A record number of Canadian companies have been forced by the global economic recession to liquidate or restructure their operations. Hidden behind these bankruptcy statistics are a growing number of insolvent companies with underfunded pensions. There is no current data, but practitioners say they have never before seen so many companies land in bankruptcy proceedings with pension deficits.
Ian Markham, a director with pension consultant Watson Wyatt Worldwide , estimates the average Canadian business pension plan is 20 per cent short of the assets they need to fund their long term pension obligations. That deficit adds up to about $50-billion, a staggering IOU that he says is crippling a number of companies.
"The pension burden has proven to be too great," said Mr. Markham.
Corporate pension plans that are still standing face unprecedented stresses. Their deficits loss are squeezing employers at a time when pension costs are soaring as retirees live longer and an aging work force nears retirement. Staggering under this weight, businesses are lobbying federal and provincial governments to relieve their burden.
- How big is the pension burden for companies in Canada today?
- What do they want Ottawa and the provinces to do to fix the problem?
- Why is the corporate pension system in such bad shape?
Ian Markham, an actuary with 30 years of pension consulting experience, took reader questions in a live discussion.
Ian Markham is Director, Pension Innovation, for Watson Wyatt in Canada, co-ordinating the development of Watson Wyatt's pension-related innovation, tools and research. Ian provides strategic advice to several major pension plans in the private and public sectors - including plans that are sponsored by corporations and multi-employer plans that are jointly sponsored by members and employers. He was an Expert Adviser to the recent Ontario Expert Commission on Pensions.
Claire Neary: Do you agree that there is little future for company pensions in the private sector?
Ian Markham: We need to look at the evolution of the role of pension plans. Many years ago, defined benefit plans were viewed by companies as part of the employees' compensation package. However, given the average cost and size of these plans, more and more private sector companies have come to regard them as a financial subsidiary whose risks are too large to be effectively managed under the current legislative environment. I believe that many companies are waiting to see what legislative pension reform packages are introduced by governments across the country in 2010. If solvency deficits can be paid off over 10 years on a permanent basis going forward, rather than the 5 years typically required today, I expect this would actually entice many companies to keep their defined benefit plans rather than switch to the other major kind of pension plan known as defined contribution (rather like a whole lot of individual RRSPs). However, I am sure that we will see very few new traditional defined benefit plans set up, if the company alone is on the hook for deficits. The focus today is naturally on the very difficult situation that is faced by a number of today's pensioners and older plan members, as we have witnessed in the stories in this Globe & Mail series - but we shouldn't lose sight of the ability for today's younger workers to be able earn a modest if not decent pension in the future, and that ability depends on the willingness of companies to keep their pension plans going for many years.
Claire Neary: Why did so many pension plans give large pension improvements and take contribution holidays in the late 1990's when there were pension surpluses available? Why didn't they save those surpluses for a rainy day?
Ian Markham: You have got to put yourself in the mindset of the late 1990s, when the financial picture was looking rosy. Pension plan surpluses were common and quite large. While there was always the possibility of a stock market correction at some point in the future, investors did not expect it (otherwise the market would not have continued to grow the way it did). Defined benefit plans were increasing in size, and there was increasing attention on risk management, but there was still a fundamental belief in the long term strength of the global stock markets. Solvency funding was not in focus then, because solvency liabilities were determined based on higher bond yields than today and were therefore quite low. So the vast majority of pension plans assumed that either benefit improvements were affordable or that companies should access some of that surplus. It is easy with hindsight to criticize this mentality. But the market did not see what was coming, so it is hard to expect that individual companies could have planned for it. If you look at it today, however, we have had two major market corrections within a period of six years, and at last we have all learned that it can happen again and soon. The focus needs to be on better management of these defined benefit plans going forward.
Claire Neary: Why do so many pension plans still have such large deficits when the market has recovered so much this year?
Ian Markham: To answer this question, we must consider which kind of deficits we are talking about. I assume this question is referring to solvency deficits, because they tend to drive what private sector companies have to contribute to their pension plans these days. Solvency liabilities went up by about 10% in 2008, and by another 10% so far this year, simply because of decreases in the interest rates that are used to calculate these liabilities. The recovery in the market typically has restored most but not all of the losses in asset values, but the increase in liabilities means that the typical plan is still in a sizeable deficit. My guess is that typical private sector plans are around 80%-85% funded now.
Ian Scott: To your knowledge, roughly how many private companies in Canada have established new defined benefit plans in the last 5 or even 10 years?
Ian Markham: Almost none. The only situations in which you will see a new defined benefit plan these days occur when a company sells off a division and insists that the buyer sets up a new defined benefit plan for the affected employees and keeps it in place for at least a couple of years after the transaction. However, even these situations are becoming rare, because the seller may not be able to find a buyer with such a condition in place.
Paul Woods: What should governments do to ease the burden on plan sponsors?
Ian Markham: Paul, I assume that you are referring to defined benefit plans. In that regard, private sector employers find the funding rules for defined benefit plans to be too volatile - notably the rules for "solvency funding," which assume that the plan will wind up and that each active plan member will retire at the age where their cost to the pension plan is at its highest. These solvency liabilities can swing very dramatically over short periods of time, as the interest rate that is used to calculate these liabilities (long Canada bond yields) changes. Then the resulting solvency deficit (the difference between the solvency liabilities and the value of assets) usually has to be paid off over five years, a period which many companies view as too short for a pension plan where there is no intention to wind it up. Given that the pension fund investments for the vast majority of defined benefit plans don't match these liabilities, company contributions tend to swing wildly from year to year. So these companies want to pay off their deficits over longer periods of time. Another problem for them is that when the markets finally recover, a lot of the solvency contributions they are now paying may end up as surplus that, in the eyes of the CFO, could perhaps have been better invested in the business. It would be a lot more acceptable to them if either of two things is allowed. First, if those solvency contributions could be refunded to the employer if it turns out that they were not actually needed. Second, if the solvency deficits could be paid for not by real contributions but by letters of credit - an annually renewable bank promise to pay a specified amount if the company fails (the bank will either charge a very high interest rate or will not renew that promise if it thinks that the company is at risk of not having enough assets to pay the bank back). And companies would rather know what the permanent funding rules are once and for all, so that they can make their decisions as to whether to keep their defined benefit plans or not - especially for plans that do not cover unionized workers. I believe that a number of companies would be willing to accept some trade-offs, like doing actuarial valuations more frequently, having limits placed on benefit improvements, and disclosing more information to their plan members. Some may be willing to contribute towards a "rainy day fund" - a larger cushion over and above the amount needed to pay the promised benefits. However, all this depends on the number of years over which they are allowed to pay off their deficits.
Jacquie McNish: Hi Ian, one of the things that kept coming up when we were reporting for our Retirement Lost series was concern about actuarial assessments and assumptions, particularly with regards to the discount rates that are used. Has recent market volatility taught us that there needs to be more discipline and oversight here?
Ian Markham: Jacquie, in today's world, employer contributions to defined benefit plans are dominated by solvency funding rules, which actually give actuaries very little discretion. So concerns about actuarial assessments and assumptions presumably relate to the time when going concern valuations used to be what determined employer contributions (and maybe they will do again one day, once the markets recover). The discount rates used in going concern valuations are typically based on the premise that the pension plan will continue forever, and actuaries usually assume that the equities held in these pension plans will earn a higher rate of return than fixed income. Actuaries have looked at long periods of time in the past and have created complicated models that predict these higher expected returns on equities, but that also show there are far higher risks with equity investments as compared to fixed income. Here is an example of greater discipline and transparency on the part of the actuarial profession. Secondly, actuaries invariably build in an additional cushion because of those risks. Many actuaries these days will also do projections to show the potential for deficits if investment returns fall. The Canadian Institute of Actuaries is in the process of changing the standards that actuaries should follow in these valuations, to make sure that all these risks are adequately accounted for.
Mike Filliter: Do you foresee pensions becoming a declining source of retirement income in the future? Do people saving for retirement now need to start worrying about saving more?
Ian Markham: Mike, your question raises two issues: declining private pension coverage levels; and the amount of retirement income generated from existing pension plans. In terms of the first issue, the percentage of employees not covered by private pensions have been rising from 65% in early 1990s to more than 70% in recent years. The reality is that there is an increasing demand for private sector pensions to help workers save for retirement, but the employers are not willing to do so for many reasons, some of which I have discussed earlier. Regarding the second issue, there is definitely a trend in the private sector to switch from defined benefit to defined contribution pension plans, especially for new hires, as well as for existing employees who elect to switch. The concern here is that many of these defined contribution plans have employer contribution rates that are likely to produce lower pensions than the defined benefit plans they replaced. So there is indeed a need for individuals to think hard about saving more for retirement.
Linda McNeil: This question relates to accounting disclosure , CICA 3461, versus actuarial costing of pension liabilities. It has been my experience that the two sets of rules used to determine the pension plan's unfunded liability causes a great deal of confusion for plan sponsors and this is due mainly to the determination of the discount rate. Do you think that will ever be a time where the basis for the discount rate is co-ordinated between the two professions?
Ian Markham: Linda, I am sure that the accounting profession will not change its discount rate rules to be based on solvency discount rates that are in place to protect plan members. The accounting discount rate is based on high-quality corporate bond yields. So the question becomes: will all governments across Canada change their solvency discount rates to be based on high-quality corporate bond yields? This is certainly a solution that has been raised by a number of major plan sponsors as a means of reducing solvency liabilities. However, politically, it is more likely that governments would want to keep the linkage between solvency liabilities and the cost of winding up a pension plan.
Frank: What happens to a defined benefits plan pension if a company declares bankruptcy tomorrow. Do they prorate the pensions for people already receiving pensions? and what happens to people who have yet to collect their pension.
Ian Markham: Frank, the answer to your question depends on the jurisdiction where the plan is registered, and whether the plan is underfunded at the time of the sponsor's bankruptcy. For example, if an underfunded plan is registered in Ontario, all retirement benefits (for current pensioners, as well as pensions already earned by current active members) are prorated based on the plan's level of funding at the time of the sponsor's bankruptcy. Of course, Ontario also has the Pension Benefit Guarantee Fund (PBGF), which can fill part of the gap for Ontario members.
V.P. Mayne: Apart from the various regulatory agencies proffering their opinions on pension provided by larger Canadian companies. Is there a monitoring group that can tell us if the pension is in trouble on a real time basis.
Ian Markham: There is no special pension watchdog tasked with looking only at plans at risk. However, provincial and federal pension regulators do conduct various types of risk assessment and monitoring.
Neil: Ian I find it somewhat unusual that in an environment where most employees in Canada who have no coverage work for small employers we have all of the heavy weights of the industry commenting and making suggestions for a group of people they have largely never met or interacted with on a professional basis. In my experience of countless employee meetings in this sector I can tell you that employers in this group and indeed the plan members in this constituency do not participate because of cost and a fear of increasing expenses or reducing take home pay. They are also leery of big government, they do not know the pension regulatory system is broken, they do not understand the difference between a target benefit plan and a defined benefit plan and just feel they can't afford it. My question then is, would tax policy not be a better way to encourage increased participation by employers and employees in the largely uncovered group? We have incentives for everything else so unless we want to broaden universal CPP coverage wouldn't this make the most sense.
Ian Markham: Neil, we already have tax policy encouraging both RRSP contributions and contributions to registered pension plans. So, presumably, you are advocating even greater investment of tax monies to encourage retirement savings. The trouble is, the people who are more likely to be in a position to take advantage of these measures are those with higher incomes. Outside the realm of tax policy, a number of provinces, including British Columbia and Alberta, are currently looking at instituting a voluntary defined contribution supplement to the CPP. However, it remains to be seen what tax treatment will be afforded to any such contributions.
Tudor Patroi: Is there a way to increase contributions to a defined benefit plan guaranteed by the government of Canada - I am thinking to CPP mainly, not sure if other options are available - such that in the end you can get a pension that you can live from? I think that for now for employees of private companies there is no way to get a pension of, for example, $50k/year that will be guaranteed by the government of Canada.
Ian Markham: This builds on my response to Neil's question. Increasing the CPP's defined benefit is not risk free, contrary to Jack Layton's assertion in yesterday's Letter to the Editor. If the CPP Investment Board were consistently to get a lower rate of return on assets than the government's actuary is expecting, this would lead to higher employer and employee contributions. Or, if there were a cure for cancer, there would be a considerable additional cost of pensions as people live longer, and contributors would have to pay for that eventually. A swift increase in CPP benefits would impose too heavy a potential burden on future generations. It would need to be phased-in over several decades to become manageable.
mark Mettrick: Ian, does the government allow overfunding (and a tax deduction) in the good years? It seems to me that there is lots of downside/underfunding, but no focus on how to promote overfunding or DB pensions. I am assuming of course that DB pensions are actually a good public policy by reducing the future burden on OAS and by having a part of the population with spending power. Thoughts?
Ian Markham: Mark, the Income Tax Act currently requires employers to take a contribution holiday when the surplus in a defined benefit pension plan reaches a certain threshold. For the vast majority of pension plans, this is just 10% of actuarial liabilities. Swings of that magnitude can occur in a matter of weeks as we have all recently seen. This is definitely a rule that should be changed, and the threshold should be increased. In addition, I said to Paul Woods in response to his question earlier, " I believe that a number of companies would be willing to accept some trade-offs, like doing actuarial valuations more frequently, having limits placed on benefit improvements, and disclosing more information to their plan members. Some may be willing to contribute towards a "rainy day fund" - a larger cushion over and above the amount needed to pay the promised benefits. However, all this depends on the number of years over which they are allowed to pay off their deficits." This rainy day fund would be a way of promoting "overfunding".