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Canada Post's Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation

September 20, 2005
Ms. Diane Lafleur
Financial Sector Policy Branch
Department of Finance
L'Esplanade Laurier
20th Floor, East Tower
140 O'Connor Street
Ottawa, Canada K1A 0G5

Dear Ms. Lafleur,

The Department of Finance has recently sought the views of Pension Plan Sponsors concerning a wide range of issues including the funding of Defined Benefit Pension Plans. I would like to take this opportunity to respond to some of the matters raised in your questionnaire as well as highlight developments that are presently having a major impact on the funded status of the Canada Post Pension Plan and, by extension, our ability to finance the operational requirements of our business.

Background

Canada Post Corporation assumed responsibility for its Pension Plan effective October 1, 2000. We did so because, as a Crown Corporation, we needed to control the overall compensation arrangements required to attract and retain the staff required to fulfill our mandate to effectively manage all aspects of the Canadian postal system. Through legislation, Canada Post must offer the same benefits as the Public Service Superannuation Board.

Funds in the amount of $7.025 billion, representing the commuted value of all current employees pension benefits, were transferred to a trust account in the name of Canada Post Pension Plan over a period beginning October 1, 2000, and ending September 30, 2002. This commuted value also included a small "going concern" actuarial surplus of only about $70 million calculated by actuaries representing Treasury Board and Canada Post. Those employees retiring prior to September 30, 2000 continued to receive pension benefits from the Public Service Superannuation Board. As a result, the duration of our pension liabilities is, therefore, longer than would be the case for most other pension plans.

Consistent with those of the Federal government, RCMP and Canadian Armed Forces, The Canada Post Pension Plan is designed as a defined benefit plan that offers pensions that are fully linked to increases in the cost of living.

You are certainly aware that equity markets experienced a sharp decline in 2001 and 2002 and that real rates of return have declined substantially in virtually every year subsequent to the inception of our plan. You may also be aware that this has been indeed a difficult time for all pension plans, particularly those that had not had the opportunity to build surpluses during the decade of the 1990's. However, despite these factors, we have been able to earn competitive rates of return on plan assets and have made special contributions to the pension plan such that as of June 30, 2005 our surplus had grown from $70 million at inception to $256 million on a "going concern" basis.

That being said, by the rules established for federally regulated pension plans, the plan has fallen into a steadily increasing solvency deficit of $184 million as of December 31, 2003 and $1.136 billion as of December 31, 2004. This is the result of declines in real rate of return bond yields and the implementation of new standards for the calculation of solvency liabilities recommended by the Canadian Institute of Actuaries.

Current situation

Our appraisal of the current situation is therefore as follows:

  • Our pension plan is well funded on a going concern basis.
  • We have been, and continue to be, committed to funding all solvency deficits in accordance with pension legislation.
  • We enjoy an AAA credit rating with various agencies.
  • Notwithstanding increasing profits in the past 5 years, funding the full extent of these deficits will place a great strain on our balance sheet, since total Canada Post liabilities amounted to $4.314 billion as of December 31, 2004, of which $1.267 billion represented shareholders equity. Our total revenues amounted to $6.651 billion during the past year.
  • Providing a high quality letter-mail service requires continuous capital funding from Canada Post Corporation. Our letter-mail business is also under significant competitive threat and as a corporation, we must invest in new as well as existing lines of business in order to provide the service our customers expect as well as the return our shareholders require. Accordingly, the need to allocate significant funds to our pension plan could render our ability to fund operational requirements problematic.
  • Funding the full extent of our current solvency deficit could drive our pension plan surplus position on a "going concern" basis to a potential amount of over $ 1.3 billion. Our actuaries tell us that this surplus funding is not required to meet pension obligations over the longer term.
  • Such a surplus would represent at least 10% over and above what is needed to meet pension obligations. This would almost inevitably lead our membership to seek improved benefits.
  • Pension benefits available to plan members are already extremely generous and might indeed prove difficult to improve.
  • Improvement in benefits well in excess of market norms would also likely create public perception issues.
  • Under the terms of existing tax legislation, current service contributions are in any event prohibited in circumstances where pension plans maintain a surplus position of over 10% of the actuarial liability. This would be inconsistent with our need to fund a larger deficit.
  • It is worth noting that our funding target is based on a going-concern discount rate used to determine the plan's liabilities of 6% per year. This rate is still quite conservative in today's economic environment.

In addition to the above, current rules create financial uncertainty due to contribution volatility for sponsors such as ourselves. Volatility could be reduced by the use of more conservative investments such as real return and long-term bonds, but this would decrease expected rates of return over the longer term, resulting in a significant increase in going-concern liabilities and current service costs. For Canada Post, such an increase in cost would be considerable and would likely require corresponding reduction in pension benefits.

Finally, guaranteed pension indexation has been encouraged in the past since it protects members' purchasing power. However, it is evident that current rules are penalizing sponsors that offer fully indexed pension plans. This is because of the mandated use of fluctuating longer term Real Return Bond interest rates to calculate solvency liabilities.

Recommendation

Pension plans that are regulated under provincial rules have generally been able to obtain relief from rules governing the calculation and amortization of solvency deficits over the past several years. These include plans registered in Ontario with total assets estimated in the range of about $270 billion, as well as plans registered in Quebec with total assets estimated in the range of about $150 billion.

However, plans falling under the federal jurisdiction , believed to total about $87 billion, have yet to receive any such relief.

As a result, the vast majority of pension plans in Canada do not find themselves in the current position of Canada Post Corporation described earlier. Ironically, Canada Post has a small subsidiary company, Innovapost, with a pension plan that has a substantial solvency surplus, simply because it is regulated under a different jurisdiction.

It is generally accepted that there is a pressing need to standardize pension plan funding requirements across all jurisdictions in Canada. Only in this way can we create the "level playing field" needed to promote effective competition among pension plans and, by extension, corporations as a whole.

But, in the absence of such standardization, there are some aspects of the regulations that apply to Ontario based pension plans that we most strongly believe should also apply to the Canada Post Pension Plan. As you are likely aware, Ontario based pension plans represent the largest component of plan assets in Canada.

Specifically, The Province of Ontario allows pension plans to exclude future automatic indexation from the calculation of solvency liabilities and also allows the smoothing of both pension assets and liability discount rates. These regulations apply to some of the largest defined benefit pension plans in Canada, including The Ontario Teachers Pension Plan and the Ontario Municipal Employees Retirement System, both of which offer pension benefits that are very similar to those offered by the Canada Post Pension Plan. At the present time, federal regulations do not allow this exclusion, and only allow asset smoothing.

Our recommendation to the federal government is that permission be given to pension plans under its jurisdiction to adopt these measures. In the case of Canada Post, this would substantially improve our present situation without weakening the security of pension benefits for our membership. Other federally regulated pension plans would no doubt also benefit from this measure.

Alternative Recommendations

Without any prejudice to this recommendation, and in the event that the federal government is unwilling to implement some of the provincial regulations listed above, Canada Post further recommends the following new measures for federally regulated pension plans.

1. More flexibility should be granted regarding the approach used to determine solvency liabilities. Current standards are not very precise. The most recent CIA document mentions "actuaries would be expected to take into consideration the fact than indexed pensions would likely be backed by assets with yields correlated to inflation".

On any theoretical wind-up of the Canada Post Pension Plan, about $8-9 billion of plan liabilities would have to be settled through annuity purchases, an amount that approximates 40% of total Real Return Bonds issued by the Government of Canada. Moreover, buying annuities may not be the best approach from a cost point of view.

An alternative approach with full immunization of liabilities would be appropriate. Real Return Bonds would still need to be purchased, but there would also be the introduction of an overlay to include exposure to corporate bonds, as outlined in the attached document. This would make sense from both a market and a cost perspective.

2. Longer amortization periods, particularly for those with a high credit rating. This could work as follows:

  • No funding would be required for a deficit of less than 5% of assets. However, sponsors could not take contribution holidays if the solvency surplus is less than 5% of assets. The rationale for these rules could be that small variations around the breakeven point are normal temporary deviations.
  • Funding of solvency deficits between 5% and 10% of assets could be amortized over 15 years.
  • Funding of solvency deficits between 10% and 15% of assets would be amortized over 10 years.
  • Funding of solvency deficits greater than 15% of assets would be amortized over 5 years.

3. The smoothing of solvency liabilities should be allowed, since smoothing of assets is already permitted under the PBSA. As previously noted, smoothing of solvency liabilities is allowed in Ontario.

4. Special accounts to earmark solvency special payments should be permitted. Payments would be returned to the plan sponsor if no longer needed.

5. The use of letters of credit to cover solvency deficit or solvency special payments should be permitted. Sponsors should have the ability to cancel such letters of credit when they are no longer required. It should be noted that the use of this facility would reduce the Corporation's available credit.

We are grateful that the Department of Finance has taken the initiative to seek input on these matters. We ask that the most serious consideration be given to our proposal at the earliest possible convenience, as we will soon be required to conduct another actuarial valuation for the year ending December 31, 2005. Without changes in legislation, we will then in all likelihood be in the position of having to fund an even larger solvency deficit because of the unique factors I have described, which are faced by few, if any, pension plans in Canada.

We would welcome the opportunity to discuss our perspective with you at your convenience.

Yours truly

Doug Greaves

Douglas D. Greaves
Vice President, Pension Fund and Chief Investment Officer