Worrisome News On The Pension Front

Conspiracy theorists must wonder whether there is a link between the movement to eliminate mandatory retirement in those provinces that still permit it and the worrisome news that many company pension plans are in serious financial difficulty. Letting a worker decide whether to retire at 65 rather than being forced to by a blanket company policy is clearly a good thing. Not so good is the news that Canada’s corporate pension plans are underfunded by $250 billion. Pension experts warn that some plans will simply collapse — and with them the retirement plans of affected workers. That startling news comes from a study released by the Association of Canadian Pension Management. Coauthored by Watson Wyatt Worldwide, Mercer Human Resource Consulting and Towers Perrin, the study assessed the state of 1,029 Canadian pension plans in the private and public sectors — about one half of all plans. Those studied had $275 billion in assets and a total of $250 billion in unfunded pension liabilities. (The unfunded amount is what the plans require to pay the future pensions of both contributing and retired members). Serious underfunding isn’t just an issue for big-name companies that have made the news, the study found. Assets of some of the smallest plans are less than half of what is required to cover pension liabilities. “Most employers will simply face the music and pay this money and hope that the 1990s come back,” said Michel St. Germain of Mercer. “But some won’t survive. Some plans will be terminated with the potential for a reduction in plan benefits.” Nick Le Pan, the federal superintendent of financial institutions, was already on record as saying he “cannot guarantee” that pension commitments will be made by all of the 50 federally regulated plans that his agency placed on a “watch list.” Whether it becomes a “death-watch” list remains to be seen. Le Pan made what may stand as the colossal understatement of the year when he said: “This environment forces us to to be much more activist and interventionist. We have assessed our tolerance levels and the current environment suggests less tolerance on part is prudent.” The Globe and Mail reported that 81 of 104 large corporations listed on the S&P/TSE index faced a pension-funding shortfall of $18.7 billion last year. The other 23 showed funding surpluses, but even those were dramatically reduced by investment losses. In the fall of 2002, the median return on pension investments was negative 10 per cent; by year end things “improved” to negative 4.6 per cent. Marcel Larochelle of Mercer Investment Consulting told the Globe that total losses to all Canadian pension funds last year was $100 billion. David Burke, head of the Canadian retirement practice at consultant Watson Wyatt, told the Globe: “We really are on the cusp of employers taking major action. At the end of the day, you need more money or you pay out fewer benefits. There is no silver bullet.” The problems arise with defined-benefit plans, so-called because plan members receive annual statements that project what their retirement earnings will be at age 65, based on current earnings and years of service in the plan. Typically, these plans are funded jointly by the employee and the employer, with each contributing some percentage of the worker’s gross income. From the employer’s perspective, defined-benefit plans are costly to maintain and administer. Federal and provincial pension legislation requires that defined-benefit plans be actuarially sound, that is that they maintain sufficient funds to provide for the pensions of existing retirees and anticipate the future cost of the retirements of those still working and contributing. Plans that operate with a sufficient surplus of funds beyond what is required can actually contribute to a company’s bottom line by creating a contribution “holiday” for the employer during which it may suspend its contributions for a period of time. Employers cannot unilaterally alter pension-benefit amounts for employees in defined-benefit plans in normal circumstances. However, when companies go out of business, plans are wound down and pension amounts can be reduced in the process, depending on the value of plan assets at the time. Barring a highly unlikely resurgence in investment returns, pension experts predict a range of probable outcomes to the current pension crisis: Companies may try to get out of defined-benefit plans and convert them to defined-contribution plans; or they might close enrolment in defined plans to new employees; or they might ask employees to make additional pension contributions to offset deficits. Plans will surely collapse and be wound down as financially troubled companies go out of business. Institutional stockholders can be expected to add defined-benefit plans and the open-ended risk that they represent to existing concerns over executive compensation and poor financial performance. One pension expert, Malcolm Hamilton of Mercer, says defined-benefit plans have always been a questionable prospect. “I think the shareholder is getting fleeced here,” he told the Financial Post. “There’s nothing wrong with the retirement system that wasn’t wrong five, 10 or 15 years ago. A rising stock market simply hid all the problems.” Defined Contribution Plans: The other kind of pension, the defined contribution plan, is fundamentally different from the defined-benefit plan. There is no guarantee of a pension amount at retirement — and no potential liability for employers. These plans are very similar to personal RRSP plans, except they are governed by pension legislation, which means that after the vesting period of two years, the funds become “locked-in” and are inaccessible to the plan member, usually until age 55. Annual statements in these plans simply indicate how much money is in the plan and the year-over-year change. At retirement, the plan member annuitizes whatever amount is in the plan in order to create a monthly pension. Complicated actuarial calculations and expensive administrative costs do not come into play, nor are companies on the hook to top up plans when market conditions create shortfalls. This, then, is the kind of plan that new companies typically set up. No guaranteed retirement amount means no risk to the employer. The risk to the plan member is that a sudden, precipitous decline in the investment markets can significantly erode the savings for retirement — right up to the moment of retirement when there is no time left to recover the losses. For that reason, defined-contribution plan investments are inherently conservative which, while no protection against losses, at least minimizes exposure to huge losses. Both kinds of pension plans rely on return on investments. The problem for companies with defined-benefit plans is that a “promise” has been made to plan members that they will receive a certain amount of money at age 65. Negative returns create deficits that must be covered by more contributions to meet the promises made. Among the companies that are injecting extra cash into their pension plans: Inco: $73 million for at least the next two years; Bombardier Inc.: $50 million this year; Alcan Inc.: $30 million; Canadian Pacific: $40 million. Each company is burdened either by huge fund deficits or as-yet-unrecognized pension debt. And then there is Air Canada, which was ordered by federal regulators to come up with $200 million for its pension plan, which has a shortfall of $1.3 billion. The demand prompted the national air carrier to seek court protection from its creditors while attempting to restructure itself into a leaner organization. Canada Pension Plan As for the Canada Pension Plan, everything points to changes that will eliminate the option to draw benefits as early as age 60, albeit at a level less than what is payable at the normal retirement age of 65. This provision, in place since 1987, is partly behind the record numbers of early retirements recorded in Canada in recent years. Last year, 80,000 Canadians opted to begin collecting CPP benefits at age 60; 57,000 waited until age 65, while only 7,100 started at age 66 or more. For those who wait until age 65, the maximum monthly pension is $800. At age 60, the amount is $560 or 30 per cent less. Those who delay the start of CPP until after age 65 get six per cent more per year that they hold off. For many workers who also have access to company pensions, the CPP early-draw pension presents a “no-brainer” in deciding whether to retire early. Why not take the reduced CPP pension at 60, which provides a maximum of $33,600 over five years — and continues for life? If one waits until age 65 and manages to live another five years, the benefit total is $48,000. Most people consider that the odds of living to age 65 are better than those of making it to age 70. In the CPP game, if you wait to age 65, you have to live until age 68.5 to get the $33,600 pocketed by the person who started CPP early and made it to 65. Should you expire any time before 68.5 years, you lose. The Office of the Chief Actuary has issued a report saying that the early-draw CPP benefit is too generous because it permits people to contribute less to the plan and draw from it longer. Chief Actuary John Menard says the feature is placing a cashflow strain on the CPP. His report to the federal government awaits a response. If changes are coming, they will be made jointly by Canada’s finance ministers and will require the consent of two-thirds of the provinces (not including Quebec, which has its own plan). Political sensitivity over a backlash from the influential baby-boomer generation will doubtless influence the timing of the introduction of changes. Again, younger workers and those not yet in the work force, that is those with less political clout, are likely to face the consequences of any changes to the CPP. One possible change that the boomer generation ought not, in good conscience, protest is the lifting of a provision that exempts those drawing CPP from having to make contributions if they return to the work force.

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