In a nutshell

Two private sector pension related bad news stories landed in my inbox in the past week: (1) the Auditor General of Ontario warns that the province (via its monitoring arm the Financial Services Commission of Ontario, the FSCO) does an inadequate job in protecting pension plan members and (2) Nortel pension windup, the process being in its 7-th year since bankruptcy, is further delayed to June 30 for the negotiated plan and December 31 for the non-negotiated/managerial plan for all provinces.

Canada/Ontario’s private sector DB system is still in systemic failure. Nothing has changed in the past decade: FSCO still appears incapable of doing its job to protect pension plan member who still have operational plans, the Nortel pension plan is in its 7^th year since bankruptcy yet the FSCO is still unable to deliver a timely pension windup, the Federal/provincial governments have made no progress on credible pension reform (though Ontario has at least committed to small step of delivering an expanded CPP-like ORPP), and nothing was done to provide a safety-net for pensioners who ‘suddenly’ are victims of a bankrupt employer with an underfunded pension plan. The tweaking of private sector pensions so far can only be described as band-aids.

The reality is that the shift from DB to DC (or its more refined form of Target Benefit (TB)) is well under way. The elements of a solution are available once we accept that the DB train has left the station, these are: (1) auto-enrolment and save-more-tomorrow defaults until contributions are at a level consistent with target benefit level over expected work life, (2) low-cost investments including life-cycle based default asset-allocation models for retirement portfolio, (3) low-cost longevity insurance option for longevity risk management, and (4) protection of already earned DB pensions.

The details

According to an Auditor General of Ontario News Release (thanks to Ken Kivenko for bringing to my attention) the underfunding of Ontario based DB pension plans has deteriorated significantly over the past decade under the watchful eyes of the Ontario government’s FSCO: the proportion of underfunded Ontario pension plans has increased from 74% to 92% while the total funding shortfall has increased from $22B to $75B. The auditor general also notes that the “FSCO has limited powers to deal with administrators of severely underfunded pension plans… (but also that the) FSCO could use the powers it does have more effectively to protect plan members”. The report also recommends that the FSCO be given similar power as the federal regulator OSFI has and that it exercise its existing and proposed enhanced in powers more aggressively.

Furthermore, the News Release notes ominously that “It is uncertain whether FSCO’s Pension Benefits Guarantee Fund, designed to protect members and beneficiaries of single-employer defined-benefit pension plans in the event of employer insolvency, is itself sustainable.”  Even this minimal government run (though apparently not government guaranteed) insurance fund introduced in 1980 in Ontario is the only one in Canada. It was designed to protect the first $12,000/year of pension, which according to Bank of Canada inflation calculator would have had to increase to almost $36,000 today to maintain its intended protection at the same level. Other Canadian provinces don’t even have this minimal protection, whereas the U.S. and the U.K. run insurance schemes protecting private sector plans to about USD $55K level.

The unwillingness/inability to protect pension plan members in Ontario/Canada is not news to Nortel’s Canadian pensioners who have had to accept the consequences of Nortel’s bankruptcy with a 41% underfunded Canadian pension plan. All this occurred under the watchful oversight of the Ontario government’s FSCO. And FSCO, who hired Morneau-Shepell to administer the Nortel plan after bankruptcy, is responsible for the no windup of Nortel’s Ontario based pension plan in its 7^th year after bankruptcy.

The key reason given for the latest delay, in addition to the complexities involved, is the  necessity to get approval of all provincial regulators where Nortel operated. NRPC, the Nortel pensioners’ watchdog, notes that the FSCO is now committed to monthly milestones toward windup dates when each pensioner will receive personalized options package to consider annuity or lump-sum or transfer to RRQ options where applicable.

Of course as we all know, it wasn’t just the FSCO who failed miserably in protecting pensioners…In an April 17, 2009, just three months after Nortel declared bankruptcy, a blog post entitled Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now? asked: 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:  Nortel’s Board of Directors and Officers, the Administrator of the pension plan (in this case the same Board of Directors), the pension plan trustee, the investment managers, the actuaries responsible for the valuation of the plan and for specifying the minimum required Nortel contributions to fund the plan, and the regulators/regulations, the FSCO/Ontario government in this case.

The failure to raise flag, to raise a voice, to shine a light on the rot eating away at the Nortel pension plan, would be considered by most pensioners a reflection on the integrity and competence of all fiduciaries/professionals/regulators involved in this matter. At the time of the bankruptcy in January 2009, the last valuation of the funded status of the pension plan available to the pensioners was 86% as of December 31, 2006 by Nortel’s actuaries at Mercer. The opacity of the real funded status of the pension plan was not just due to the black magic of actuarial calculation (e.g. out-of-date mortality data or liabilities calculated using the expected return on the pension plan portfolio; i.e. the riskier the portfolio, the higher the expected return, the higher the discount rate used for liabilities, the lower the liabilities of the plan and the lower required contributions by the plan sponsor), but also the requirement to perform a valuation only once every 3-years (recently modified to annual if funded status drops below 85%; but 3-years is an eternity and actuarial valuations have a lot of flexibility, so processes are inadequate to properly monitor plans). In addition the government decision after the financial crisis to provide solvency relief to companies which sponsor pension plans, without at the same time increasing the priority of pension plan shortfall from fully funded level should the sponsor seek bankruptcy protection, has just aggravated an already very dangerous situation. The result unsurprising: more of Ontario’s private sector pension plans are more underfunded, and even more Canadian pensioners will be hurt again and again due to no lack of protection when companies choose to escape their responsibilities to pensioners via bankruptcy protection.

We are now in the 7^th year after bankruptcy and 5-years after finding out that the actual funded status was not 86% but only a “conservatively calculated” 59%. You would think that pensioners now benefit from improved transparency and protection of the remaining assets deemed to deliver 59% of their original pensions.

Instead, we have not had any indication over the past 5-years about:

-the funded status of the pension plan as measured by current reporting requirements

-the funded status of the plan against the reality of having to purchase annuities from private insurance companies in an illiquid annuity market in Canada

-the impact of interest rates, which are even lower today, than when the 59% valuation was done, and the impact of the recent (but much belated) recognition by the Canadian Institute of Actuaries of some part of the well known but unrecognized longevity increases

-the current make-up of the Nortel pension portfolio (rumor had it that it was supposedly converted from a 60% stock and 40% bond allocation to a 100% bond portfolio shortly after bankruptcy to immunize/protect the plan from further interest rate changes by asset liability matching; if that happened, it certainly was conservative but depending on its timing, may have locked-in most/all of the portfolio’s market losses near/at market lows.

-now we are told that the windup delay is primarily due to time required (the difficulty???) to get all the provincial regulators to agree, but we are not told what the reasons are the areas of disagreement among the provincial regulators. (Can you believe the waste of time and money involved in having each province with its own set of regulations/regulators?) But if the issue is money (and it usually is), then it may have something to do with its fair allocation to the pensioners in each province where regulators have responsibility to ascertain that their pensioners receive their fair share

-and speaking of (un)fair share, my understanding based on a number of discussions with Morneau-Shepell back in 2013 is that the lump-sum value, for Ontario pensioners who will have that option,  will be diverging adversely from cost of buying an annuity (i.e. the lump-sum to be offered it will be less than the amount the Ontario government would have to pay to buy the promised annuity from a highly (?) rated insurance company) due to the mechanism that the Ontario government has mandated the lump-sum calculation. I summarized my understanding at the time in Nortel pensions: Why CV/LIF value is less than annuity value for Nortel’s Ontario pensioners? (If this is true, then why would such an unfair treatment be specified as such by the Ontario government?)

-and for those taking annuity: will the insurance companies deliver on their promises?

-the pension level derived from the 59% funded status (of the partially indexed pension) was understood by most pensioners as the rock bottom pension level based on the status of the trust funded portion of the plan and even guaranteed by the Ontario government (if I recall correctly), with upside opportunities from recoveries from the$ 7-9B assets that Nortel had under court administration. Unfortunately, lawyers and other professionals have already feasted on the Nortel carcass to the tune of $1.5B (and still counting). Also the U.S. court allowed a $1B of post-bankruptcy interest claim to U.S. bondholders (can you believe that…post bankruptcy interest?) which at least was challenged by the Ontario court; but remember that the Canadian/Ontarian court has agreed to have residual assets of this Canadian company to be placed in a JPMorgan lockbox in the U.S.A. (Can you guess who will get paid first when there is a disagreement between U.S. and Canadian courts/laws?). Furthermore, given that the Ontario government guaranteed that pension at this reduced floor level (plus PBGF making whole the first $12K of pension for Ontarians), then does it mean that the annuities will be guaranteed as well by the Ontario government?

-and of course, those choosing annuities will have to live with the inflation risk. This may not seem like a hot issue given the recent experience with inflation, but annual inflation rate was 3.1% between 1980 (when Ontario introduced the PBGF) and now. This again may not be a serious issue for pensioners in their 80s, but could further devastate the purchasing power of younger pensioners.

You might think that after almost 7 years in this process, if the windup hasn’t as yet been finalized, then at least pensioners would get complete transparency and clarity as to the process that going on. One might have expected that the windup process is one that should take perhaps 60-90 days, and in extreme situations of very poor pension administration and regulatory oversight perhaps even up to a year. (The Ontario law, which was invoked to calculate the lump-sum due instead of annuity, has perhaps assumed such a time-frame.) Why would pensioners believe that FSCO’s tabled windup work plan now aiming at December 31, 2015 for the non-negotiated/managerial plan will actually happen as now predicted based on FSCO performance so far?

Bottom line

The transparency of the entire process since the January 2009 bankruptcy has actually deteriorated dramatically even compared to the low bar set for pension transparency before bankruptcy.

Personally (and I am one of Nortel pensioners as well), I have lost all confidence in this process Today, for my planning purposes, I’ll assume that we’ll have to take another 5-10% haircut on the portion of the pension unprotected by PBGF (non-Ontario pensioners that means on the entire reduced pension), and that we won’t get any proceeds from the bankruptcy process. If the Auditor General of Ontario’s concern, about the PBGF’s ability to meet its commitments, materializes then Ontario pensioners will be even worse than currently expected.

I hope that I am being overly pessimistic, but I don’t want to be disappointed again, after having been disappointed again and again.

There is little pensioners can do now, than roll with the punches. Federal and provincial governments offer inadequate oversight while pension trouble is brewing but before the trouble is evident, and then offer inadequate/no protection for private sector pension plan members once a sponsoring company chooses bankruptcy protection even if they have Billions in cash and Billions in assets. When DB plans work, they are wonderful (as in the case of low-cost to the employee, inflation indexed, federal government guaranteed pension plans), when they fail as is the case of Nortel (and other Canadian companies) many pensioners’ retirements are devastated. The solutions are many, but increasingly more and more people conclude that you can’t rely on anyone but themselves.

The shift from DB to DC (or its recently refined form of Target Benefit (TB)) is well under way, for those who still have any form of pension plans. The elements of a pension reform solution are available once we accept that the DB train has left the station; the elements are: (1) (mandatory or) auto-enrolment and save-more-tomorrow defaults until contributions are consistent with target benefit level at end of expected work life, (2) low-cost investments including life-cycle based default asset-allocation models for retirement portfolio, (3) low-cost longevity insurance option for longevity risk management, and (4) protection of already earned DB pensions if sponsor becomes bankrupt (either by raising claim priority of plan shortfall in bankruptcy or establishing pension insurance like in the U.S. and U.K where Nortel pensioners’ trust funded pensions were protected up to about USD$55K/year). Of course all this must be implemented under the umbrella of a fiduciary level of care. (Many of these elements were presented in a Pension Reform brief presented to the Ontario Expert Commission on Pensions in November 2007.)

P.S. And for those retirees who are now thinking of going back to work, consider the recent article  “The semi-retirement myth” which argues that your retirement is inevitable, despite ”late-life fantasies” driven by “financial desperation”, as the “combination of health issues and age discrimination” conspire to foil the attempts at continued employment. The article concludes that “A poll conducted last year found 79 percent of Americans agreed Social Security benefits should be increased, with the bill paid by the wealthy.” This of course must be a joke, as the only way to really pay for not prefunded benefits is to force the next generations of workers, our children and grandchildren, to pay for our retirements; and none of us would want to see that happen.