Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now?

Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now?

(Originally published April 17, 2009, and re-hosted on WordPress March 5, 2012)

There has been much ink spilled already about the destruction of Nortel, Canada’s technology icon. As an almost 30 year employee of Bell-Northern Research/Nortel and now a pensioner, I often wonder how we got to this state of total disaster as far as pensions are concerned? This is clearly a problem for Nortel DB pensioners now that the company is under CCAA bankruptcy protection, but be assured that there are hundreds of thousands of other Canadians who may also become victims.

The problem starts with the last published solvency valuation of the Nortel plan as of December 31, 2006, indicating funded status at 86%. This valuation is now almost three years old. Three years is an eternity, and my guesstimate puts the current solvency ratio at about 60%; i.e. if the plan is wound up today pensioners may have to absorb the body blow of a 40% reduction in pensions.

Whose fault is it? How did we get here? These are valid questions that many pensioners have. After all, we supposedly had layers upon layers of checkpoints that may have given pensioners the illusion of a fail-safe system protecting our pensions. Any one or more of these checkpoints could have prevented us from reaching this point. You don’t have to be a lawyer or an actuary, and I am neither, to have legitimate questions as to how we got here.  Let’s look at these checkpoints, layer by layer:

Nortel’s Board of Directors and Officers the leaders of the sponsoring corporation have the fiduciary duty toward pensioners to secure and protect their earned pension benefits. The Board and the Officers of the corporation didn’t prevent the disaster.

The Administrator of the pension plan also has fiduciary responsibility toward pensioners. In this case the Administrator appears to be the same Board of Directors. (Pensioners have no say and, as the saying goes, are treated like mushrooms, kept in the dark with the occasional application of ‘fertilizer’.) The administrator didn’t prevent the disaster.

You would expect that the pension plan trustee, would also have a fiduciary duty to protect the interests of the pensioners, and perhaps they could have raised some flags. The trustee didn’t prevent the disaster.

The investment managers must have both fiduciary duties and professional standards to adhere to.  They must have known that pension plans have bond like liabilities and 55-60% asset allocation to equities was perhaps not a prudent/appropriate investment approach for what should have been a more asset-liability matched strategy. The investment managers didn’t prevent the disaster.

The actuaries responsible for the valuation of the plan must have had fiduciary duties and professional standards to adhere to. You would think that actuaries would have used prudent assumptions to protect the pensioners and would have warned the company if the plan was at risk of not meeting its obligations. The actuaries didn’t prevent the disaster.

The regulators, the FSCO in this case, and the regulations have no doubt been established to guarantee that the necessary oversight is in place to insure that the company meets its obligations to its pensioners. The regulators failed to prevent the disaster.

What protection does exist?

The PBGF, Ontario’s pension guarantee fund, had established in early 1980s a still operational ceiling of $1,000/month pension guarantee. It’s good that there is some insurance, but that doesn’t provide a lot of protection for pensioners who spent 30 years with the company and who may have to take a 40% reduction on their pensions. Have Ontario Premier McGuinty’s latest pronouncements on the GM pension plan been intended to signal that he’ll walk away from even these minimal guarantees?

What next?

With Nortel now in bankruptcy protection under CCAA, the Court could decide that as part of any arrangements resulting from the CCAA proceedings, the pension fund deficit will receive priority over other unsecured creditors. The priority is justified because: (1) the pension fund is a trust fund with its associated implied protections, (2) pension plan participation was compulsory, (3) participation limited or completely prevented RRSP contributions due to CRA’s PA formula, (4) trust fund contributions were part of each individual’s compensation (often suggested that benefits including pensions represented 15-30% additional compensation), (5) pensions are nothing more than deferred wages, (6) pension underfunding are past earned and unpaid wages. Similar argument for pension plan underfunding priority should apply if or when the company goes into liquidation. Bondholders, customers, suppliers and other creditors willingly entered into contractual agreements with full understanding of the risk of dealing with a company with less than stellar credit rating; in fact the bondholders received high interest rates to assume the risk of lending to the company.  On the other hand, pensioners/employees had no choice since the plan was compulsory, they had neither a say in the running the plan nor the necessary information/expertise to understand the state of the plan (information asymmetry relative to employer and other creditors). In fact many believe that Nortel is hiding the state of the plan, especially given multiple reports in the press that one of the main reasons for the bankruptcy protection is the need to make up major pension plan shortfalls. It sure sounds like not all unsecured creditors are or should be equal!

The Federal government recognized that pension plans and their associated trust funds deserve special priority in bankruptcy. Last summer it passed new bankruptcy legislation giving priority to current year pension plan obligations on par with past wages in case of sponsor bankruptcy. The government should now consider extending that legislation and in case of bankruptcy explicitly give same priority to any existing pension plan underfunding.

The problems with Ontario (and Canadian) pension system are many, as illustrated by the 142(!) recommendations of Commissioner Harry Arthurs of the Ontario Expert Commission on Pension on how to fix the DB pension system. Anything that needs 142 fixes may need to be replaced rather than fixed, but only after existing earned commitments have been fulfilled. A good place to start to build a new pension system for Canadians is the CSPP proposal of Keith Ambachtsheer under the sponsorship of the C.D. Howe institute.

P.S. In the interest of full disclosure, I amone of the 2000+ NRPC (Nortel Retiree Protection Committee) members; these views are mine and are not necessarily those of the NRPC.

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