbitration? What have been the terms of the surplus sharing deals between companies, members and beneficiaries?

How can you judge the current provisions and assess the need for changes without analyzing their history?

As noted earlier, the employer's position as plan administrator gives it a heavy advantage with respect to surplus distribution. The legislation needs to be amended so that the employer must have the approval of the union or plan members if surplus is to be distributed, with timely access to arbitration if no agreement is reached at a windup or partial windup. There must be firm time limits on windup or partial windup to ensure that employers do not delay the process to gain additional leverage.

It is deeply disturbing that the paper suggests that OSFI continues to believe that the PBSA does not require the distribution of surplus on partial windup. The courts, unanimously, at three levels (including the Supreme Court of Canada) have said, in the Monsanto case, that the law in Ontario (which is virtually identical on this issue to the PBSA) requires the distribution of surplus on partial windup. The Supreme Court rejected the OSFI interpretation of the law (an interpretation that is based purely on bureaucratic convenience), yet the paper suggests that this wrong interpretation remains OSFI's position. This is unacceptable. The government and its bureaucrats cannot ignore a clear Supreme Court decision.

On the issue of whether the law with respect to partial windups should be amended going forward, there is no reason to change the current rules (though clearly OSFI must enforce them). A partial windup reflects the fact that a shutdown or major downsizing has similar effects on plan members to those of a full windup, and requiring surplus distribution at that time (as opposed to allowing employers alone to decide if they want access to surplus) is elementary fairness. Immediate vesting, while a positive step, does not provide the equivalent protection. The possibility of a partial windup declaration can be a means of ensuring that an employer cannot simply keep a plan running on a reduced, or token basis, to avoid the requirements of a full windup, so partial windups should be maintained in the legislation.

In funding defined benefit pension plans, there is inevitably a tension between limiting current costs and increasing the size of the fund and benefit security.

The current solvency funding rules were developed and introduced at a time when long-term interest rates were substantially higher, and where solvency shortfalls were a relatively minor problem. With current low long-term interest rates, plans can have significant solvency deficits, while actuarially healthy on a going-concern basis.

Lengthening the amortization period for solvency deficiencies reduces benefit security. Such a change on a general basis would only be acceptable if there are other offsetting changes in the funding regime to improve benefit security, including the changes suggested above to limit and control contribution holidays, a requirement for employers to fund unfunded liabilities on plan windup (as proposed with S-3, but inexplicably never enacted), higher priority in bankruptcy and insolvency proceedings for pension unfunded liabilities, and a federal pension benefits guarantee fund.

Letters of Credit are not a workable alternative to solvency funding. Who will police and monitor Letters of Credit to ensuring that they are current and effective? It would also be necessary to constantly monitor the issuer of the letter of credit, since a letter of credit provided by an institution which is itself inadequately funded or can become insolvent is useless.

The paper asks whether funding rules and amortization periods should be different based on the financial strength or vulnerability of the companies involved. This is highly problematic. A company's financial condition may not be transparent, and it can change quickly. Who will be in a position to review and police such provisions? Certainly not the actuaries and consultants employed by the plan sponsor – and the regulator clearly lacks the capacity.

It is not clear what "greater disclosure ... of a plan sponsor's financial condition", as suggested in the paper, would mean. For a public company, what additional financial information could be made available? Would private companies be required to publish their financial statements?

More generally, it is important, as recently proposed by the CIA task force, that every pension plan have a clear and public funding policy – which makes transparent the funding strategies, contribution holiday policies, use of surplus, etc.

The idea of special accounts, as a method for employers to avoid possible surplus sharing on plan windup, is highly problematic. Instead of trying to encourage employers to fund above the minimum (an unlikely prospect at best), the focus of any changes needs to be a set of funding standards that will provide a high level of benefit security for all plans.

The resurrected proposal to declare void plan amendments which bring the solvency position of the plan below 85% is rigid, and would make it difficult to start up new DB plans, as well as to upgrade existing flat benefit plans. This change would have had little impact on the current crop of solvency deficiencies, which arose because of sharp declines in stock markets and long-term interest rates (as well as a history of contribution holidays), rather than major plan upgrades. The appropriateness of benefit improvements is best dealt with in the context of a clear plan funding policy, which recognizes the nature of the specific plan.

As was said earlier, an employer's responsibility for full funding on plan windup is essential, particularly for financially-vulnerable sponsors, and should have been introduced subsequent to S-3. This is a necessary complement to a federal Pension Benefits Guarantee Fund.

To conclude, this review of the federal PBSA is timely. It is essential, however, that legislative changes do not work to lessen benefit security at a time when many pension plans are vulnerable. Any loosening of funding rules must at least be offset by changes to enhance benefit security.

I look forward to the opportunity to participate in future steps in this review process.

Sincerely,

Louis Erlichman
Canadian Research Director
International Association of Machinists and Aerospace Workers