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The Canadian Broadcasting Corporation's Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:
September 14, 2005
Ms. Diane Lafleur
Financial Sector Policy Branch
Department of Finance
20th Floor, East Tower
140 O'Connor Street
Ottawa, Canada K1A 0G5
Private & Confidential
Dear Ms. Lafleur,
Thank you for giving us the opportunity to provide our comments on the consultation paper "Strengthening the Legislative and Regulatory Framework for Defined Benefit Pension Plans Registered under the Pension Benefits Standards Act, 1985" published in May 2005 (the "Paper").
This Paper raises important issues for debate. We agree that the legislative framework for federally registered defined benefit pension plans should be reviewed.
Background on CBC
The Canadian Broadcasting Corporation (CBC) is a Federal Crown Corporation (Agent of Her Majesty). As an Agent of the Crown, assets and obligations of the CBC are assets and obligations of the Federal Government.
CBC's operating revenues are approximately $1.5B, including government funding of $1.0B, with a payroll of about $500M. CBC operates in a highly unionized environment.
CBC is Canada's national public broadcaster and one of its largest cultural institutions. CBC is accountable to all Canadians, reporting annually to Parliament through the Minister of Canadian Heritage.
CBC enjoys the same credit rating as the Federal Government that is AAA by rating agencies. The risk that CBC becomes insolvent is basically "nil".
Background on the CBC Pension Plan
The CBC Pension Plan was established on September 1, 1961. It replaced a group annuity plan which was effective April 1, 1943.
Its provisions are very similar to the Federal PSSA, with some differences with respect to early retirement conditions and pension indexation. However, contrary to the PSSA, the CBC Pension Plan is subject to solvency funding since it is registered under the Pension Benefits Standards Act.
The following outlines key information on the CBC Pension Plan:
- Market value of assets of $3,814M as at June 30, 2005.
- Approximately two thirds of liability is with respect to pensioners – the plan is a very mature plan.
- All benefits are indexed to CPI, subject to a maximum annual indexation of 2.7%.
- The plan's estimated financial position as at June 30, 2005 is as follows:
|(in $ Million)|
|On a going-concern basis||On a solvency basis|
|Value of assets||$3,573||$3,810|
The main explanations for the plan's solvency deficit are the steady reduction in the yields of Federal Real Return Bonds (RRBs) over the last years and the market downturn of 2001-2002. The plan's solvency position is linked to RRBs because of the guaranteed indexation feature. It is worth noting that the plan had a solvency excess of $1.3B as at December 31, 1999.
Issues related to Plan Funding
CBC manages its pension plan in a prudent manner. Due to its context, CBC has a long-term view of its pension plan and plan wind-up is not an issue. Accordingly, the pension plan funding target is based on a relatively conservative going-concern basis with appropriate provisions for adverse deviations.
CBC's views of solvency funding requirements are as follows:
- It does not really provide more benefit security. In fact, the best security to plan members is a financially secured sponsor.
- It reduces the CBC's ability to use capital to achieve its corporate mandate. The CBC cannot borrow for working capital needs and most of its operating revenues come from government funding. If the CBC has to use its capital to fund solvency deficits, it will have to reduce its operating expenses, and potentially to reduce services to Canadians.
- It generates financial uncertainty due to contribution volatility. Such volatility could be reduced through more conservative pension fund investments, such as the use of RRBs and long-term bonds to better match the plan's liability. This approach would however decrease the long-term expected rate of return on plan assets, resulting in a significant increase in the going-concern liability and current service cost (lower discount rates mean higher liabilities). It is therefore not viable since it would increase cost or would require reduction in benefits in the long-term.
- In the medium-term, solvency funding may produce important going–concern surplus. This would result in pressures to increase benefits.
- It penalizes sponsors having pension plans providing guaranteed indexation. Pension plans are implemented on a voluntary basis and guaranteed pension indexation is encouraged since it protects the members' purchasing power. However, in practice, sponsors providing guaranteed indexation have been penalized in recent years since they have larger solvency deficiencies due to fluctuations in RRB rates, and they have smaller room for plan improvements (e.g. non-indexed pension plans can provide ad-hoc pension increases).
- With these rules, the CBC is not comparable with Ontario organizations since funding requirement is much lower and flexible in Ontario. If the Ontario solvency rules were applied to the CBC Pension Plan, it would have a significant solvency surplus as at June 30, 2005 instead of a deficit.
Based on the above, and given that CBC's assets and obligations are those of the federal government, it is our view that the CBC Pension Plan should not be subject to solvency funding requirements.
Alternatives for solvency funding
Without any prejudice to our preferred position stated above, and in the event that the Department of Finance is unwilling to exempt the CBC Pension Plan from solvency funding, we would like you to consider the following alternatives:
- More flexibility on approach used to determine the solvency liability should be provided. On plan wind-up, almost all CBC Pension Plan liabilities, or about $4B, would have to be settled through annuity purchase. This is considered a "theoretical" exercise since the size of the plan would require buying close to 20% of the total RRBs issued by the Government of Canada, given that the plan's indexation is linked to CPI increases. Also, buying annuities may not be the preferred approach of CBC's shareholder, that is the Government of Canada, from a cost point of view. An alternative approach achieving full immunization of liabilities could be appropriate. The investments would still include RRBs, but would also use an overlay to include exposure to corporate bond market, which would make sense from a market and a cost perspective.
- Longer amortization periods for organizations with high credit rating and/or backed by the government. The amortization period would also reflect the size of the solvency deficit. For a highly rated organization like CBC, 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 would 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.
- Smoothing of solvency liabilities should be allowed, since smoothing of assets is already permitted under the PBSA. Smoothing of solvency liabilities is allowed in Ontario.
- Use of letters of credit to cover solvency deficit or solvency special payments.
Use of letters of credit
Concerning the use of letters of credit, CBC believes that it would provide an interesting funding alternative. However, legislation should provide that it can be cancelled by the plan sponsor when it is not required anymore from a funding point of view. Also, the letter of credit's face amount can be very volatile if it covers the full solvency deficiency due to leverage effect. For example, a plan with a solvency ratio of 99% could have a solvency ratio of 95% the next year. This would quintuple the face amount in just a year, from 1% to 5% of plan assets – or from $35M to $175M in the case of the CBC Pension Plan.
Encouraging good governance
The Corporation would also encourage any measure that would promote good governance, such as:
Close monitoring of the plan's financial position;
- Investment policy reviews and fund return monitoring;
- More disclosure to plan members; and
- Establishing formal funding policies. We would like to point out that this is essentially a documentation requirement since large sponsors already have funding policies in practice, even though these policies may not be formally written.
Companies under the CCAA or BIA
We do not believe that companies with poor credit rating should be entitled to special relief since they potentially sponsor the plans where there is the most risk for plan members.
Issues related to Plan wind-up
Deficit on plan termination would need to be funded
CBC agrees that members' benefits should be protected on plan termination, as it is the case in provincial jurisdictions.
Concept of partial wind-up should be eliminated
CBC views on partial plan wind-ups can be summarized as follows:
- The concept of partial wind-up is very artificial since decisions that could trigger a partial wind-up are normally not linked to the pension plan;
- What constitutes a partial wind-up is not always clear in the Federal legislation, in particular in the case of business reorganizations;
- In practice, some sponsors may apply the concept strictly and others not. This results in inequities between employees of different employers;
- Potential surplus distribution creates uncertainty and is a disincentive for employers to fund pension plans;
- Surplus at time of partial wind-up is very notional and cannot be precisely measured;
- Vesting rules (e.g. vesting after two years of membership) were necessary in the past to prevent cumbersome administration for seasonal employees or sponsors having high turnover. It is not an issue anymore with the technology, tools and systems available; and
- The Quebec approach under which partial wind-ups were eliminated and immediate vesting was granted should be a model for other jurisdictions.
For these reasons, CBC would strongly recommend that:
- The concept of partial wind-up be eliminated, and
- Full immediate vesting be extended to all plan members.
Otherwise, as a minimum, OSFI should confirm that surplus does not have to be distributed on partial wind-up.
Implementation of a guarantee fund
Ideally, we believe that members of all Canadian defined benefit pension plans should benefit from the protection of a guarantee fund, similar to the CompCorp protection for insurance policyholders or RRSP investors.
However, we believe that a standalone guarantee fund for federally regulated pension plans should not be implemented for the following reasons:
- The lack of credibility given the small number of plans, that is less than 500 plans;
- Sufficient risk spreading could not be achieved since large plans are too important in proportion of the group. As shown in the statistics at the end of the Finance's Paper, the 10 largest plans have more than 63% of total assets, or $56B vs. $89B;
- The risk of wind-up is very heterogeneous between plans (for example, between large crown corporations and small private employers), and as such, the risk premium could not be equitable unless a complex risk-based approach is developed; and
- The guarantee fund would likely not be sufficient in case of wind-up of a single large plan. As a result, large plans would pay most of the premiums but would not be covered in practice, unless the government is involved to back the guarantee fund. As a concrete example, there was the failure of the Canadian Commercial Bank and Northland Bank in 1985 in which the government ended up bailing out the depositors because of the insufficiency of the Deposit Insurance Fund.
CBC's point of view is that relevant pension information should be communicated to plan members in a practical and timely manner. For the CBC Pension Plan, the Pension Board of Trustees and the Plan Annual Report play an important role in that regard. CBC has no objection with additional disclosure requirements on the following:
- The plan's financial situation,
- The minimum funding requirements, and
- The sponsor's funding decisions.
For practical reasons, sponsors should have the flexibility to communicate any additional disclosure requirement on the members' annual pension statements.
However, CBC does not agree with any compulsory disclosure on the sponsor's financial conditions given that:
- For public entities, financial disclosure is already legislated and members should not have access to more information than the publicly available information; and
- For non-public entities, financial information is strictly private and confidential.
CBC agrees with the concept of banning plan amendments for plans having important deficits. This would increase the likelihood that members receive the promised benefits.
However, the criteria for the void amendment should be appropriate for organizations with high credit rating and/or backed by the government. For an organization like the CBC, the criteria should be based on the pension plan's going-concern funding position instead of the solvency position.
Furthermore, CBC does not agree that older benefits would have a higher priority than benefits recently established. Once incorporated in a plan, all benefits should be provided as promised, should be equally funded, and should be equally treated on plan termination. This is a matter of equity and contractual obligations.
We trust this submission is helpful in your consultation and would be pleased to present it in person at your earliest convenience.
Vice-President and Chief Financial Officer
1. Standards for calculating solvency liabilities of fully indexed pension plans are not very precise. Most of the guidance is contained in a document recently released by the Canadian Institute of Actuaries mentioning that "actuaries would be expected to take into consideration the fact that indexed pensions would likely be backed by assets with yields correlated to inflation". [Return]