The Ontario Expert Commission on Pensions delivered its report, “A Fine Balance, Safe Pensions, Affordable Plans, Fair Rules ” (Report). The well-written Report grapples with difficult issues made particularly challenging in difficult economic times.

The Report makes welcome recommendations with respect to funding and partial plan wind-up for private sector pension plans. Public sector plans should be happy with its prescriptions. Other suggestions are unnecessarily complex and bureaucratic.

This Communiqué focuses on private sector pension plans.

Funding Measures

The Report would raise the minimum funding threshold. While this would result in better benefit security for members of single employer plans, the failure to deal with the issue of surplus ownership in ongoing plans (except in cases of merger or conversion) means that sponsors would not fund above the minimum. In addition, an increased funding threshold makes sponsorship of such plans even less attractive.

On a more positive note, sponsors would be allowed to use letters of credit and possibly pledges of corporate assets to secure a portion of the liabilities.
 
Benefit security would be strengthened by:

• the elimination of smoothing and the current permitted exclusion of certain benefits (such as inflation protection) from solvency funding;
• the setting of a funding target of 105 per cent of solvency liabilities; and
• the increase of authority for pension regulators to intervene.

The necessity for transitional measures is acknowledged but the proposed transition periods are either too short or not described. If these changes are adopted, a transitional period of at least 15 years will be necessary to allow for an orderly transition for large mature plans.

MEPs, JSPPs and Public Plans

The Report recommends exempting multi-employer plans (MEPs) and jointly-sponsored pension plans (JSPPs) from the requirement to fund on a solvency basis, primarily because these plans may reduce benefits on wind-up. Bucking the trend in other jurisdictions, however, the Report does not recommend exempting what it calls public sector and broader public sector plans, which would include university plans for example, from solvency funding.

A new type of pension plan, the jointly governed target benefit pension plans (JGTBPP), an amalgam of the MEPP and the JSPP, is touted as a new vehicle to which any type of pension plan could migrate. The JGTBPP would be jointly governed and would permit accrued benefit reductions in order to deal with funding deficiencies.

Public sector plans and broader public sector plans (those that are not MEPPs or JSPPs) and even single employer pension plans, are encouraged by the Report to become JSPPs, MEPs or JGTBPPs. The Report does not, however, set out how this would be done. Unless participants are willing to accept a possible reduction in their past service benefits, the legal problems in reducing accrued benefits would appear to be insuperable.

Partial Wind-up and Surplus

Partial Plan Wind-Ups

The Report recommends wholesale change to the concept of a partial plan wind-up. There would be no surplus distribution on partial plan wind-up, and no requirement to purchase annuities. A partial plan wind-up would require a "plan reduction report" to enable the regulator to monitor the financial health of the plan. Partial plan wind-up would only be required when 40 per cent of the active members are terminated within a two-year period.

Surplus on Mergers

Under the Report, surplus in an original plan can be transferred to new plans provided that the original plan maintains a 5 per cent security margin (i.e. over full funding) as of the date of completion of the transaction. Surplus in an exporting plan can be merged into an importing plan, provided the members of the exporting plan become members of the importing plan and the importing plan has a 5 per cent security margin as of the date of completion of the transaction.

The ability to accomplish plan mergers would be permitted unless there is specific language preventing the transfer of surplus. This recommendation appears to adopt case law in this area. Subject to union approval or in the absence of a union, subject to the approval of 2/3rds of active member representatives and retirees, the regulator can approve such mergers on an expedited basis. It is difficult to determine how this would work in practice and what objectives this requirement would satisfy.

Surplus and Conversions

The Report recommends that, following conversion of a plan from defined benefit (DB) to defined contribution (DC), surplus carried over from the DB component should first be used to provide the 5 per cent security margin for the DB benefits earned. If there is any additional surplus, then it can be used to pay for DC employer contributions or DC expenses under the DC component.

Conversions would require employer notice to active and retired plan members and to any union or similar body. With approval from such a body or with 2/3 approval of unrepresented active members and retirees, the regulator could approve the conversion without delay. Absent approval, the conversion application would be processed in the usual manner. This approval process appears to be cumbersome, unnecessary and difficult to justify.

Plan Failure

Among the recommendations made in the Report to address the risk of plan failure, two are realistic and could be implemented immediately. Giving the regulator power to require a valuation when a plan becomes “at risk” would be meaningful. However, the accompanying requirement that the regulator create benchmarks to identify plans at risk is problematic because there is no universal way to define “at risk”. In today’s admittedly exceptional economic climate, for example, it is difficult to see how any private sector plan would not be at risk.

Another proposal, to give the last five years of benefit improvements second priority when benefits must be reduced, and to exclude them from Pension Benefits Guaranteed Fund (PBGF) coverage, is realistic and would assist in some situations. These initiatives would not prevent plan failure or cure the ill effects of plan failure.

At the other extreme, the Report would dramatically increase PBGF coverage and create a separate new agency to administer the PBGF. Risk-based premiums would be determined on asset/liability match and sponsor financial health as well as on a plan’s funded status. Disturbingly, those least able to pay would be expected to pay more premiums; those best able to pay would not. Such an economic prescription cannot be the answer to the risk faced by pension plans and their sponsors.

The government would fully review the PBGF and decide within five years whether to revise or discontinue it. The Report’s discussion of the PBGF acknowledges its flaws and the difficult policy surrounding government assistance when plans fail. In effect the proposal exacerbates the moral hazard that the scheme creates for weaker plan sponsors to transfer their liabilities onto the backs of stronger plan sponsors. While the PBGF is self-funding, it is easy to see how a sympathetic government might be tempted to tap taxpayers for PBGF deficits. In effect, this recommendation merely postpones the PBGF’s day of reckoning.

Champion and Advisor

To reinvigorate the pension system, the Report recommends the creation of a new government agency, the Pension Champion (PC) to be a type of “think tank” for new pension ideas. The Report recommends the development of large plans, in which small and mid-size employers can pool their resources in order to achieve economies of scale. Also, the Report proposes the formation of a new Pension Community Advisory Council (PCAC). The PCAC would advise government, which would make pension policy at the instigation of the PC. Pan-Canadian standardization of pension rules would be a goal of the PCAC even though such a quest has proven unsuccessful in the past.

Under the Report, the above measures to achieve innovation and better pension policy making would be assisted by flexible, accommodating and comprehensive pension legislation, something the Report concedes would be a “formidable task”.

Governance

The Report makes broad recommendations with a view to improving the quality and transparency of plan governance, and calls for greater participation in plan governance by active and retired plan members. Some of the proposals call for a much greater emphasis on governance by the regulator than is presently the case.

In addition, the Report recommends that a pension advisory committee (PAC) be mandatory for plans, other than those where active and retired members participate in a governing body, jointly sponsored plans or plans where members vote not to establish a PAC. A PAC would be comprised of at least five members, including one representative selected by retired members and one selected by each class or group of active members. Under the proposals, the PAC would have no formal governance role or decision-making capacity. The Report then expresses the hope that “positive experience with PACs will encourage employers, workers, sponsors and members to start down the road to a more fully realized model of joint governance”.

Investments

The Report ‘s recommendation that plan statements of investment policy reveal whether socially responsible investment practices are adopted in respect of investment decisions is consistent with the approach adopted in many European countries, where these disclosure requirements have played an important role in encouraging integration of environmental, social and corporate governance information into the decision making process. It is expected that this will encourage investors to properly assess a greater range of investment risks and should also help with identification of investment opportunities.

Regulatory Changes and PBA

The Report recommends a single-purpose pension regulator with increased expertise, resources and powers. Similarly, the adjudication of pension issues would be heard by a tribunal with specific expertise.

The Report recommends that a rewritten Pension Benefits Act (PBA) should become the exclusive source for pension plan law. Since pension legislation would be comprehensive, the courts could only overturn its decisions in exceptional circumstances.

The PBA would also offer standard form simplified pension plans to encourage the expansion of pension plans to smaller employers.

Ontario Pension Agency

The Report recommends that an Ontario Pension Agency (OPA) be established to receive pool, administer, invest and distribute pension funds left stranded when plan members leave a plan or a plan is wound-up. This would be an additional portability option for members.

The OPA would also receive and administer funds payable to pension beneficiaries who cannot be located. This is similar to what is in place in Quebec.

Other Changes

A number of other changes have been recommended including grow-in rules and vesting. 

Grow-In

The Report proposes to extend grow-in to any member of a single-employer pension plan with 55 points who is involuntarily terminated, This is surprising given that only two provinces currently offer grow-in, the other one being Nova Scotia. The Report indicates that it wishes to move towards harmonization of provincial legislation but this would lead to the opposite result. This requirement would not apply to jointly sponsored plans, multi-employer plans and the proposed jointly governed target benefit plans.

Immediate Vesting

The Report proposes to extend immediate vesting to all active plan members.

Comment

The recommendations on use of surplus in pension plan wind-ups, conversions and mergers are for the most part welcome news to the pension industry. However, the Report does not go far enough in dealing with the funding issues impacting defined benefit plans. It was hoped that the Report would have gone further to assist single-employer DB plan sponsors by rebalancing the playing field.

It does not bode well when the central recommendations of the Report are the creation of new bureaucracies. Unless pension coverage is made mandatory, expanding pension coverage by means of such bureaucracies is simply putting the cart before the horse.

The Report lists several new plan designs that should be considered, chiefly those that would aggregate employers and employees to achieve larger scale, yet it provides no clear guidance on how to motivate employers to do so and no clear path on how to realize this objective.

The Report proposes several measures that can only be accomplished by inter-jurisdictional cooperation, something that has proven difficult in the past.

Next Steps

Feedback can be provided to the government on the Report proposals by February 27, 2009.