More Overselling of Pensions?

The Honourable Jim Flaherty, Canada's Minister of Finance, released a reform plan for the federal private pension legislative and regulatory framework on Tuesday:

"Our Government has listened carefully to Canadians," said Minister Flaherty. "We understand the value of secure and sustainable pension plans. We are proposing a balanced package of measures for the benefit of pension plan sponsors, plan members and retirees."

Today’s announcement comes out of extensive consultations with Canadians, beginning with the January release of a discussion paper, Strengthening the Legislative and Regulatory Framework for Private Pension Plans Subject to the Pension Benefits Standards Act, 1985, and including online consultations.

In March and April, Ted Menzies, Parliamentary Secretary to the Minister of Finance, chaired a series of national public and private consultation meetings across Canada to hear the views of Canadians on strengthening the framework.

The package includes measures to:

• Enhance protections for plan members.
• Reduce funding volatility for defined benefit plans.
• Make it easier for participants to negotiate changes to their pension arrangements.
• Improve the framework for defined contribution plans and for negotiated contribution plans.
• Modernize the rules for investments made by pension funds.

"These reforms will provide enhanced benefit security for workers and retirees while allowing pension plan sponsors to better manage their funding obligations as part of their overall business operations," said Minister Flaherty.

In particular, the Government plans to restrict an employer’s ability to take a contribution holiday unless a 5-per-cent funding cushion remains, change the solvency funding methodology to make it less volatile and less pro-cyclical by basing the funding requirements on a three-year average, and require employers to fully fund pension benefits on plan termination.

In addition, the Government intends to increase the pension surplus threshold under the Income Tax Act, which applies to both federally and provincially regulated defined benefit plans, to 25 per cent from 10 per cent.

The proposed changes are aimed at federally regulated private pension plans, which represent about 7 per cent of pension plans in Canada.

While some of the proposed changes can be introduced by changes to regulation, others will be implemented by legislation, which is expected to be introduced in Parliament.

Protecting seniors is a priority for the Government. In addition to these pension framework modernizations, the Government has taken action by:

• Introducing legislation to implement the results of the Canada Pension Plan (CPP) Triennial Review, concluded at the May 2009 Federal/Provincial/Territorial Finance Ministers’ Meeting, which includes a number of measures that will improve the effectiveness and resilience of the CPP while ensuring it remains affordable and fair for future generations.
• Leading a Federal/Provincial/Territorial Research Working Group on Retirement Income Adequacy, which will report to Ministers of Finance and Ministers Responsible for Pensions in December to ensure that all Canadian governments have a common understanding of the strengths and challenges facing the retirement income system in Canada.

This builds on our Government’s four-year record on seniors’ issues, which provides $1.9 billion annually in tax relief to seniors and pensioners, including:

• Increasing the Age Credit amount by $1,000 as of 2009, on top of the $1,000 increase introduced as of 2006.
• Increasing the age limit for maturing pensions and Registered Retirement Savings Plans to 71 from 69 as of 2007.
• Introducing pension income splitting as of 2007.
• Doubling the amount of income eligible for the Pension Income Credit (to $2,000 from $1,000) as of 2006.

In addition, the new Tax-Free Savings Account will provide additional tax-efficient savings opportunities for all Canadians, including seniors.

Soon after the press release, the media started commenting on the proposed reforms. Jonathan Chevreau of the National Post reports that Ottawa's pension reform has five main objectives:

1.) ENHANCED PROTECTIONS FOR PLAN MEMBERS

i. Plan sponsors will be required to fully fund pension benefits on plan termination. Any solvency deficit that exists at the time of termination will be required to be amortized in equal payments over no more than five years. The obligations of the employer determined following the termination will be considered unsecured debt of the company. This would eliminate the possibility that a pension plan could be voluntarily terminated when assets are not sufficient to pay full promised benefits.

ii. Employer contribution holidays will only be permitted if the pension plan is more than fully funded by a solvency margin, which will be set at a level of 5% of solvency liabilities. The practice of taking contribution holidays was widespread in the past and has been a contributing factor towards the underfunding of pension plans during the past several years.

iii. Sponsor declared partial terminations will be eliminated from the Act.

iv. There will be immediate vesting of benefits. Under the current framework, there is a two-year maximum period before accrued benefits are vested. It is proposed that vesting be made immediate upon membership in a plan.

2. REDUCE FUNDING VOLATILITY FOR DEFINED BENEFIT PLAN SPONSORS

i. Introduce a new standard for establishing minimum funding requirements on a solvency basis that will use average - rather than current - solvency ratios to determine minimum funding requirements. The average solvency position of the plan for funding purposes will be defined as the average of solvency ratios over the current and previous two years. This will be based on the market value of plan assets. The amortization period for solvency deficiencies will remain at five years. The going concern methodology and its 15 year amortization period will remain unchanged. Annual valuations will be required to support the new solvency funding standard.

ii. Sponsors will be permitted to use properly structured letters of credit to satisfy solvency payments up to a limit of 15% of plan assets.

iii. The 10% pension surplus threshold in the Income Tax Act will be increased to 25%. The Income Tax Act allows employers to make whatever contributions are necessary to ensure that pension benefits promised under a defined benefit Registered Pension Plan are fully funded on an actuarially determined basis. However, if plans have surplus funds over a specified threshold, employer contributions must be suspended. The new threshold will apply for 2010 and subsequent years.

3. RESOLUTION OF PLAN-SPECIFIC PROBLEMS

A workout scheme for distressed pension plans will be established to help facilitate the resolution of plan-specific problems that arise in some circumstances when a particular plan sponsor cannot meet near term funding requirements. The scheme will permit sponsors, plan members and retirees of a distressed pension plan to negotiate funding arrangements that are not in conformity with the regulations to facilitate a plan restructuring. It will respond to situations where the existing framework imposes funding requirements that cannot be reasonably met, and as such, may actually be detrimental to benefit security.

4. FRAMEWORK FOR DEFINED CONTRIBUTION AND NEGOTIATED CONTRIBUTION DEFINED BENEFIT PLANS

i. Provisions of the Act and the Regulations will be revised to provide clarity on the responsibilities and accountabilities of the parties involved with defined contribution plans. Plan sponsors and members will benefit from a framework for defined contribution plans that will:

• Provide explicit guidance on the responsibilities and accountabilities applicable to employers, members, administrators and investment providers with respect to defined contribution plans. The framework will consider the Capital Asset Plan (CAP) Guidelines released by the Canadian Association of Pension Supervisory Authorities to provide best practices on these roles.

• Eliminate the requirement for a Statement of Investment Policy and Procedures for a CAP defined contribution plan.

•Measures specifically pertaining to defined contribution arrangements will be clearly articulated in the Act and Regulations.

ii. Pension plans will have the option to permit members to receive Life Income Fund (LIF) payments directly from a defined contribution pension fund. Permitting the payment of LIF-style retirement benefits directly from the defined contribution plan account balance allows members to continue to have their pension savings managed by the plan, instead of having to assume greater personal responsibility for the management of the funds by transferring them to a LIF account at a financial institution.

5) MODERNIZATION OF PENSION FUND INVESTMENT RULES

The present pension fund investment framework, which imposes a prudent person standard supplemented with quantitative investment limits, will be modernized as follows:

• Remove the quantitative limits in respect of resource and real property investments.
• Amend the 10% concentration limit to limit pension funds to investing a maximum of 10% of the market value of assets of the pension fund (rather than the book value) in any one entity. An exception to this rule will exist for pooled investments over which the employer does not exercise direct control, such as mutual fund investments.
• Prohibit direct self investment (e.g., an employer would no longer be permitted to invest any amount of its pension fund in its own debt or shares).

OTHER MEASURES

i. To reduce administrative burden for plan sponsors and permit the orderly windup of plans upon termination, the benefits of members who cannot be located will be permitted to be transferred to a central repository.

ii. The Office of the Superintendent of Financial Institutions will be given additional powers to intervene when there are concerns about the work of a plan's actuary.

iii. A number of other technical improvements to the Act and the Regulations will be made to align the framework more explicitly with the way that it is commonly interpreted and administered. These technical amendments are as follows:

• Restrict annuity purchases for an ongoing plan if the plan is underfunded to be consistent with the treatment of transfers of lump sum benefits.
• Amend the definition of termination to avoid catching situations where the plan is not necessarily terminated, and clarify the timing and content of information to plan beneficiaries following a termination.
• Eliminate pre-1987 references in the Act, which are largely out of date.
• Remove the requirement that pension plans report to the Superintendent on inflation adjustments made to the pension benefits.
• Amend the definition of former member to ensure that plan members who have transferred to a new plan do not have a say in future surplus distributions in the older, original plan.
• Clarify that in situations where the accrued benefits constitute small amounts, they can be paid out as a lump sum at retirement.
• Require that payments owed to pension plans be remitted monthly rather than quarterly.

Terence Corcoran of the National Post writes More overselling of pensions:

One of the underlying problems of the Canadian pension plan system -- public and private -- has been the tendency of its promoters to oversell products that could not be delivered. We have actuaries who told us how pension funds could beat the stock market over the long term, governments who took on public service pension risks without telling taxpayers about the costs, and unions that loaded their private sector employers with pension liabilities that could never be met.

And now comes Finance Minister Jim Flaherty with a reform plan that, once again, oversells what he is actually doing. "Our government has listened to Canadians," he said Tuesday. "We understand the value of secure and sustainable pension plans. We are proposing a balanced package of measures for the benefit of pension plan sponsors, plan members and retirees."

What Mr. Flaherty delivered, instead, was a list of worthy fiddles with rules and laws governing pensions that are subject to the federal benefits standards act. That means only 7% of Canadian pension plans will be affected by the proposed reforms. The fiddles, moreover, will do nothing to relieve the shortfalls faced by that 7% should their pensions be underwater or their employers in bankruptcy.

Spotting this obvious gap in Mr. Flaherty's announcement, Liberal finance critic John McCallum accurately charged the government with failing to bail out the average Canadian pension plan that's struggling with a 20% deficit. But then Mr. McCallum, playing the usual game, promised the Liberals will soon deliver their national plan for pension reform. It will include a new Canadian Pension Plan scheme, more tax incentives and other proposals. The Liberals, in other words, will oversell Canadians on another pension program that will not deliver.

Mr. Flaherty's reforms, had they been in place, might have made the current private pension problems less severe. Making it easier for plan operators to add new money to pension plans when the plan is in surplus acts as an incentive for more corporate contributions. But there are no guarantees corporations would have made those extra contributions -- especially when they were being told by investment and actuarial experts, time and time again, that the stock market would soon rise and the pensions plan was safe.

None of these short-term federal fixes, nor any of the political banter, will matter much over the longer term. Pension law and economics are broken, and the process of bringing about major reform will take several years -- assuming all the players at the table can reach agreement. Each province will have its own ideas, and a long list of private players, including the insurance industry, will also want to shape the outcome of any reform effort.

But even if some new national approach is worked out, it is unlikely anybody is going to be able to rescue the private-sector pension plans that so many companies adopted as perks for their employees. The best hope is a recovery in financial markets, which could over time reduce the deficits. Once plans are in balance, it will be a lot easier to begin unwinding the old plans and bring in new plans for new employees. That process is already underway.

For pension plan members and individual Canadians, the best approach is to approach all reforms and plans with great skepticism. The tendency to oversell, to promise results and benefits that can't be delivered, is especially powerful within government.

You'll recall Mr. Corcoran reported on the model that's killing pension funds back in February. His criticism of the pension reforms is spot on. Even though the reforms are sensible, they're a day late and a dollar short. More importantly, they do not address the looming pension crisis that will grip Canada in the coming decade.

The pension debate needs to reopened. It's not a Conservative, Liberal or New Democratic issue, it's about doing what's best for hard working Canadians. The reforms proposed today are simply not enough and will leave far too many Canadians teetering on the edge of pension poverty. Surely we can do better. We owe it to millions of Canadians that through no fault of their own, have fallen victim to vagaries of the market.

***UPDATE on Proposed Pension Reform***

CARP welcomes changes but states it is only a first step in the right direction. Canada's actuaries call for the federal government to go deeper for effective pension reform. The Globe & Mail reports that Ontario pledges pension overhaul. And CBC says benefits of new pension rules likely years away. Finally, The Association of Canadian Pension Management (ACPM) says it welcomes Finance Minister Jim Flaherty's "leadership on reforms" to private pensions but warned the goal of adequate retirement income has been "undermined because some Canadians simply aren't saving enough." (you hear that Canadians, the ACPM thinks you should save more!)