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Pensions are by far the most gruesome political challenge facing elected officials today.

High standards ensure solvency, but also the Hobson's choice of higher contributions or lower benefits for existing members.

Lower standards keep contributors happy, but worry existing beneficiaries.

More worrisome, lower standards expose the government to incredible risk.

In the last major downturn, Ontario's government passed legislation allowing the province's biggest companies to opt out of pension contributions. The theory was that these companies were "too big to fail" and relieving them of the pension obligations would help them make needed investments, weather the economic storm and maintain employment. Suddenly, instead of contributing tens of millions of dollars to pension plans, they only had to put $5-million in a special Ontario Pension Benefits Guarantee Fund (OPBGF).

Well, one of those companies deemed too big to fail in fact did. Stelco's death pitted shareholders against employees in a battle over dollars, with the province on the hook as the ultimate backstop to those pension obligations. And there was nowhere near enough money in the OPBGF to cover Stelco's obligations, let alone all the other companies'.

Ford and GM Canada, two more of the companies allowed to opt out, are not on great financial footing these days either - thanks in part to their pension plans.

Today, the government is facing the same choice Ontario faced in 1992: relax standards and increase risk to the Treasury down the road, or maintain standards and increase the political and economic risk from layoffs today.

Depending on the decisions the federal and provincial governments make in this downturn, we could be facing a lot more stories like this in the future…

Stelco plan may hit taxpayers hard

Thursday, March 11, 2004 ERIC REGULY

Stelco's pension plan has a $1.2-billion hole in it. The Ontario government's pension guarantee fund has $230-million in it. Do the math. Somewhere along the way, the government might have to find a monster wad of money to bail out the steel maker's pension plan. For this you can blame Bob Rae's old NDP crew. The ex-premier thought giving Stelco a pension break was the charitable thing to do. Today, it looks like a disaster.

Stelco is in bankruptcy protection. This is no easy restructuring. The unions, facing the potential destruction of thousands of jobs and a fat pension plan, claim the company is not actually insolvent. Stelco says it is, and if you tallied up the assets and liabilities you would believe management's argument. Stelco is one ugly mess. But that's not half the story. The dirty little secret is that Ontario's taxpayers might get dragged kicking and screaming into the mess. The tab for their role could easily come to hundreds of millions of dollars.

A quick history lesson is in order. Many premiers ago, in 1980, Ontario set up the Pension Benefits Guarantee Fund (PBGF). It was designed to protect defined-benefit pension plan members should their plans be wound up with insufficient assets, say through a bankruptcy or liquidation. It is funded by a small levy on employers. In general, it pays out no more than $1,000 a month per person in pension benefits. The fund is unique in Canada, which doesn't mean it's a bad idea. It has worked pretty well.

Enter Bob Rae. In the early 1990s, Ontario was in recession and employers were in trouble. Six big companies in particular -- the Canadian divisions of GM, Ford, Chrysler and IBM, Sears Canada and Stelco -- wanted the flexibility to trim their pension plan contributions. When the good times returned, they presumably would top up the plans.

The Sorry Six got their wish. This meant their funds could ignore their solvency tests, that is, the assets didn't necessarily have to cover their liabilities, assuming they were to be wound up at any point in time.

In exchange, the companies made higher contributions to the PBGF. But the extra payments were insignificant compared with the tens of millions in savings from the effective contribution holiday.

The Rae government thought it was doing the right thing by giving the province's largest employers some financial wiggle room. In Stelco's case, it totally backfired. This happened partly because the government forgot to insist there be absolutely no pension benefit improvements for companies taking advantage of the solvency test-relief scheme. During the 1990s, Stelco enriched its employee pension plans, ensuring the train wreck was only a matter of time.

Meanwhile, thanks to PBGF payouts -- Algoma Steel pensioners, among them -- the fund was getting depleted. According to Stelco's restructuring advisers, about $773-million of Stelco's pension shortfall would be eligible for PBGF funding should the Stelco fund be wound up and replaced with something else, or just eliminated if the company were to disappear (as the U.S. steel giant LTV did). That's $543-million more than the contents of PBGF's piggy bank. For a government running a deficit and hospitals to pay for, that's a lot of money.

The problem is, no one will throw good money after bad. That means no one will contribute fresh money to Stelco, enabling it to emerge from bankruptcy protection and become a competitive steel maker again, unless the monster pension issue is fixed. All roads lead to the Queen's Park on this front. With the PBGF too small to cover the Stelco plan's liabilities, the McGuinty Liberals have some decisions to make. The fund can borrow from the government, but how would it be paid back? Alternatively, the government could just write a big cheque to make the Stelco employees and retirees happy. After all, it was the government, though a different one, that helped Stelco's pension plan achieve crisis status. You could argue the government has a moral obligation to rescue it (it technically has no legal obligation because the PBGF has no financial recourse to the government).

So assume the government will have to come up with the money at some point. There's a right way and a wrong way to spend it. The wrong way is to attach no conditions to the cheque. Stelco bondholders would love this. They scored a big win when Stelco took advantage of Mr. Rae's largesse; in effect, it allowed the bondholders to "borrow" the money from the pension fund on the belief they would have no obligation to pay it back. This helps to explain why the senior Stelco bonds trade at about 65 cents on the dollar -- an exceedingly high price for a piece of paper backed by a company whose liabilities greatly exceed its assets, no matter which way you measure them.

Instead of giving a free ride to the bondholders, who assume an unconditional bailout of the Stelco pension plan is coming, why not make all the stakeholders contribute to the bailout plan? This would be easy to accomplish. Here's one scenario: The pension fund gets its several hundred million or so and would take a significant slug of equity in the new Stelco in return. Taxpayers would get value for their investment when the shares are sold, presumably at a profit.

A compromise like this would make the best of a bad situation. The bad situation was created when the Rae government tossed Stelco's pension-contribution obligations out the window more than a decade ago. Using a taxpayer-financed pension bailout to enrich the bondholders would only make it worse. Value for taxpayers has to be factored into the equation.

 

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