As part of the Ontario government’s proposed new funding framework for defined benefit pension plans, they have recently released a description of proposed changes to the formula for calculating a pension plan’s annual Pension Benefit Guarantee Fund (PBGF) Assessment. Unsurprisingly, the PBGF Assessments are increasing. But the real question is whether the increase in these assessments will be sufficient to keep the PBGF sustainable.
The New Funding Framework and the change to the PBGF Assessment
When developing the new funding framework, the Ontario government has attempted to balance the need to keep defined benefit pension plans affordable, with the desire to help protect the security of member’s pension entitlements. As noted in our earlier client memo and blog, the new funding framework should provide more stability in the contribution requirements for defined benefit pension plans. But as part of this balancing act, the Ontario government has increased the protection provided by the PBGF by increasing the guarantee from $1,000 per month to $1,500 per month, and eliminating the age and service eligibility requirements for PBGF coverage for future wind-ups (roughly speaking, a 50% increase in benefit coverage).
The proposed changes will see the PBGF Assessments change as follows:
Roughly speaking, the PBGF Assessments will increase by approximately 50% to 80% for many pension plans. However, the actual increase will differ for each plan, and somewhat interestingly, the assessment of 0.015% of PBGF Liabilities could results in a substantial increase in the PBGF Assessments for well-funded pension plans.
The Problems with the PBGF
For those of you who have followed our blog over the years, you will recall that I raised concerns with the PBGF in a previous blog. Forgive me, as I repeat these concerns here…
For those unfamiliar with the PBGF, the program provides protection to Ontario members and beneficiaries of privately-sponsored DB pension plans in the event of plan sponsor insolvency. It is interesting to note that Ontario is the only jurisdiction in Canada to have such a program. Generally speaking, the PBGF guarantees pension benefits up to $1,000 per month (soon to be $1,500 per month) for members who meet certain criteria. The PBGF is financed by premiums paid by plan sponsors, which are determined based on the formula established in the regulations.
While the PBGF sounds like a good idea, there are many problems with it – most importantly, that the risks are not spread according to insurance principals (as was noted in the Drummond Report back in 2012). To this end, it is worth noting that the PBGF risk exposure is highly concentrated in a couple of industries, and subject to the catastrophic risk of a default of a relatively small number of companies that sponsor very large pension plans. Furthermore, the premiums charged by the PBGF do not reflect the underlying risk of default for a particular plan sponsor. And finally, the PBGF presents a moral hazard in that it doesn’t have the incentive system to encourage plan sponsors to take less risk in the management of their DB pension plans.
Back in 2010, a study commissioned by the Ministry of Finance to evaluate the sustainability of the PBGF found that the program was unsustainable and would require either the premium rates to be set at a rate of about 10x the rate then in effect, or a significant cash infusion into the program.
On several occasions since its creation in 1980, there has not been enough money in the PBGF to cover its claims; and in those instances, grants and loans have been made from the Ontario government to the PBGF to stabilize the program for the near term. In 2010, a grant of $500 million was provided to the PBGF from the Ontario government, and the formula for determining the premiums were roughly doubled.
Now, the Ontario government is increasing the benefits provided under the PBGF by approximately 50%, and increasing the premiums by approximately 50% to 80%. This still leaves us short of the 10x increase in premiums that were noted in the 2010 study. Furthermore, with the other changes in the new funding framework (i.e. reducing the funding target to 85% of the solvency liabilities), the size of future defaults could be even higher than those that were reported in the 2010 study.
In an ideal world, the Ontario government would have refreshed the sustainability study for the PBGF when developing the new PBGF Assessments. However, it does not appear that the Ontario government has prepared such a study; and it is not clear to me what analysis, if any, the Ontario government did to come up with the new fee structure for the PBGF Assessments. Again, my inclination is that this program continues to present a significant risk to future generations of Ontario taxpayers.
While protecting DB plan members from the risk of not receiving their full pension when their employer becomes insolvent is a laudable goal; to me, a properly constructed system should not rely on an implicit promise of a government bailout, especially since fewer and fewer taxpayers are members of DB pension plans themselves.