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Union |
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No. 2 – Spring 2007 |
By Don Lee
Funding rules for employer-sponsored pensions keep re-emerging as a
political issue. The economic issue at the core is always the same –
maintaining the security of pensions when jobs are disappearing. In this
latest round, public concern has been fueled by several high-profile cases of
corporate restructuring in which job security has been on-the-line, and by a
steady flow of alarmist opinion to the effect that unfunded pension
liabilities are undermining Canada’s competitive position.
In this new chapter of pension funding issues, the concerns are coming,
for the most part, from the corporate sector – the employer side of the
bargaining table. The primary focus of complaints from companies and their
pension consultants are the rules which impose increased contributions when a
pension plan is running a solvency deficit.
An actuarial valuation on a solvency basis discloses what would happen
if a pension plan were wound-up – would there be enough money to pay-out the
full amount of benefits earned – or would there be a deficit? Even if the
plan is ongoing, as most are, any such deficit must be made up within 5 years.
If the plan is being wound-up, several jurisdictions now extend the same
funding requirement to any corporate vestige of the plan sponsor which
continues to operate in Canada.
This legal requirement gives considerable comfort to both active and
retired workers in defined benefit pension plans. Their pension entitlements
are not completely secure, but are only at risk in the event the employer goes
bankrupt, leaving no one to pay down the solvency deficit on plan wind-up. In
that unhappy case, both active and retired workers would see the amount of
their pensions reduced in proportion to the available funds versus the wind-up
value of their entitlements. Although there is a Pension Benefits Guarantee
Fund in Ontario, that scheme only covers pensions up to a limit of $1,000 per
month.
It is only a few short years ago that the pension issue of the day was
control of surplus. That earlier chapter of the pension story exposed and
created new dimensions to funding deficits, and specifically their treatment
on plan wind-up. In Ontario and several other jurisdictions, the battle for
control of surplus was tranquilized, at least in part, by new rules requiring
that, on plan wind-up, surplus not be paid out without an agreement between
the plan sponsor, the active members and the pensioners, or failing that, a
court order.
The most controversial aspect of that requirement has been its
application to partial plan wind-ups. The Ontario rules often resulted in a
portion of surplus, from an otherwise ongoing plan, being distributed to plan
members affected by the partial wind-up.
The corporate world resisted this aspect of the rules with all its
fire-power, but ultimately lost the point when a case involving Monsanto went
to the Supreme Court. The court confirmed the position of the Financial
Services Commission of Ontario, namely, that the contested rules on surplus
distribution also apply in the case of a partial wind-up.
The extent of surplus on plan wind-up is the result of a variety of
factors and may even be affected by the wind-up itself. Laying out the complex
interplay requires a little patience.
While a pension plan remains ongoing, active members of the plan expect
that their pensions to move ahead in some fashion with future wage increases.
In many cases, this “indexing-to-wages” is part of the plan formula – in
a plan based on final average earnings. In other cases, it happens on an
occasional or ad hoc basis as the result of employer discretion or collective
bargaining – in a flat benefit or career earnings plan.
During the 1970’s and 1980’s, a comparable set of expectations and
arrangements developed with respect to the adjustment of pensions for price
inflation during retirement – the Pension COLA. In many cases, this “indexing-to-prices”
became part of the formula. In other cases, it continues on an ad hoc basis.
When a person terminates employment and withdraws the commuted value
(or lump-sum value) of their pension, the potential value of any future ad hoc
adjustments is lost. And even if movement ahead with future wage growth is
part of the formula and fully funded, in a plan based on final average
earnings, the value of the “indexing-to-wages” is lost.
But an “indexing-to-prices” provision affecting pensions during
retirement is not lost. The value of Pension COLA is reflected in the commuted
value when it is part of the plan formula.
This imbalance between the treatment of indexing-to-wages and the
treatment of indexing-to-prices, when calculating lump-sum values on
termination of service, is even more disconcerting when we consider that an
indexing-to-wages provision must be funded. The estimated liabilities for past
service and the annual cost of future service include an assumed rate of
future wage growth. As a result, when a larger group is terminated, surplus
may increase because their benefits will no longer move ahead with future wage
increases, as had been anticipated in the basis of funding.
Unlike an indexing-to-wages provision, an indexing-to-prices provision
can be exempted from the funding rules and, these days, often is. As a result,
a plan that appears to be in a surplus position might actually show a
substantial deficit if the plan were wound-up. This can happen because the
commuted values paid out are supposed to include the value of
indexing-to-prices during the period of retirement, even if they have not been
funded.
A similar circumstance applies to early retirement benefits. Under
legislated rules, the prospective early retirement benefits of all plan
members must be funded on the solvency basis.
But the value of those same benefits is not reflected in the commuted
value paid out to an individual plan member whose service is terminated. Thus
a wave of terminations which does not lead to a partial wind-up may actually
improve the funding position of pension plan – because of early retirement
benefits which are funded but not paid out.
The notion that a pension plan might profit from a plant shutdown or
mass lay-offs created an politically explosive issue in the 1980’s. The
Ontario government and several others responded by improving lump-sum
settlements in the case of pension wind-up or partial wind-up. The
improvements included the vesting of early retirement provisions on the basis
of prospective service – the “grow-in” rules – and the requirement for
an agreement with affected plan members concerning the sharing of surplus.
These reforms clearly represent a significant set forward for employees
affected by a plan wind-up, but it has never been clear why employees or
pensioners, not directly affected by a partial wind-up, should not enjoy
equivalent benefits.
In November 2006, the Ontario government appointed a new Expert
Commission under the guidance of Harry Arthurs, a distinguished professor of
labour law. The commission includes two experienced specialists from each of
the labour side and the employer side. It will report on how to update the
Pension Benefits Act by the summer of 2008, after consulting with pension plan
stakeholders.
Employers and the pension industry will seize upon this opening to
press for relief on the funding rules, and specifically, the five-year funding
requirement for deficiencies on a solvency (or wind-up) basis. Organized
labour may be persuaded to cede this point in favour of stronger guarantees
for benefits undermined by an employer’s bankruptcy. But the unions and plan
members at large could also be asking other questions.
In the complex interplay of issues surrounding surplus, inflation
protection and plan wind-up, there is good cause for new solutions to several
remaining problems:
q
Plan sponsors
are able to exempt themselves from funding indexing commitments to pensioners,
leaving retired plan members vulnerable to funding shortfalls on plan wind-up
caused by an employer’s bankruptcy.
q
When indexing
is excluded from pension liabilities in a valuation for funding purposes, the
result may be an artificial surplus, which could be used to cover a
contribution holiday for the employer, further aggravating the plan’s true
position on wind-up.
q
When members
terminate their service (or are laid-off) the value of any “wage-indexing”
is excluded from the lump-sum commuted value paid out, even though it may be
fully funded.
q
The value of
early retirement provisions is not paid out to terminating members unless they
are affected by a full or partial plan wind-up.
q
There is no
mechanism to ensure a fair distribution of surplus to members remaining in an
ongoing plan affected by a partial wind-up.
If the new package of reform includes some stronger scheme of insurance
against funding shortfalls, plan members will have more secure pensions. But
without more coherent provisions on the funding of indexing and the basis of
payouts on termination, some employers will inevitably be tempted to transfer
their pension liabilities to the rest of us, as their own ship is going down.
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Pension Reform is an occasional series published by Union Pension Services Ltd. as a free service to clients and friends in the labour movement. Anyone receiving this document is free to re-produce and distribute, in whole or in part, subject to recognition of the source. The password for printing this document is available upon request. Copies of past issues can be viewed at www.uniontech.com .
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E-MAIL: donlee@uniontech.com