Thursday, January 15, 2009

Who Will Rescue Workers and Pensioners?



Canada's Globe and Mail reported that the province of Quebec promises to guarantee pension plans:
As the global financial crisis jeopardizes the future of private pension plans, the Quebec government is taking the unprecedented move of guaranteeing benefits to pensioners and workers of companies whose plans go bankrupt.

Nearly a million workers and pensioners in Quebec are registered in more than 950 private company pension plans with assets worth about $100-billion. A handful of those pension plans could become insolvent this year if the companies declare bankruptcy, Quebec Employment Minister Sam Hamad said yesterday.

Under a bill tabled yesterday, the Quebec Pension Plan (known as the Régie des rentes du Québec) will take over the management of insolvent pension plans and guarantee retirement income for five years to those who are entitled. If proved successful, the measure could be extended beyond the five years and perhaps become permanent, a senior government official said yesterday. The fund could also be transferred to an insurance company.

All opposition parties and Quebec's major business and labour leaders support the bill. It is expected to be adopted today and will be retroactive to Dec. 31, 2008.

The legislation gives the QPP the authority to improve benefits to workers if needed. If the targeted pension plans have insufficient assets to cover benefits, the government will pay the required sums to make them solvent.

Quebec companies will have 10 years rather than five years to replenish shortfalls in their pension plans. Currently, the market value of the assets of Quebec's private pension plans is 70 per cent of their total solvency liabilities, or what they need to pay out in benefits. This represents a $22-billion shortfall to bring solvency levels up to 100 per cent. Many cash-strapped companies face serious problems in meeting their pension contribution obligations.

"We are the first in Canada to take these measures ...We aim to protect pensioners by taking over pension plans that go bankrupt and ensuring that benefits are paid out," Mr. Hamad said yesterday. "It was urgent that we act now... It gives companies more liquidity and reassures workers and pensioners."

The initiative was one of a half dozen economic stimulus measures Premier Jean Charest's newly re-elected government included yesterday in Finance Minister Monique Jérôme-Forget's economic update. Ms. Jérôme-Forget also announced $250-million in refundable tax credits for home renovation projects, a benefit of up to $2,500 for homeowners.

Other measures included a 50-cent increase in the minimum wage to $9 beginning on May 1, and public investments bringing the total amount in infrastructure and energy development projects to $13.9-billion in 2009.

Ms. Jérôme-Forget said she will try to avoid a deficit in the 2009-2010 fiscal year and expressed optimism that Quebec could even avoid falling into a recession. She said she will announce new initiatives in her budget in March, depending on what Federal Finance Minister Jim Flaherty announces in his Jan. 27 budget, and the impact of the massive multibillion-dollar economic aid package announced by United States president-elect Barack Obama.

"Let's wait and see. Let's not panic now. I'm not trying to put on rosy glasses. I'm trying to be very, very down to earth and wait for what Flaherty is going to do, wait for what's going to happen in the United States. Then in March I will have an update," Ms. Jérôme-Forget said in a news conference yesterday.

Much of Quebec's financial health rests with the federal government decision on whether to reduce equalization payments to the province. At tomorrow's first ministers meeting in Ottawa, Mr. Charest will demand that Prime Minister Stephen Harper reverse his unilateral decision to change the plan and reduce payments to Quebec.

"What Ottawa is doing with equalization payments is unacceptable," Mr. Charest said yesterday. "As far as I'm concerned, that is not the way the federal government said they would do business. "

In response to these measures, the National Post's Kelly MacParland came out with a scathing article in her blog asking Who's paying Quebec's pension largesse?:

Here are a couple of items to chew on.

The Financial Post reports that the disposition of Nortel's pension plan could develop into a battle royal between the Ontario government and other creditors. That's because, like hundreds of other companies in Canada, Nortel doesn't have nearly enough money to cover its obligations to retirees:

"According to court documents, Nortel had a shortfall of US$1.8-billion in 2007, well before the fall market meltdown. A recent RBC analyst report pegs the deficit at US$2.8-billion. The court monitor states only that the funding deficit has "significantly increased" since 2007."

Money still in the plan is protected. But the gap -- the $2.8 billion -- is a problem.

"If a company has been told by a pension regulator to make special top-up payments and fund a shortfall, then those payments and the regular contributions it makes are subject to a claim that ranks above unsecured creditors when divvying up assets.

However, any shortfall after that ranks as an unsecured creditor claim and if the company goes bankrupt, then the pensioners are left holding an empty bag."

Ontario has something called the Ontario Pension Benefits Guarantee Fund, "which backstops pension payments up to US$1,000 a month." But the fund already has a deficit of US$102-million.

So now let's look at Quebec. The Globe reports that the Quebec government is promising to guarantee the pensions of companies that go bankrupt.

...

Quebec's Finance Minister, Monique Jérôme-Forget, also says she's going to raise the minimum wage, and hopes to avoid a deficit this year.

Well, good for them, I guess. Quebec is Canada's biggest nanny-state, so it's not surprising it would go further than other province in using the treasury to rescue people. And who can complain about pensions being guaranteed? Hundreds of thousands of Canadians who have spent decades contributing to a pension could get royally screwed if the recession forces their employer into bankrupcy when the plan is in deficit.

Still, at the risk of Quebec-bashing, you can't help wondering if Quebec's benevolence is being paid for by the rest of the country. Quebec will get $8 billion in equalization payments this year, which is approximately $8 billion more than Ontario, B.C., Alberta or Saskatchewan will get. Quebec gets 60% of the total equalization pie. ("Three pieces for me, half for you; three pieces for me, half for you..."). Even Dalton McGuinty could probably balance his budget with an extra $8 billion.

How is it possible to continue pretending Quebec is a "have-not" province when it can afford to lavish billions of dollars on free daycare and guaranteed pensions, while the "have" provinces are struggling just to get by, and yet still have to pony up the $8-billion annual subsidy Quebec needs to finance its fantasy world?

Ms. MacParland (and Ms. Francis at the same newspaper) should stop bashing Quebec and focus on the problems at Ontario's two largest public pension plans, Ontario Teachers' Pension Plan (Teachers') and Ontario Municipal Employees' Retirement System (OMERS).

In the early evening, the Globe and Mail posted another article stating that the QPP won't make up private pension shortfalls:

Quebec's offer this week to protect pensions when companies go bankrupt will not guarantee full payouts for workers and should require no cash contributions on the part of the government, according to a pension consultant who worked on the new program.

Michel St-Germain, a partner at pension consulting firm Mercer in Montreal, said workers need to understand that the Quebec government is not intending to make up shortfalls in pension plans when companies fail.

“The reality is pensions will not be increased – it just gives breathing room,” he said.

The program will give pensioners the option of having the Quebec Pension Plan take over management of their assets for a five-year period if their pension fund is insolvent.

The government will not contribute money to make up any shortfalls in pensions at the time of the bankruptcy, but will guarantee that pensioners receive at least their reduced pension levels as measured at the time of the insolvency.

For example, if a pensioner were eligible to retire with a $1,000 monthly pension, and the company's pension plan is so underfunded at the time of insolvency that their pension is cut to $700 a month, the Quebec government has pledged to guarantee that $700 level of payment for five years.

Quebec Employment Minister Sam Hamad said yesterday that the minimum payment level could rise if the pension manager is able to earn excess returns by investing the pension assets successfully.

“Any additional profit we get will be returned back to the retirees,” he said.

Mr. Hamad said the Quebec government was not willing to offer a full pension guarantee to workers because it could require extremely large payments when companies are bankrupt. He noted that Ontario's Pension Benefit Guarantee Fund, which guarantees employee pensions to a maximum of $1,000 a month, is risky because a large bankruptcy will require high government contributions.

“We have to keep people responsible,” he said. “They are private pension plans.”

Mr. St-Germain said the Quebec program was created because the market for annuities in Canada is limited, especially during the economic downturn.

Typically, pension administrators buy annuities to guarantee a steady monthly income for retirees when a pension plan is wound up. But Mr. St-Germain said annuities are difficult to buy right now.

“You need to purchase annuities in a short period of time,” he said. “It's impossible to buy annuities for a large group. ... The market is just too thin.”

He said the five-year program will provide more time and avoid the need to buy annuities at steep current prices.

He said the intention is that the money in the program will be invested conservatively in bonds to ensure the government will not lose money and have to contribute cash to make up a shortfall.

“This is supposed to cost zero to the Quebec government and the Quebec taxpayers,” he said.

As for the likelihood of additional profit, pension lawyer Michel Benoit of Osler Hoskin & Harcourt LLP in Montreal said he isn't confident the government can manage money conservatively and still earn excess returns to improve underfunded pensions.

“I've never seen a government invest money that would be a benefit to you,” he said.

Martin Rochette, a pension lawyer at Ogilvy Renault LLP in Montreal, said the far more significant part of the relief package is the government's pledge to give companies an additional five years to make up shortfalls in their pension plans.

The provision is similar to relief offered already by the federal government and by some provinces, including Ontario. But Ontario has required companies to get employee consent to extend pension funding, requiring complex notification and education efforts. Pension experts have warned that few companies will use the relief.

Mr. Rochette said many Quebec companies will take advantage of the offer because the program is easy to use.

So the Quebec Pension Plan (known as the Régie des rentes du Québec) will take over the management of insolvent pension plans, ensuring that workers and pensoners get a minum payment, and the Quebec government is giving companies an extra five years to top up their underfunded pension plans.

[Note: This explains why so many people from Quebec's National Assembly have been busy reading my blog lately.]

But while this is a step in the right direction, let's not forget who manages money for the Quebec Pension Plan - the Caisse de dépôt et placement du Québec (Caisse). The same Caisse that got slaughtered in 2008 as their board was 'taken in' by lure of ABCP:

Quebec Finance Minister Monique Jérôme-Forget says directors at the Caisse de dépôt et placement du Québec didn't fully understand what they were getting into when they believed they could make huge profits on a multibillion-dollar stake in commercial paper.

The board members of Canada's biggest pension fund manager were taken in, along with other investors, by credit ratings that underestimated the risks of asset-backed commercial paper (ABCP), the Finance Minister said.

“Those who sold these products throughout the world … did not know the contents of the commercial paper,” Ms. Jérôme-Forget said in the National Assembly.

“Not only did they not know but they relied on credit rating firms who had the mandate to evaluate them. DBRS, for instance, gave commercial paper a triple-A rating while giving Quebec bonds a double-A rating. You can understand that this was a major mistake.”

For the second consecutive day, Ms. Jérôme-Forget was in the hot seat in the Quebec legislature, having to explain why the Caisse invested $12.7-billion of Quebeckers' savings in ABCP. The extent of the pension fund's losses in ABCP will be unveiled in its annual report expected at the end of February.

The minister said this week that members of the board of directors at the Caisse were not only “taken in” by overly optimistic ratings but that they didn't understand what they were getting involved in when they approved the investments. The Caisse was a major investor in Coventree Inc., which was the largest creator of the securities that eventually froze.

“I'm not thrilled with what is going on at the Caisse. I'm not very happy that they invested $12.7-billion in commercial papers,” she said at a news conference Wednesday. “It is clear that they were fooled by this product, that they didn't understand it. In life when you don't understand something, you'd better try and understand it.”

A spokeswoman for DBRS, Caroline Creighton, said the agency is willing to discuss the issue with Ms. Jérôme-Forget.

“DBRS assigns ratings based on the information provided to us,” she said in a statement. “We are open and transparent in how we assign our ratings, and we now ask for and publish industry-leading detail and disclosure from issuers. We also now require compliance with our Global Liquidity Standard when assigning ABCP ratings.”

Ms. Jérôme-Forget is being too kind. Let me spell it out for you: for years the Caisse invested in ABCP making a killing in their cash reserves as they easily beat their T-bills benchmark. Only problem was that they were doing this with a product that had a liquidity mismatch between longer-dated assets and short-dated commercial paper funding.

For years this worked well, making the money market traders at the Caisse very rich as they easily beat their bogus benchmark which did not reflect the risk of this ABCP. As long as the returns came in, the big bosses kept mum.

[By the way, they were not alone as PSP Investments also bought a good chunk of ABCP as did Ontario Teachers but to a lesser extent.]

Then all hell broke loose, Henri-Paul Rousseau admitted they underestimated the risks of ABCP (no kidding!) but he escaped the fury, leaving Richard Guay to take the heat and ultimately, the fall.

And the board of directors of the Caisse and PSP Investments? We are not hearing much from them because they know they screwed up too.

All I can tell you about ABCP is what one senior pension fund manager told me when an investment banker approached him to invest in it:

"The sales guy told me it's a no-brainer, to which I replied, yeah, you have to have no brains to invest in this paper."

I will never forget that quote but this is no laughing matter because a lot of innocent victims got screwed with ABCP. Regulators fell asleep on the switch and so did the senior managers and board of directors of these "sophisticated" pension funds.

Let me repeat something ad nauseum: all these pension funds need an independent performance audit at least once a year and all stakeholders, including taxpayers, should see the results of these audits. This should be legislated into the laws that govern these public pension funds.

Importantly, unless we get more transparency on the benchmarks used to evaluate all investment activities, quarterly performance results, where and who they invest with, the minutes of the board of directors and clear accountability where responsibility is assigned along with meaningful repercussions for taking excessive risks and losing substantial sums, then absolutely nothing will change at these large public pension funds. It's going to be business as usual with the same disastrous results.

Over in the United States, the outgoing head of the U.S. agency that insures corporate pensions said on Thursday a new investment approach undertaken under his watch that relies more heavily on equities remains the best long term strategy:

Charles Millard, the executive director of the Pension Benefit Guaranty Corporation (PBGC), said in an interview with Reuters the plan gives the agency, which is running a deficit, the best chance of sustaining itself and pay benefits.

"It's much more diversified than the prior policy and that has reduced near term and long-term risk," Millard said, noting that a decision to unroll it slowly has enabled the PBGC to avoid some of the recent market turmoil.

Under the policy approved last February, PBGC recently began a gradual move from a largely fixed-income portfolio to one that allocates 45 percent of corporate assets to investments in equities.

Another 45 percent remains in fixed income and 10 percent of the portfolio will go to private equity, real estate and other "alternative investments."

"Come talk to me in 20 years," Millard said in addressing criticism from some quarters, mainly political, that PBGC should be more careful considering its deficits, a worsening economy and staggering markets.

"A diversified investment policy for the long term is one of the foundations that will make this organization better (positioned) to meet its obligations."

Millard said he has discussed the investment strategy and other PBGC matters with the incoming Obama administration.

The PBGC reported $4 billion in investment losses for the fiscal year that ended September 30, or 6.5 percent of assets. Over the same period stronger yields helped reduce its deficit by nearly $3 billion to $11.2 billion.

The agency's deficit in recent years was blamed on bankruptcies and pension plan failures at major airlines and steel companies.

The agency reports $62.9 billion in pension plan assets under its control compared with $74.1 billion in liabilities. Much of the balance sheet reflects traditional single-employer plans.

Millard said the PBGC has enough money to pay long-term benefits and is not likely to be harmed by roiled markets and a woeful economy so long as any plans it assumes from failed or bankrupt companies are well funded.

He said the agency is carefully watching automakers, auto suppliers and small hospitals that do not have the financial cushions or other resources to weather severe economic strain.

Under Millard, the PBGC has been more aggressive about monitoring companies in troubled industries and taking steps to make troubled companies shore up pensions.

Premiums paid by companies, pension assets and investment returns fund the agency's pension insurance.

Investment yields have been stronger and companies must, by law, pay closer attention to contribution requirements.

The PBGC insures pensions for 44 million people participating in 30,000 plans. Its books mainly reflect the health of traditional corporate pensions, which pay a fixed benefit over many years.

I am curious to see where Mr. Millard will land on his feet for his next job. As for PBGC's move into equities and alternative investments, I wrote this not too long ago:

So where does all this leave pension funds? It leaves pensions in peril. And here is the kicker: the U.S. Pension Benefit Guaranty Corp. (PBGC) - the government agency that insures pension retirement savings for roughly 44 million workers - tapped three investment firms to help manage $2.5 billion in real-estate and private-equity assets, segments the pension insurer's board approved earlier this year for expansion into:

BlackRock Inc. (BLK), Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co. (JPM) were selected to manage the investments, provide support to PBGC's in-house investment staff and help build the corporation's institutional capacity.

"These relationships will benefit the PBGC, not only with private equity and real estate investments, but in risk analytics and mitigation, consolidated reporting and staff augmentation," said Director Charles E.F. Millard.

Last month, PBGC said it reduced its deficit by roughly $3 billion to $11.15 billion in its latest fiscal year but warned the ongoing financial crisis could cause fiscal instability in this new year. The agency had $4.34 billion in stock market losses for the fiscal year.

Wait till the PBGC gets clobbered in their real estate and private equity portfolios. These are the perils of following the herd who tried to follow Harvard and Yale.
It's mind-boggling to see how the U.S. federal government agency in charge of insuring private pensions has now decided to take on more equity risk and invest into alternative investments - the same alternative investments that exacerbated this financial crisis.

If we get a long period of debt deflation and a protracted slowdown, Mr. Millard's risky decisions will be judged as reckless and dangerous. But he will not be the one sitting in front of a Congressional panel in 10 or 20 years answering some tough questions if the PBGC loses billions on these risky investment decisions. He'll be long gone by then.

No wonder a recent survey by the National Institute on Retirement Security (NIRS) revealed that 83% Americans are worried about their ability to retire. Unlike the 'Miracle on the Hudson' that happened today, they know that if their pensions crash, they will not escape unscathed.

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