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David F. Howe's Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:

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

Comments of David F Howe, FCIA, FIA, ASA

(These comments are entirely personal and do not reflect the opinions of former colleagues)

This consultation paper is timely given the problems, particularly the funding problems, of the DB plans of some major plan sponsors. Given the cause of much of the current concern, namely corporate bankruptcy, your paper fails to raise an important change in funding requirements which would go a long way to working the way out of the current problems and avoiding a recurrence of the present environment. I will therefore first outline this proposal and then comment on your suggestions.


In Ontarioitis generally impractical for a plan sponsor to walk away from an insufficiently funded plan without actually going bankrupt or invoking the Companies Creditors Arrangement Act. This is as it should be for DB plans since a promise has been made for benefits earned to date which should be fulfilled. Therefore, to protect against plan sponsor default, the funding of DB plans should take account of the creditworthiness of the plan sponsor. This is the key factor of my proposal.

As demonstrated in the aftermath of the market collapse, the great majority of sponsors were able to accommodate the increased contributions that resulted. What logic is there in applying the same rules to the financially secure as to those on the brink of failure? As the credit rating of the entity declines more stringent funding requirements would automatically and immediately apply. A falling rating generally results in greater borrowing costs so why not greater pension contributions for poorly funded arrangements?

Using the current regime as a basis, a graded scale of contribution requirements would apply depending on the creditworthiness of the plan sponsor. Entities with first class credit ratings would be required to fund only on a going concern basis, those in the lowest category might require that assets be sufficient for a minimum of 90% of the wind up liability.

Establishing creditworthiness for public corporations might best be done by the use of the ratings of such institutions as Standard and Poor's. The ratings for unrated entities might be based on a ratio of pension underfunding to corporate assets or market cap. Special indices would be needed for private companies and non corporate entities.

The focus of the proposal is not simply to improve funding levels for at risk plans but to improve the governance and management of plans to avoid problems. Management and boards of directors or governors would be far less likely to make rash promises and far more likely to take swift action to correct past mistakes.

It would be my strong recommendation that this proposal be studied first by a business school with access to actuarial skills. A statistical review of recent wind ups and their cause would help dispel (or confirm) the alarmist view of some commentators and a business school would be best placed to make detailed proposals on measuring creditworthiness and the long term implications of their proposals.

Clearly these proposals are not applicable to multiemployer plans. An exception should also apply to allow union negotiated plans to opt out.

The above is a brief outline. I anticipate publishing a more detailed proposal in the near future. It is worth noting that the Bush Administration has a proposal along these lines.

Comments on Paper

The following comments address the issues raised in the paper. The paper's opening comments say that the consultation paper seeks to improve the security of and ensure the viability of DB plans. The focus is however heavily influenced by how current economic and social circumstances influence existing plans. (The first issue addressed is surplus, not the contributions that give rise to such surplus). However times change and therefore before any proposal is adopted it should be tested against other circumstances. Having been in this business for more than 30 years I am very aware of the long term nature of pension commitments and the need to anticipate changing environments.

My comments are also made in the hope that this initiative and the responses will be seriously considered by the Provinces to achieve greater uniformity.

A. Surplus

It is politically impractical to change the current environment which has developed from case law. However, it should be possible for a plan sponsor to make a clean start by providing that plan texts be specific as to surplus ownership with respect to all contributions made after a given date. This can probably be achieved by amending the Successor plan rules. I see no reason to encourage plan sponsors to contribute more than the "minimum" if there is little or no risk of default on the pension obligation. (See Proposal above)

Dispute Settlement Mechanism

Given the present circumstances I see no reason to change the mechanism. If the proposal outlined in the previous paragraph were adopted there should be fewer disputes in future.

Distribution on Partial Termination

I would support an approach similar to Quebec. In fact unless there is some extremely strong reason not to, I would adopt exactly the same approach in the cause of uniformity.

B. Funding

The opening section notes that a viable sponsor is the best security and I agree. However to suggest that those in financial difficulties should somehow be able to waive their obligations is unacceptable. When speaking to corporate directors, investment managers, bond analysts etc, they generally felt that although increased contributions might drive an entity to the wall sooner it would probably not alter the eventual outcome.

I would support the use of Letters of Credit for Solvency purposes and the concept of notional accounts for solvency payments.

I would disagree with extending the Solvency funding period. Rather as proposed above, Solvency tests should be eliminated for the creditworthy sponsor and tightened for others.

Regarding disclosure, I doubt if this would have any practical impact. Reference is made to the sponsor's financial condition being such as to imperil the plan. I imagine that that risk would be identified in the financial press long before any company would be willing to admit such in writing. It might however have some relevance for multiemployer and some non corporate plans.

C. Void Amendments

The proposal to restrict benefit improvements for less well funded plans is inappropriate. Many financially strong sponsors are more than able to accommodate the cash costs associated with a less than 85% funding ratio and if such a rule had existed in my early consulting career few sponsors would have introduced plans with substantial past service. (This was deemed necessary at the time due to the failure of DC plans to provide adequate benefits).

The concept of generational priority when terminated plans have insufficient assets is not uncommon and would be a sensible addition.

D. Full Funding on Plan Termination

I would support this proposal in the form that already exists in Ontario. However I would be dubious if it is appropriate to place the pension obligation above the rights of other debtors in the event of financial failure of the plan sponsor.

E. Pension Benefit Guarantee Fund

I would oppose the introduction of a PBGF especially if my proposal to link contributions to creditworthiness were not adopted. A PBGF should be a payer of last resort which is only called on in extreme/catastrophic circumstances. It is quite inappropriate to ask the worthy plan sponsors to support the inept. I believe the current funding of the PBGC grew from similar plans for the insurance, banking etc industries. Pension Plans are quite different entities being non profit institutions. The greatest weight in measuring responses to this issue should lie with those who have to pay the bill, the DB plan sponsors, the great majority and best managed of whom will not need to resort to insurance. For the same reason, plan sponsors should have the major say in determining the rules if such a plan were instituted.

August 25, 2005