1991 – 2006: 15 Years Of Regress For DB Plans
By: Paul Owens
The last 15 years have been difficult ones for pension plans in general and Defined Benefit plans in particular – not that anyone should come to the conclusion that the prior 15 year period from 1976 to 1991 represented a period of tranquillity and peace for the pension industry either.
It is hard to select the single most significant event impacting pension plans over the last 15 years – there are, unfortunately, so many candidates.
A quick, and by no means complete, listing of the usual suspects produces the following for consideration broken down into our assessment of whether they were ʻgoodʼ or ʻbadʼ for the pension system. We do not pretend the allocation to ʻgoodʼ or ʻbadʼ is devoid of subjectivity.
- Increase and eventual removal of the Foreign Property Rule in the Income Tax Act
- Increase in emphasis on Liability Driven Investments
- The Enfield decision and its impact on pension governance
- Asymmetry in risk-reward sharing, the result of court cases and legislation that reinforced that for single employer DB pension plans, surplus belongs to the member and deficits belong to the employer (some readers may see this as a good thing)
- Complexity of financial reporting arising from having to do funding, solvency, and pension expense actuarial valuations and the fact that the rules of each change regularly
- The impact of the bursting of the tech bubble on decreasing the funded status of DB pension plans and lowering the account balances in Defined Contribution and CAP vehicles
- Insufficient maximum pension, surplus, and RRSP limits under the Income Tax Act
- The Monsanto decision and its impact on partial plan wind-ups
- The continuing lack of single uniform pension legislation for employers who operate in more than one province
The bad events outnumber the good events, not only in straight numbers, but in terms of cumulative impact.
The consequences of all of the above activities, where the bad outcomes outweigh the good ones, are:
- DB pension coverage has decreased from 44 per cent over the past 15 years to about 34 per cent of the work force with an increasing imbalance between coverage in the public versus private sector
- The number of registered pension plans continues to decrease
- There is an accelerating trend for DB private sector sponsors to terminate their DB plan or convert it to a DC pension plan or group RRSP
- The amount of deficits are higher than they otherwise would be due to low surplus thresholds
- There has been a major transfer of risk from the pooled or group basis inherent in a DB plan to an individual basis for those lucky enough to remain covered under a DC arrangement; those who donʼt even belong to an employer sponsored DC arrangement have a real appreciation of trying to meet the dual challenges of ensuring an adequate post-retirement income and being totally exposed to risk on an individual basis
When one looks at all the negative events from far enough away, one no longer sees a group of unrelated individual events, but rather a major and, if one believed in conspiracy theories, a concerted and deliberate attack on the DB pension system.
An outsider could question the logic of why anyone would continue to chip away at eroding what was a reasonably workable retirement wealth accumulation system.
Fragmentation Of Pension System
This leads us back to identifying the biggest development over the past 15 years – the fragmentation of the pension system and the repeated focus on maximizing the constituent parts of a DB system as opposed to ensuring the viability and growth of the system as a whole.
To be sure, each of the ʻbadʼ events is important in its own way. However, none, on its own, would have caused the pension system to deteriorate to the precarious state it is in today.
A DB pension plan was designed to deliver a defined benefit and had a long-term focus or time horizon – now up to as long as 75 years. One of the consequences of a DB plan is that risks are pooled or shared. While the value of the plan as a whole is maximized, it is impossible to maximize the value of each individualʼs entitlement each and every year. Cross subsidization is inherent in a DB plan. It becomes mathematically impossible to achieve intergenerational equity at any point in time, let alone over a period of time.
We provide two examples to illustrate the dangers of focusing on the components:
- Distribution of surplus on partial plan wind-up – While Monsanto has settled the issue from a legal perspective in Ontario, the whole situation is illogical. For a DB plan, surplus can only materialize when the plan is totally wound up. This is a clear example of where trying to ʻprotect ʼ a component or segment of the plan, threatens the overall plan as a totality and creates instant winners and losers.
- The artificially low pension and surplus limits in the Income Tax Act – These do temporarily limit the level of tax deductibility for those remaining plan sponsors with a DB plan. If the cushion is eroded as a result of a low surplus limit, then deficits will emerge at an earlier date, contributions will be increased, and plan sponsor taxable income and taxes paid decrease. This is hardly a good outcome for either the plan sponsors or the federal treasury. Similarly, the low maximum pension limits result in lower replacement ratios starting at manager salary levels, or migration to RCAs or non-funded SERPs with a resulting increase in risk for the member. I can go on, but I think you can provide your own examples.
Whose fault is it?
While it is convenient to single out a particular villain, to quote Walt Kellyʼs Pogo, “We have met the enemy, and he is us.”
Each group, by trying to maximize its own entitlement at a particular point in time, has threatened the viability of the system as a whole and has diminished the magnitude of the ultimate amount of retirement wealth that can be accumulated.
Itʼs a classic case of killing the goose that lays the golden egg.
However, there may be a faint glimmer of hope. As this article was being written, the McGuinty government announced the formation of an expert commission to review Ontario pension legislation. Maybe, this will turn out to be the most significant event when the next 15 years are reviewed.
Paul Owens is plan manager and chief executive officer for the Colleges of Applied Arts and Technology (CAAT) Pension Plan.
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