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Canadian Labour Congress' Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:
Submission by the Canadian Labour Congress to the Department of Finance
Consultation Paper (May 2005)
"Strengthening the Legislative and Regulatory Framework for Defined Benefit Pension Plans Registered under the Pensions Benefits Standards Act, 1985"
September 15, 2005
On behalf of the three million members of the Canadian Labour Congress (CLC), we want to thank you for affording us the opportunity to present our views. The CLC brings together Canada's national and international unions along with the provincial and territorial federations of labour and 137 district labour councils whose members work in virtually all sectors of the Canadian economy, in all occupations, in all parts of Canada.
The CLC wishes to commend the Department of Finance for undertaking its public consultation on the financing of defined benefit workplace pension plans (Regulatory Framework for Federally Regulated Defined Benefit Pension Plans). The subject matter of this consultation is important to the CLC. Approximately two-thirds of union members belong to workplace pension plans compared to less than 30% of non-union members. Union members with workplace pension plans belong overwhelmingly to defined benefit (DB) plans.
In recent years, changing conditions in financial markets have created a number of problems for the financing of workplace pension plans. In the past several months, these concerns have been raised by the CLC President with the Minister of Finance and other ministers, and by CLC staff with staff of the Department. The CLC regards the consultations as a response to the concerns expressed by the CLC and by others, including some employers and representatives of the 'pension industry.'
The consultation paper raises a number of specific questions and suggestions and invites a response to them. Most of these will be addressed directly below. The CLC will also raise a few additional ideas about pension financing that we believe are worth discussing. But first, a few general points about the issue and the paper need to be made.
Because the consultation document tends to raise regulatory issues as problems for plan sponsors, it is important to make the general point that what is required of pension regulation depends somewhat on the role that workplace pensions are expected to play in the pension system as a whole. The broad contours of Canada's regulatory regime were put in place in the context of debates about the shape of the pension system as a whole. Against the advice of the trade union movement, governments accepted the argument of the 'pension industry' that a regime that left lots of room for highly regulated workplace pensions was to be preferred to a regime that relied more heavily on public programs (Old Age Security (OAS) and the Canada and Quebec Pension Plans (C/QPP).
As such, the CLC takes this opportunity to reiterate the need to strengthen and improve the C/QPP. An improved system that would cover a larger share of workers' salary would cover all workers, provide a transferable benefit as workers move from one job to another, could take non-remunerated years of child-rearing into fuller account, and would cost less to administer than the current plethora of private plans.
Furthermore, given that regulatory law makes no provision for the equal sharing of pension management responsibilities, substantive law has been relied upon to protect the interests of plan members. The fact that sponsors may find certain aspects of regulatory law inconvenient is a fact worth noting, but it is a decisive argument for nothing. That said, it would have been worth setting the review of DB financing issues in the context of a wider discussion of review of Canadian pension arrangements as the CLC has proposed.
In addressing DB financing issues, the CLC has been mindful of the tension that exists between the competing objectives of providing security to promised benefits through the full funding of pensions, and the stabilization of pension contributions. In recent years, pension contributions have been destabilized by changes in financial markets. Moves in the direction of solvency valuations and accounting rules have accentuated the impact of market changes on pension contributions, and has influenced employers to under-fund DB plans. Unfortunately, the lack of stability in DB pension contributions has undermined the security of benefits by contributing to the general shift from DB to defined contribution (DC) plans, or to abandon workplace pensions altogether.
Throughout the text, the shift to DC and/or the abandonment of workplace pensions is noted as a problem. But, the problem is frequently associated with domestic regulatory and/or judicial issues. Explanations of this sort overlook the reality that the problems are found in the context of very different regulatory settings. It is also striking that no mention is ever made of the deliberate mismatching of assets and liabilities that characterizes pension financing. To some extent, the current financial difficulties of DB plans have to be recognized as the inevitable and appropriate outcome of this mismatching as plans undertook investment policies that were far too risky given their level of maturity.
Returning again to the tension between benefit security and contribution rate stability, it is important to assess the specific suggestions in the consultation document against the backdrop of how one wants to balance these objectives. Unfortunately, that is generally not done explicitly in the consultation document. Although the security-stability tradeoff tends not be addressed explicitly, suggestions in the consultation document lean in the direction of sacrificing benefit security to contribution stability. Clearly, this is a source of concern in that it exposes plan members to increased risk in the face of plan termination, unless one wants to contemplate a system of pension insurance - a possibility that is raised in the consultation paper.
Finally, and without detracting from the fact that the CLC commends the Finance Department for launching the consultation, the CLC is curious to know how this consultation will be coordinated with the CAPSA Model Law exercise which has just included a pension finance component.
The trade union movement has fought for years to place limits on employers' access to DB pension surplus and the regulatory regimes that are now in place are a partial reflection of those efforts. Yet, the regulatory regime emerges in the discussion of surplus in the consultation paper as a preface to asking whether there are disincentives to plan sponsors funding DB plans more fully (i.e. if we give them greater access to surplus, will they fund more fully).
The question itself seems to embrace the logic of the asymmetric risk argument that is doing the rounds these days in Canada and elsewhere. As is noted in the text, this argument presumes to know where risk and pension costs fall in DB plans, and this is not known with clarity. First order effects may be clear, but second and subsequent order effects are not. To the extent that employers' special payments to pension plans result in lower pay or downward adjustment to other parts of employees' compensation, the risk has been shifted to the employees. Furthermore, the widespread and widely acknowledged practice of employers taking contribution holidays in the 1980s and 1990s is hardly indicative of employers gaining nothing from surpluses and neither, for that matter, was the widespread use of surpluses to finance special early retirement programs.
International comparisons today and Canadian history provide little support to the suggestion that a more relaxed regulatory regime, with respect to surplus, will result in more complete funding. Our experience suggests that more complete funding requires a regulatory mandate that would require it. To lead off the discussion by asking if there are disincentives is to start with the wrong foot forward. At the same time, the CLC would argue for the elimination of the rule under the Income Tax Act (ITA) that requires employers to stop contributing to plans with surplus above a threshold level. A maximum may be required for plans for owner-operators of business and senior executives, but not for most plans.
On the question of partial wind ups, the CLC is of the view that partial wind up provisions are important to retain in pension law so that regulators have some middle ground between closing plans down completely, and adopting a business-as-usual approach when things start to go wrong with pension plans. Our general experience has been that regulators have used this authority appropriately.
In addition, the CLC wishes to register its view that there is no real ambiguity as to how the Monsanto decision applies in the federal jurisdiction. The language that is in the Pension Benefits Act of Ontario that was contested in Monsanto is virtually identical to the language in the federal Pension Benefits Standards Act. The possible ambiguity referred to in the text of the consultation document strikes us a wishful thinking on the part of those who supported the losing side in the case. The CLC will be vigilant to be sure that the intention of the Supreme Court is upheld.
The consultation document raises a number of issues related to funding requirements. One important suggestion is the suggestion that amortization periods for solvency deficiencies be extended from five to ten years. The CLC will make a number of additional suggestions below that bear on this issue. For the moment, the CLC will simply note that as a stand alone suggestion, this proposal adds inappropriate risk to the likely fulfilment of pension promises to plan members. It is a suggestion that has to be coupled with issues such as the balance of public and private arrangements and/or pension insurance.
The consultation document also raises the question whether plan sponsors should be able to recover solvency surpluses on plan termination. The CLC believes that this issue should not be treated independent of the question of the liability of plan sponsors on plan termination. If a sponsor can terminate a plan that is underfunded on a going concern basis and recover a solvency surplus, and face no liability for the unfunded liability on a going concern basis, then perverse incentives are in place. Recent economic and financial circumstances have created few situations of solvency surplus and going concern deficits, but in longer stretches of history, these are to be expected - especially in final and best average earnings plans.
In cases where plans are underfunded on both bases and sponsors can walk away from their pension debt without penalty, as is now the case in the federal jurisdiction, there is a strong incentive for pension plan sponsors to incur debt with their pension plan employees rather than go to capital markets. There is a strong argument to make for treating pension debt as debt that has to be paid on plan termination. (As an aside, it is not clear why the accountants are so preoccupied with measuring pension debt that does not have to be repaid in some jurisdictions.) In bankruptcy situations, the prospect of recovering any money for the pension plan will require some change in the status of pension debt in bankruptcy.
The consultation document raises the question whether pension plans should be required to have a formal funding policy. The CLC strongly supports this idea. Given the current context of employer/plan sponsor control of workplace plans, formal policy statements will help plan members and unions assess more clearly the risks to plan members in pension promises made to the plan members. Moreover, while formal statements may cause some acrimony between employers and plan members in the short-term, in the longer term it should lead to more complete understanding between plan members and unions on the one side, and sponsors on the other.
In the consultation document, the question whether plans should have a formal funding policy is linked, somewhat surprisingly, to the question whether plan members should have access to information about the financial health of the plan sponsor. What is surprising about the question is that the financial health of the plan sponsor is critical to the security of plan members' benefits, yet it has played little role in Canadian pension financing rules. (Ontario's "too big to fail" rules with respect to amortizing solvency deficiencies represent a limited and not particularly refined attempt to incorporate the credit worthiness of the plan sponsor into Canadian funding rules.)
Canadian pension financing rules have relied overwhelmingly on measures of funded status of pension plans (pension assets versus liabilities) as measures of the risk in the financing of pension plans. The funded status, as measured in pension balance sheets, provides a good measure of what is at stake if a plan is terminated due to the plan sponsor's bankruptcy or for other reasons. But by itself, it provides no information about the likelihood of the sponsor being unable to meet special payments to get rid of unfunded liabilities. Assessing the risk to plan members in this manner is rather like being given one dimension of a room and being asked to guess at its square footage.
The consultation document asks whether respondents agree that plan amendments with past service components should be void if they reduce funding ratios below 85%. The general effect of such a requirement would be to reduce the risk of default on promises to plan members. But, as the CLC has pointed out on previous occasions, a requirement of this sort might also curb the benefits paid to today's retirees from workplaces where the default risk is effectively zero. The question whether one supports the 85% threshold is clearly linked to the question whether one wants to take account of the credit worthiness of plan sponsors in determining financing requirements. Generally, this proposal has the potential of introducing too much rigidity in the improvement of benefits (particularly when it comes to flat benefit plans), never mind starting a new DB plan. We believe this is better addressed though the establishment of clear funding policies.
The CLC shares the concern with the authors of the consultation document that we need more information about letters of credit before endorsing or rejecting them. The CLC is concerned not only about the rights of buyers and sellers to terminate contracts, but also about limits on the credit worthiness of parties to acceptable contracts. We would prefer that plan members' benefits not be backed by the equivalent of junk bond
The CLC has promoted the idea of pension insurance for many years and, therefore, is pleased that it appears as a possibility in the consultation document. The consultation document asks specifically about a program of pension insurance in the federal jurisdiction. For many years, the CLC has been of the view that the extension of pension insurance beyond Ontario would have to be done on a multi-jurisdictional basis (i.e. setting up a program for the federal jurisdiction only would not likely be viable). The CLC is also mindful of the many pitfalls in a scheme of pension insurance. There are clearly potential problems of moral hazard and adverse selection. But, the CLC also believes that it is important to keep working on the possibility of pension insurance - especially if ideas like increasing amortization periods that would expose plan members to increased risk were adopted. Pension insurance may prove to be the best of a difficult set of choices.
The consultation document raises a number of specific suggestions and questions about DB pension financing. Most of them have been identified and responded to above. But, there are some possible responses to the financing issues facing DB plans that are not captured in the consultation document or in the foregoing comments.
Comments made on ideas in the consultation document have already suggested one idea that deserves some focussed discussion in the period ahead. For reasons noted above, it is important to have some discussion of how, if at all, the credit worthiness of a plan sponsor should be taken into account in DB financing rules.
The risk faced by plan members is subject to varying degrees of control based on financing policies of plan sponsors. All other things being equal, plans that are minimally funded as a matter of policy will subject plan members to more risk than will plans that are not minimally funded. This reality is reflected in some of the discussion in the consultation document (e.g., the discussion of void amendments) and in some of the recent work of the Institute of Actuaries. The requirement of a formal funding policy will make some of the risks more transparent. But, one aspect of plan sponsor decision-making that might be assessed in terms of its impact on the security of plan members' benefits is investment policy.
The rules governing investment policy per se have always been oriented to the protection of plan members' benefits. But, it may be worth considering whether targeted funding levels (reserve requirements) should reflect investment policy. If a plan sponsor wishes to pursue a high risk investment policy that is likely to produce highly variable returns through time, it may be that assets should be targeted to reach a positive multiple of liabilities so that during the inevitable periods of poor performance, assets will still come close to equalling liabilities.
Within the DB world, it is flat benefit plans and career average earnings plans that are most likely to create situations where plans are terminated with insufficient assets to cover liabilities. This is the case not only in Canada, but elsewhere as well, and there are a variety of reasons for this. For current purposes, it will suffice to suggest that it may be appropriate to have some discussion of whether the tax and regulatory rules should require or permit the projection of benefits under these plans.
As was noted at the outset, the CLC is pleased that the Finance Department is undertaking the consultation on the financing of DB workplace pension plans. Its outcome is very important to our members, and we look forward to actively engaging in the debate on the issues. It strikes us as being constructive to add to the agenda the issues raised immediately above, and to be prepared to set the discussion in the context of the overall structure of Canada's pension arrangements. In context, it is worth noting our concern about declining workplace pension coverage. This issue overlaps with the financing issue, but is distinct from it as well. It raises serious questions about the ability of these plans to deliver good retirement incomes for most workers.
This document is respectfully submitted on behalf of the Canadian Labour Congress:
|Kenneth V. Georgetti,||Hassan Yussuff,|
Marie Clarke Walker,
|Executive Vice-President.ï¿½||Executive Vice-President.|
September 14, 2005
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- Canadian Labour Congress. "Workplace Pensions: current difficulties and going forward." March 2005.