Game Changer – 21st Century Funding of DB promises
A new set of rules for funding defined benefit pension plans is emerging in Canada. I think we need to be honest about what we want from pension funding rules; and, then when we decide what that is, we need to be honest with plan members about the system that we have chosen to protect their pensions.
My career in the pension industry started long after the pension legislation of the 1960s set out how a pension plan ought to be funded. Fortuitously, I started in 1986 just as Ontario was re-examining pension rules for defined benefit pension plans and a few years before the Federal Government completely re-worked the tax rules for allowing tax-deferred savings for retirement benefits. As these legislative changes unfolded, pension funding was defined by the following truths:
- The going-concern valuation was the benchmark to ensure a plan had enough assets to deliver its promised benefits, and if a plan failed that test, a long-term (15 year) plan was put in place to make up any shortfall. Pensions never had to be 100% funded at all times.
- Pension funds should not be abused to accumulated excessive surpluses to allow corporations to avoid taxes on earnings.
- Solvency testing was a good idea just to double check benefit promises could be delivered in the event a sponsor failed – but the test rarely asked for more assets than the more stable and revered going-concern valuation.
Changes in minimum benefits, new ideas like ‘grow-in’, and a rapidly declining interest rate environment saw pension funding turned upside down by the end of the 1990s. By the time of the tech crash in the early 2000s, solvency funding was driving pension funding and it wasn’t pretty – most plans were suddenly insolvent, many below the threshold that required annual valuations which caused unaffordable volatility in pension costs from year-to-year. Although I had seen some sponsors convert their DB plans to DC plans in the 1990s – this new world of unpredictable costs drove sponsors to DC.
It is a complex discussion as to whether employers and workers are better off in DB or DC – but there are many in the pension industry, including governments, that believe DB should be saved. As a result, we have had more than a decade of ‘funding relief’ in many jurisdictions as governments try to push out the burden of solvency funding and give sponsors the relief that they need to ideally keep a DB plan, but at a minimum keep sponsors from going out of business which is the worst outcome.
In recent years, governments have come to see that, having opened the door to a more relaxed funding standard on a ‘temporary’ basis, they have backed themselves into extending new rounds of relief every time the prior round expires. As a result, governments have been moving to re-define how pensions should be funded. So far Quebec and Ontario have moved to shifting the focus away from solvency funding and towards going-concern funding. Nova Scotia is considering doing the same with the added layer that new rules will only apply to plans where members agree. BC is currently consulting with interested parties on how to re-balance the deal between encouraging sponsors to make DB promises and giving those sponsors time to smooth out contributions to deliver on them. For 40 years, almost every industry group has called on governments to harmonize our pension rules – it is somewhat stunning to me that at this stage each province is doing something different.
What are the similarities and differences in this new world on funding pensions across Canada? The main similarity is that solvency funding is de-emphasized, and the going-concern funding is prioritized and strengthened. In Ontario the new solvency target is 85% (also proposed in Nova Scotia) while Quebec has completely eliminated the solvency test. Both Ontario and Quebec have placed its focus on going-concern funding and moving beyond a ‘best estimate’ approach that has emerged in actuarial standards in the past two decades, with new legislation explicitly providing that a ‘provision for adverse deviations’ (PfAD) be added.
What do these new rules do for plan sponsors and members:
- For sponsors, year-to-year volatility in contributions will be reduced, however over the long-haul contributions are expected to be greater than necessary and at some point, if the actuaries make good predictions, surpluses will be revealed.
- For plan members, benefit security is NOT enhanced. The way the PfAD is being sold is as ‘additional protection’ and we need to clean up that poor thinking. The truth that is plain to see is that a reduced solvency test means that in times where the cost of pensions is high compared to long-term cost estimates (when interest rates are lower than historical averages), then members are at risk if the sponsor ceases to exist. The old rules sought to close a solvency gap over 5 years – the new rules allow these gaps to persist indefinitely.
With Sears so prominently in the news of late and Nortel not too far in the rear-view mirror, why are we easing up on protecting plan members? The answers are to accommodate business and to encourage the continuation of DB plans. I cannot tell you that this is the wrong answer. As I have learned since the ORPP fiasco, politics is not my game.
For many workers, a 90% funded DB plan might still be better than a DC plan where low rates of contribution and investment guesswork can lead to no better result. What I do know is that if DB plans are to continue to rely on the ongoing viability of the plan’s sponsor, then we need to be honest with plan members that this most recent change in pension funding rules is not increasing the protection of their benefits but rather increasing their reliance on the plan sponsor funding the plan. We should not sit by quietly and let our governments pretend otherwise.