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The Pension and Employee Benefits Group of Blake, Cassels & Graydon's Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:

Box 25, Commerce Court West
199 Bay Street
Toronto, Ontario, Canada
M5L 1A9

Deliveries: 28th Floor
Telephone: 416.863.2400
Facsimile: 416.863.2653

Pension & Benefits Group
Reference: 99997/99993

September 15, 2005


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

Dear Ms. Lafleur:

Re: Strengthening the Legislative and Regulatory Framework for Defined Benefit Pension Plans Registered under the Pension Benefits Standards Act, 1985

I. Introduction

In response to the Department of Finance's 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") we are pleased to provide this submission (the "Submission") on behalf of the Pension and Employee Benefits Group at Blake Cassels & Graydon LLP. The Group consists of 16 lawyers in Toronto, Montreal and Vancouver whose practices are devoted to pension, benefits and compensation law.

We appreciate the opportunity to comment on the Consultation Paper. The views expressed in this Submission are those of the partners in the Blakes Pension and Employee Benefits Group. We are not writing on behalf of, or to express the views of any client of Blakes. However, our comments are influenced by our experience working with many Canadian pension plan sponsors, administrators, service providers, trustees and custodians, both in connection with plans registered under the federal Pension Benefits Standards Act, 1985 (the "PBSA") and in connection with plans registered under various provincial pension standards statutes.

Following are our comments on a number of the "Issues for Discussion" identified in the Consultation Paper. These issues are addressed in the order in which they appear in the Consultation Paper. In general, our comments relate to defined benefit registered pension plans that are not multi-employer pension plans ("MEPPs") although in a few cases we have identified specific MEPP or defined contribution plan issues arising with respect to the questions raised in the Consultation Paper.

II. 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.

It is critically important to businesses and labour that pension plan funding obligations be predictable. Without funding predictability, companies cannot make business plans regarding new investments, new products, and new jobs. Without funding predictability, companies will not willingly provide or continue defined benefit pension plans.

As you will note from our comments on specific issues addressed in the Consultation Paper, we agree that there is asymmetry and inconsistency in the current rules and policy objectives. In our view, comprehensive reform is more likely to strengthen the defined benefit system than temporary or piece-meal solutions. From a legal perspective, principles for reform should be comprehensive and should include certainty, flexibility, common sense, and consistency.

In our view it is important to encourage employers to make adequate provision for expected defined benefit liabilities during strong economic times to ensure the plans they sponsor will survive economic downturns or market fluctuations. Imposing arbitrary tax limits on funding that fail to recognize a particular employer's business cycle is short-sighted. We believe it is common sense in a voluntary pension system to allow greater flexibility in funding beyond threshold minimum standards. In our view this means tax rules should be more flexible and recognize that a business is not likely to view a pension fund as a more profitable investment than its own business activity. It also means that minimum standards legislation should be open to more flexibility in recognizing alternative methods of securing the pension promise, such as the use of fully secured debt instruments, including letters of credit. We believe the best way to ensure a stable defined benefit system is to provide greater flexibility above minimum funding standards that allows employers to plan within the parameters of their own business cycles.

Employers who fund beyond minimum funding standards or make provision for future fluctuations in their own business cycles should not be penalized for overestimating the amount of their contributions. A major disincentive faced by plan sponsors under current rules is that they are responsible for funding shortfalls but are effectively prevented from accessing surplus. Undoubtedly this leads to slavish adherence to minimum funding standards and as a consequence, increased benefit security risk. Requiring estimated surpluses to be distributed on partial wind up does not ensure a stable defined benefit system, as it ignores the provisional nature of an actuarial surplus as well as the long term nature of actuarial and provisional funding objectives. As discussed below in connection with partial plan terminations, it is our view that requiring estimated surplus to be distributed on partial wind-up is also inconsistent with minimum standards rules to protect funding integrity where surplus is withdrawn from an ongoing plan. If a partial wind up is simply one event in the ongoing life of a plan, it is not clear to us why a cushion is necessary for an ongoing surplus withdrawal, but unnecessary where there is a partial wind up.

Consideration should be given to implementing rules to deal with improvident benefit promises. For example, consideration should be given to imposing restrictions on benefit improvements where the improvements are likely to affect the funded status of benefits accrued to the date of improvement. This might include a prohibition on such improvements, or conceivably, a requirement for separate funding rules for benefit improvements that create unfunded liabilities.

As noted in the consultation draft, the current five-year amortization period for solvency funding is in many instances too short and, coupled with potential volatility of results, can create surplus in the future which, under current rules, is relatively inaccessible to plan sponsors. We agree that more flexibility is required, but within the context of maintaining benefit security and within a context of certainty.

For some employers, a negotiated contribution defined benefit plan appears to provide an alternative means of predicting cost while providing a defined benefit. However, despite the contractual nature of the funding commitment and legislative recognition of the role of the board of trustees under such plans, these plans remain subject to the same funding regulations as other plans. In other words, employers appear to remain responsible for adhering to legislative funding and solvency standards despite a fixed contribution commitment. This inconsistency exposes employers to uncertainty, and potential additional and unpredictable cost whenever an actuarial report discloses funding requirements in excess of negotiated levels, the plan administrator does not reduce benefits, and the union is unable or unwilling to agree to increasing employee contributions or reducing benefits. Such inconsistency between funding requirements and the nature of the plan creates uncertainty and represents not only an obstacle to funding, but an incentive to terminate the arrangement.

In summary, we think the decline in defined benefit plans and declining coverage under such plans supports the view that there are disincentives and obstacles to funding such plans conservatively, let alone building surpluses. These obstacles would be best addressed, in our view, with rules that are comprehensive, consistent, certain and flexible enough to respect the ability and willingness of sponsors to provide adequate long-term funding and security.

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

Subsections 9.2(4)-(15) of the PBSA contemplate an arbitration where more than half but less than two-thirds of the members and former members of the affected pension plan have consented to an employer proposal regarding surplus. Nowhere, however, does the PBSA prescribe the issue to be determined by the arbitrator or the test to be applied. The issue before the arbitrator cannot logically be the issue of legal "entitlement" to the surplus since an employer who can establish entitlement need not (pursuant to subparagraph 9.2(1)(a)(i)) obtain the consent of any members or former members and has no reason to make any surplus sharing proposal. It is thus not clear what issue is to be decided by the arbitrator. If the arbitrator is to decide what, in the circumstances, would constitute a fair allocation of surplus between the employer and members having regard to certain defined factors (excluding "entitlement" but perhaps including the risks to each party of litigating the issue of "entitlement"), this should be specified. The absence in the existing PBSA provisions of a clear definition of the issue to be arbitrated and the test to be applied makes resort to those provisions unattractive to employers. In fact, as currently drafted, the arbitration provisions are essentially unworkable. We understand they have not been widely used.

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.

In our view, there is essentially no need for specific provisions in the PBSA relating to partial plan terminations. In any event, there should not be any requirement under the legislation to distribute surplus as a consequence of a partial wind up. Unlike pension benefits legislation in Ontario, the PBSA does not provide enhanced grow-in benefits where a partial wind up regime is directly relevant to the determination of pension benefit entitlements. Member entitlement issues such as immediate vesting (if this is seen as a desired policy objective) and portability can be addressed through specific provisions in the PBSA or in narrowly focused provisions relating to partial wind ups. Funding of pension plans which are undergoing a partial wind up should be reviewed in the context of the overall review of funding (particularly solvency funding) under the PBSA. As discussed below, there should not be any requirement to distribute surplus as a consequence of a partial wind up. If there is any doubt concerning continuing trust or other plan rights (as opposed to statutory rights) for individuals affected by a partial wind up, the PBSA could be clarified to indicate that the right of persons affected by a partial wind up under the terms of a plan to surplus upon plan termination, if any, should be addressed as and when the plan is fully terminated and when there is an actual as opposed to an actuarial surplus.

On the question of whether there should be a requirement to distribute surplus following a partial (as opposed to full plan termination), we continue to agree with the policy reasons put forward by the Government of Canada in its intervention in the Monsanto litigation. Specifically, the policy objectives of the PBSA are not met by having regard only to the interests of laid off or terminated members; the interests of continuing employees and retirees must also be considered and addressed in any amendment to the PBSA. The objective of maximizing solvency of existing defined benefit pension plans should always be a primary objective under the PBSA. It goes without saying that the defined benefit pension sector in Canada is in serious decline, particularly in the case of medium and even some large private sector plans. The objective of maximizing solvency of existing defined benefit plans is clearly not advanced through the existence of legislation that might be interpreted to require, notwithstanding the interests of continuing members of a pension plan, immediate distribution of an actuarial surplus. The recent volatile experience in the financial markets, including changes in interest rates, vividly demonstrates that an actuarial surplus can turn, in some cases with alarming speed, into an actuarial deficit, or even a real deficit if circumstances require, or result in a full plan termination. Finally, although a distribution of surplus might be considered a benefit that ought to be protected under pension legislation, it cannot be reasonably argued that the protection of what is, at most times, a mere contingent interest warrants the same degree of legislative protection as an actual promised pension benefit entitlement.


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?

Allowing plan sponsors to use letters of credit to supplement more traditional methods of funding solvency deficiencies would be an important positive improvement provided the letter of credit arrangements are properly structured. Use of letters of credit to secure solvency funding obligations is enjoying growing support from plan sponsors and their advisors. The benefits of such arrangements would include:

  • they would provide much-needed flexibility with respect to solvency contribution requirements, while not adversely impacting the rate at which pension benefits are presently secured;
  • they would not show favoritism to any one plan sponsor;
  • they would be available to financially sound plan sponsors only, as determined by independent financial institutions; and
  • there is no additional risk to pensioners and active employees from utilizing irrevocable letters of credit as an alternative funding source.

We believe letter of credit arrangements with the following characteristics would provide the benefits outlined above:

1. Employers could forego all or a part of their required solvency contributions for any year by arranging a letter of credit for the foregone solvency contributions. At any time, the sum of the plan's assets and the face amount of the letters of credit would equal the expected assets at that time as if the required solvency contributions had been made in cash.

2. Once a letter of credit has been arranged for a specified amount of foregone contributions, it would be required to remain in effect in such amount as long as the contributions remain unpaid or, if earlier, until the plan has a solvency surplus (taking into account the face amount of the letters of credit in place).

3. The letters of credit would be required to be held by the pension plan's trustee or other funding agent. (This parallels the approach presently used for securing supplemental pension plan benefits with letters of credit.)

4. Letters of credit would be required to be called by the trustee, and the proceeds deposited directly to the pension fund, in the following circumstances [1]:

a. Failure to renew a letter of credit, unless it is no longer required (either as a result of the employer remitting the previously-foregone contributions or the plan reverting to a solvency surplus).

b. Failure to remit contributions in the plan year in which they are due based on a schedule provided by the employer or administrator.

5. It will be important to consult with the trust company industry before legislation is developed. If the letter of credit mechanism imposes an unreasonable burden or legal risk on trustees to determine, for example, compliance with pension plan contribution legislation or imposes notice requirement on trustees, trust companies will be unwilling to provide trust services for plans which use the letter of credit mechanism. Letters of credit would be required to be issued by strong financial institutions whose own credit must be rated by DBRS as "A-" or higher (or equivalent rating from another major credit rating agency) and the institution must deal at arm's length from the plan sponsor.

6. Where letters of credit are in place, additional contributions would be required equal to the deemed interest on the foregone solvency contributions on the basis that the pension fund should be compensated for the fact that the letters of credit are not interest-bearing pension fund assets.

7. Subject to our comments in paragraph 5 above, the legislation should contain clear rules regarding the role of the trustee. In particular, the letter of credit for the portion of an ensuing year's contribution to be met in such fashion would be required to be arranged before the beginning of the year. The trustee should be provided with a schedule setting out statutory minimum contributions for the ensuing year, upon which it can rely without having to independently investigate whether the schedule is correct, including the portion to be met via letter of credit. Further, any increase in contribution requirements for such year would be required to be contributed in cash. In addition, the legislation and/or regulations governing the letter of credit arrangement should clearly specify the events of default pursuant to which the trustee must call the letter of credit, how the letter of credit proceeds should be applied and any reporting obligations. The trustee should have minimal discretion in dealing with the letter of credit and should not be subject to impractical notice requirements in the event a letter of credit must be called upon.

8. In determining the solvency funded position of the plan, but not the going-concern funded position, the face amount of the letters of credit would be included in the plan assets.

9. Flexibility should be provided so that the face amount of any letters of credit in place could be reduced to extent that solvency payments for a fiscal year exceed the minimum requirement for such year. This would provide employers with the option of contributing to the fund any solvency contribution requirements that had been previously met via letter of credit. Again, trust industry input on such a mechanism will be desirable. For example, the legislation will need to provide clear guidance to a trustee of the circumstance in which it can agree to a reduction in the face value of the letter of credit.

10. The face amount of any letters of credit in place could be reduced if, at the effective date of an actuarial valuation, the sum of the market value of plan assets and the face amount of the letter of credit exceeded the plan's solvency liabilities.

11 The plan sponsor would be required to pay all fees related to securing the letters of credit in order that this proposal not dilute the security of benefits as a result of the plan incurring additional expenses.

12. Annual actuarial valuations would be required while any letters of credit remain in place.

13. In determining a plan's solvency ratio / transfer ratio, the face amount of any letters of credit in place would be included in the plan assets.

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.

We agree that there is no single amortization period that will satisfy all stakeholders. However, we support the extension of the amortization period from five years to ten years for all sponsors of defined benefit plans as a way of encouraging the establishment and maintenance of such plans. We understand that some stakeholders take the position that such an extension should only be allowed where a plan sponsor is financially vulnerable and that there should be a number of prescribed conditions administered by the Superintendent that a sponsor must meet in order to obtain an extension. This will result in significant administrative complexity for both plan sponsors and the Superintendent and may result in legal challenges where the Superintendent is required to exercise discretion with respect to sponsors' eligibility for an extension.

Alternatives to Relaxing Funding Requirements

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

We are uncertain as to the form a "special notional account" or other alternative to relaxing the funding period for solvency deficiencies would take. It is possible that some such alternatives could have merit but we believe that stakeholders need a more detailed description of the funding alternatives being considered in order to provide useful comments on the viability of any particular alternative.

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.

The PBSA currently requires that members' annual statements disclose the plan's solvency ratio (if less than one), the steps being taken to eliminate the solvency deficiency and the reduction in the members' benefits that would occur if the plan were wound up with its existing solvency ratio. We do not see a clear link between providing additional member disclosure and improved funding. At any particular time the funding of a defined benefit pension plan is a function of the plan terms and regulatory requirements relating to funding as applied by the plan actuary and the plan sponsor's ability to contribute to the plan. This is not affected by whether the sponsor has disclosed its financial situation, funding policy or contribution holidays to members.

In many cases plan sponsors financial statements and structure will be highly complex. It is doubtful that rules could be designed that would ensure members were provided with understandable financial disclosure relevant to the funding of the sponsor's pension obligations. Furthermore, public companies already provide substantial disclosure of their financial condition pursuant to corporate and securities laws, which disclosure is available to plan members. In the case of private companies, they are not required to make public disclosure of their financial affairs and may object to doing so simply because they have chosen to offer employees a defined benefit pension plan. Requiring such disclosure by private companies would be a disincentive for them to establish or maintain a defined benefit pension plan.

In addition, requiring plan sponsors to establish and disclose a formal policy on funding and/or contribution holidays is also a disincentive to maintaining a defined benefit plan because it will result in additional cost to the plan sponsor in developing, formalizing and communicating its policy and may lead to conflicts with employees who disagree with the policies (perhaps without fully understanding the actuarial and legal bases for the policies). Moreover, we do not believe that a plan sponsor is more likely to fund a defined benefit plan more generously because it is required to disclose its funding or contribution holiday policy to plan members.

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 provide at the time that the improvements comes into effect?
  • Would the proposed priority scheme improve security of longer established benefits.

In our view, actuaries are in a better position than lawyers to advise as to the appropriate funding cut-off point. Obviously, there needs to be a balance between the desire to encourage benefit improvements and the need to ensure that any such improvements are adequately funded.

In cases where a pension plan has a deficit at plan termination, subject to the ability of the plan sponsor in a single employer plan to fully fund this deficit and any changes to the PBSA to require it to do so, we agree that benefits that result from recent plan amendments should have lower priority than other benefits. It would be beneficial to disclose this lower priority in the notice to members advising them of the plan amendment.

In addition, where regulations are implemented, they should clearly deal with "improvident" proposed amendments to contribution levels under MEPPs and defined contribution plans.

D. 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.

We do not support the establishment of a federal pension guarantee fund for the following reasons:

1. Cost

a. The additional cost to plan sponsors could contribute to the shift to defined contribution pension plans or out of the pension plan system altogether.

b. The cost of the guarantee fund diverts financial resources away from making up deficits and towards paying the cost of such a fund.

c. The increased cost burden on an underfunded scheme occurs precisely when the financial health of such business is likely to be weakest.

2. Risk Based Assessment System

a. It would seem necessary to establish a risk based assessment system in order to properly charge each pension plan for its insurance risk.

b. The main problem with such a system is that those with the greatest need for protection (financially troubled companies with poorly funded pension plans) are the least able to fund it.

c. Premium levels would have to differentiate depending on the solvency level of the particular plan at the relevant time. Otherwise unacceptable cross-subsidies occur between plan sponsors.

d. Levels of coverage would have to be limited.

3. Lack of Vigilance by Plan Sponsor and Trustees (i.e. Moral Hazard)

a. There appears to be a disincentive for plan sponsors and trustees, especially in situations where plan sponsors are in financial difficulty, to manage pension plans to control risks if the relevant pension liabilities will be covered by a third party. In any event, this degree of monitoring is impractical for corporate trustees and other funding agents.

4. Risk of Underfunding of a National Pension Guarantee Fund

a. If a national pension guarantee fund were established and a deficit arose, as it has in Ontario and the U.S., there would then be pressure on the government for funding. Government funding for a system covering only a relatively small portion of the population, i.e. those with defined benefit pension plans without sufficient assets on termination, could see significant opposition. The potential economic impact of such an obligation would also have to be balanced against other government priorities.

5. The Need to Control Enhancements & Reckless Investment Policies

a. As noted in the ACPM DB Funding Report "Guarantee funds must be protected from practices that deliberately expose them to the risk of large claims. Struggling organization with poorly funded pension plans should not be allowed to improve pension benefits and/or adopt reckless investment policies knowing that the guarantee fund will make good any deficiency."

III. Conclusion

We appreciate this opportunity to provide our views on the issues raised in the Consultation. If you wish clarification of any of our comments please contact Elizabeth Boyd at (416) 863-4172 (elizabeth.boyd@blakes.com) or Barbara Austin at (416) 863-3893 (barbara.austin@blakes.com).

Yours very truly,

Pension & Employee Benefits Group
Blake, Cassels & Graydon LLP
Pension & Employee Benefits Group


1. May require an Income Tax amendment so that any such deposits are "eligible contributions" and are tax deductible by the employer.  [Back]