Under-funded pension plans

A few weeks ago in “Is your (defined benefit) company pension safe? I discussed some gauges that you may find useful in assessing the true state of the funded status of your DB pension plan like: difference between solvency and going concern basis, and actuarial assumptions like discount rates, salary increases, mortality rates, etc. You’ll recall that the difficulties pertain to the lack of transparency associated with DB pension plans (limited disclosure as infrequently as once every three years), the extent of discretion that actuaries and plan sponsors may use to make various actuarial assumptions which are then used to determine the valuation of the liabilities, and the lax regulatory environment associated with pensions in Canada. (The assets associated with pension plans are supposed to be better understood and quantified; more on this later.)

What happens if the sponsor of your under-funded pension plan goes bankrupt?

First some good news for DB pension plan members. Last month Defined Benefit Pension Plans received additional protection under new Rules Amending the Bankruptcy and Insolvency General Rules . In this reference you can also read about the non-pension related items as well (wages, deferred compensation accounts), but I’ll focus on the additional protection pensions received:

“These amendments elevate the priority of payment of wages and unremitted pension contributions to employees in the order which creditors receive payment.” New rules apply to “… pension plan regulated under any Act of Parliament or the legislature of a province or territory shall be considered as prescribed under the provision.” However the extra protection (the higher priority in case of bankruptcy) is only accorded to “unremitted pension contributions in a bankruptcy or receivership”.

What this appears to mean that if the plan sponsor is in bankruptcy, then payment of outstanding (DB and DC) pension contributions which certainly include current year pension cost (and likely even even payments required to be made in current year due to previous solvency shortfall, the Annual solvency Special Payments), get priority access to the employer/sponsor’s assets over other creditors. However, the new rules do not appear to explicitly give the same priority to making whole the complete outstanding pension plan shortfall. One could ask why the full funding shortfall would not qualify for the higher priority, if the legislature’s intent is to protect wages. After all is a pension not just deferred wages? So, while this is progress, in that the hole that was dug by poor asset returns, inadequate company contributions and overly liberal assumptions in calculation of liabilities, it does not fill the hole created over many years of neglect and inattention and lack of adequate pension regulation. The decision not to give priority to the entire funding shortfall, some will say, shows the fine balancing act the government has to play to not to damage the pension sponsoring company’s ability to raise funds for continuing operations; as priority for large deficits may deter lenders from lending and increase cost of borrowing. To others it says that traditional single sponsor DB pension plans need to be replaced and the Keith Ambachtsheer’s proposal   a good basis to build the next get pension systems for Canadians.

Secondly, you might find interesting a few years old article by Peter Merrick that was recently brought to my attention “The pension problem: Are defined benefit pension plans safe” in which writes, based on a interview conducted with a trustee of Ontario’s Pension Benefit Guarantee Fund: “What if there’s not enough pension money to go around? If a DBPP cannot meet its obligations, retirees will get first claim on the assets of the plan. Next will be employees who are eligible for pensions. The remaining money is then divided among the rest.” While this sounds good for pensioners, and not so good for plan members who are still working, it is not clear to me what mechanisms would be used to implement priority of pensioners’ claims. (I have not as yet found documentary evidence of this principle or its proposed implementation in case of bankruptcy.)

And finally, Ontario is the only Canadian province which has a Pension Benefit Guarantee Fund; unfortunately the coverage is limited to only the last unfunded $1000/month of the pension for each individual. That is the PBGF will insure that each individual’s pension is guaranteed up to $1000/month. This effectively protects pensioners with the lowest monthly pensions, but offers little or any protection to others, in most realistic cases. (Sounds more like subsistence insurance, rather than “pension guarantee”.)

The valuation of Liabilities is challenging, but at least Assets are easy?

Now back to my earlier comment that while it can be challenging to determine the value of liabilities, at least one doesn’t usually have that problem with valuation the assets (at least the publicly traded portions of it). Well how times are a changing. The Ottawa Citizen reported last week that Nortel’s Canadian pension fund has a $24M ARS (Auction Rate Securities) problem :  “Nortel Networks also has some problems with questionable investments on the books. It disclosed in a quarterly regulatory statement that there is $24 million in auction-rate securities in the Canadian employees’ pension plan. It has transferred the instrument from a current asset to a long-term investment while it determines how to fix the problem.” And the problem was so “easy” to solve, just move it from the short to the long term bucket. Who knows how many other pension plans hold toxic waste in their asset pool, but you can be sure that Nortel is not alone. The temptation to reach for extra yield in a low interest environment, is always tempting, especially when some ignorant or self dealing seller tells you on some junk and suggests that it is as good as money market instrument and previously “credible” rating agencies stamp them with their triple-A seal of approval.

Ontario Expert Commission on Pensions

I checked with Ontario Expert Commission on Pensions and Commissioner Arthurs is planning to submit his recommendations towards the end of October 2008. The Commission’s mandate was recommendations to repairing Ontario’s DB pension system, which is a fertile ground with lots of opportunity for improvement. I am looking forward to the recommendations.