Prioritizing Pensions

For those of you who do not follow the politics of pensions, Bill C-228 is a private member’s bill which proposes to amend the Bankruptcy and Insolvency Act, the Companies’ Creditors Arrangement Act, and the Pension Benefits Standards Act, 1985 to provide super-priority to pensions in the event of plan insolvency.  Specifically, this bill aims to ensure that, in the event that an employer who sponsors a defined benefit pension plan becomes insolvent, the employer must prioritize paying pensions before paying the claims of other creditors.

The concepts in Bill C-228 aren’t entirely new.  In fact, we’ve seen numerous attempts at implementing this type of reform over the years – all of which have failed – and for good reason as I’ll describe later.  However, since Bill C-228 currently has the support of the Conservatives, NDP, and Bloc, it has the prospect of potentially passing into legislation even without the support of the minority Liberal government.  As a result, Bill C-228 has garnered a lot of interest from pension stakeholders.

Why a “super-priority” isn’t a good idea for underfunded pensions

Undoubtably, I would like to live in a world where pension plan members with defined benefit pensions get 100% of the pension entitlement, 100% of the time.  However, providing such a guarantee through the “super-priority” mechanism comes with a cost that I believe is too burdensome for both plan sponsors and plan members to bear.  

Before I explain further, I think it is important to first recognize that:

  • employer provided pension plans are voluntary – should the cost of providing these benefits exceed their perceived value, then plan sponsors will transition to provide other forms of compensation;
  • the legislated funding framework does not require full funding at all times – in fact, the general trend over the past 15 years was to provide various forms of funding relief, and to transition away from a funding target of 100% on a solvency basis;
  • the existing legislation does not impose any significant restrictions on the investments in a pension plan – in fact, so long as the investments are reasonably diversified, plan sponsors are permitted to invest in securities which are volatile and even pro-cyclical.  With the anticipation of higher investment returns, this can provide plan members with better pensions at a more affordable cost (and it provides a source of long-term funding for public equities);
  • the legislation around plan surplus is asymmetric – and in particular, provides a disincentive for plan sponsors to build excess surplus in their defined benefit pension plans; and
  • it is only when a plan sponsor goes bankrupt and the pension plan is underfunded that members are at risk of not receiving their full pension entitlement.

These factors highlight the need for a balanced approach when contemplating legislative changes affecting defined benefit pension plans.  Change that is too large, or too fast, puts the system out of balance.

The Association of Canadian Pension Management has done an excellent job of summarizing the implications of a “super-priority” mechanism in their recent letter to the Standing Committee on Finance which is reviewing Bill C-228.  In particular, they have noted that there would be numerous “unintended consequences” if pensions were provided “super-priority” status, including:

  • Sponsors of defined benefit plans would experience an increase in their borrowing cost, experience greater restrictions on their borrowing, or worse – lose access to credit altogether;
  • Many sponsors of defined benefit plans would respond by winding-up and terminating their plans;
  • Insolvent companies may not be able to restructure; and
  • This would be a dramatic change to the Canadian economy (defined benefit plan sponsors would expect to dramatically de-risk their investment strategy and pursue annuity purchase strategies, creating a major shift in capital).

While Bill C-228 attempts to provide plan members with greater protection in the event of plan sponsor insolvency, in my view, these efforts would put the current system out of balance.  More specifically, while this change is beneficial for the current generation of retirees, it likely does more harm to the future generations of retirees.

Should plan members bear risk

This ultimately raises the question as to how much risk should a member of a defined benefit pension plan bear.

Most members of defined benefit plans do not understand that there is a risk that they are not guaranteed 100% of their pension entitlement, 100% of the time.  This highlights a need for better communication on the part of defined benefit plan sponsors.  However, in order to provide a 100% guaranteed paradigm, there would need to be some combination of strengthening of the funding requirements, de-risking of permitted investment strategies, and “super-priority” status for pensions in the event of a corporate insolvency. 

Unfortunately, all of these solutions increase the cost of providing a defined benefit pension, which make sponsoring a defined benefit pension plan less attractive (and potentially less effective than alternative forms of retirement savings).

One argument in favour of a defined benefit system that doesn’t guarantee 100% of benefits, 100% of the time is that, in the alternative, employers provide defined contribution pension benefits which have absolutely no guarantee – and where the members have to bear all of the risks.

What should policy makers do

In my view, the federal government should not proceed with the “super-priority” mechanism, as I believe the “unintended consequences” do more harm than good.

Further, when we are able to acknowledge that private sector employers are not going to reverse the trend away from sponsoring defined benefit pension plans, I feel that the federal government would be better off focusing its energy on initiatives that would expand pension coverage, and improve the pension outcomes, for more Canadians. 

To this end, I would much rather see the federal government focus on 1) updating the Variable Payment Life Annuity rules to provide all Canadians, and not just those who happen to be in the largest defined contribution pension plans, with access to these arrangements, as we have commented before; and 2) develop a robust target benefit pension framework within the federal pension legislation.

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