Regular readers of this commentary will be familiar with my colleague Joe Nunes’ views on the various Bad Ideas that our governments have proposed on pension matters in recent years. Now it is my turn to warn our audience on another Bad Idea being considered.
Ontario’s Review of the Solvency Funding Framework
As some of you know, the Ontario Government recently released a consultation paper to initiate its review of the solvency funding framework for pension plans. The purpose of the solvency funding review is to develop a balanced set of solvency funding reforms that would focus on plan sustainability, affordability and benefit security, and take into account the varying interest of pension stakeholders. Ultimately, this consultation will likely lead to a reform in the funding rules applicable to defined benefit pension plans registered in Ontario.
The consultation paper is well written, and provides an excellent description of both the current pension landscape and the funding rules that exist in Ontario today. This paper highlights the decline of DB plans in Ontario over the past decade; and it summarizes the key concerns raised by DB plan sponsors, namely: contribution volatility, the procyclical contribution requirements, the high cost of benefit security, the complexity and lack of transparency of the funding rules, and surplus issues. As most DB plan sponsors can attest, the prolonged period of declining interest rates and market volatility has made the funding of DB pension plans challenging in recent years.
From a high-level perspective, the consultation paper outlines two possible options for reforming Ontario’s funding framework for DB pension plans:
A. Maintaining the requirement to fund on both going concern and solvency bases – but modify the solvency funding requirements (e.g. lengthen solvency amortization periods, allow more smoothing in the solvency basis, fund only to a certain percentage of the solvency liabilities); or
B. Enhancing going concern funding requirements, while eliminating current solvency funding requirements altogether (e.g. required additional funding in the going concern valuation, force the use of prescribed assumptions in the going concern valuation).
In addition two these two possible options, there are other complementary reform measures that are being considered including: requiring valuations be performed on an annual basis, putting restrictions on contribution holidays and benefit improvements, and changing the commuted values for members who elect to exercise their portability rights upon separation.
For the record, I believe many of the options outlined in the consultation paper are reasonable approaches, each with their own pros and cons. However, there is one idea that sticks out as a Bad Idea.
The Bad Idea
One option being considered is to increase the guarantee provided by the Pension Benefits Guarantee Fund (or the PBGF). While the consultation paper correctly notes that an enhancement of the PBGF would mitigate the effects of a decrease in benefit security associated with the solvency funding reform options noted above, I believe such an option should be avoided at all costs.
The Problem with the PBGF
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 for members who meet certain criteria. The PBGF is financed by premiums paid by plan sponsors, which are determined based on the number of members in their DB pension plan(s), and the funded status of their DB pension plan(s) on a solvency basis as reported in the last valuation filed with the regulator.
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 means to force 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 it’s 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 (far less than the 10x noted above). As such, I would be interested to see a refresh of the sustainability study for the PBGF, but my inclination is that this program still presents a significant risk to 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, it seems offensive that this program is subsidized by taxpayers who are not all members of DB pension plans themselves.
As recommended in the Drummond Report back in 2012, the Ontario Government should either terminate the PBGF, or explore the possibility of transferring it to a private insurer. My guess is that a private insurer wouldn’t touch this program with a 10 foot pole. Thus, there is really just one option that is viable for the PBGF – and that doesn’t include an expansion of this program – in fact, the Ontario Government ought to consider terminating this program sooner rather than later.