Many of the more innovative measures to remove or reduce the risks associated with employer pension plans have been relatively slow to take off in Canada.
This is for a number of reasons, including the fact that some provinces, including Ontario, have yet to put in place the necessary legislation or regulations.
Over the past few years, many provincial governments have granted employers temporary funding relief, allowing some to delay major decisions about the long-term viability of their plans. However, more and more employers are looking for new ways to reduce their pension liabilities amid low interest rates, growing life expectancy, and volatile markets.
Stricter accounting rules are also leading to pensions having a more direct impact on balance sheets, making deficits from defined-benefit plans less palatable.
“Measures that have worked for many employers in the past, such as closing a defined-benefit plan, tweaking the plan’s investment portfolio or taking advantage of temporary funding relief offered by most governments, are no longer enough,” says Mark Firman, a pensions lawyer at McCarthy Tétrault LLP.
While some of the newer de-risking strategies are legally untested, the “unprecedented pension funding crisis” facing many employers means “novelty should not necessarily stand in the way” of change, he argues.
Some of the more conventional de-risking strategies include liability-driven investing; converting to a defined-contribution plan; closing defined-benefit membership to new hires; removing early retirement or other ancillary benefits; and implementing less generous benefit formulas.
Increasingly, employers are looking at risk-transference options such as lump-sum transfers and annuity buy-ins and buyouts.
These options are already popular in the United States and Britain where larger insurance and banking markets have given rise to more readily available and diverse financial products.
Lump-sum transfers involve paying out cash settlements equal to the lump-sum value of the member’s pension benefit.
Canadian pension regulators generally permit them, but specific laws are often necessary to extend the changes to pensioners.
“This is significant since pensioners are often the bulk of former member liabilities,” says Ian McSweeney, a partner at Osler Hoskin & Harcourt LLP.
In Ontario, the government passed legislation to allow members of Nortel Networks Corp.’s plan to opt out of the pension windup process and transfer the commuted value to any financial institution offering a life income fund.
Under an annuity buyout, an insurer assumes the financial risk of providing the benefits. This is an option only for inactive liabilities related to deferred vested members and pensioners. Firman warns that the employer may bear a residual risk in the rare event that the insurer becomes insolvent.
In McLaughlin v. Ultramar Ltée., the Ontario Court of Appeal upheld the employer’s residual liability following the insolvency of insurer Confederation Life Insurance Co.
But, says McSweeney, if annuities are purchased so as to fully protect the benefits under Assuris insurance limits — the prudent course in any event — the liabilities “may be rendered sufficiently remote.”
“This should be the subject of advance discussions with an employer’s auditors,” he adds.
Annuity buy-ins involve employers paying an insurer a premium. In exchange, the insurer pays the plan the amount necessary to provide some or all of the promised benefits.
The employer transfers the funding risk to the insurer but remains responsible for the risk of ongoing administrative errors.
“These risks are more pronounced in Canada and the U.S. where employers are allowed to administer their own pension plans,” says Firman. In other countries where annuity buy-ins are more common, such as Britain, pension plans must be independently administered.
Regulators may consider an annuity buy-in to be an investment of the pension plan. As the plan administrator, the employer would therefore have a fiduciary duty to ensure that this investment was in the best interests of members.
“It could be open for a regulator or plan beneficiaries to challenge a de-risking decision if they disagreed that it was in the beneficiaries’ best interests,” says Firman.
While buy-ins associated with active liabilities are unusual, they’re potentially an option.
“I suppose it’s possible to package up a portion of accrued active past service liabilities for a buy-in quote,” says McSweeney.
“A lot would depend on plan design and proper integration with the defined-benefit formula going forward.”
It might be more suited to a career average or flat benefit-type plan, he adds. “Years ago, fully insured plans used to buy annual chunks of active defined-benefit accruals and this may be similar.”
While some pension plans are looking overseas for inspiration, there’s evidence of innovation within Canada.
The New Brunswick government has implemented a target benefit pension plan based on the Dutch model that shares risks between members and sponsors.
The plan, which came into force last July, guarantees basic benefits, but ancillary benefits, such as cost-of-living adjustments, can be increased or reduced depending on the economic environment.
Adopting this option in Ontario would require regulatory change and the 2013 budget outlined steps in this direction.
The budget stated: “Ontario will also develop a framework for single-employer, target-benefit pension plans to provide employers and employees with an additional, more flexible retirement savings option.”
Jana Steele, a partner at Oslers, participated in implementing the New Brunswick scheme. “It was a big shift,” she says. “You’re taking some risk as the employer because you’re going with a fixed contribution amount but you’re also having some of the benefits of the defined-benefit model.”
Even contributions could go up or down by small amounts, she adds.
The plan looked to provide security for members’ benefits, increase the affordability of the plan, and maintain intergenerational equity.
The plan was “vigorously stress tested” and involved consultations with union representatives who appreciated the fact that pensions would have better protection under the new model, says Steele.
De-risking options
Buy-ins: Transfer the pension liability funding risk to an insurer, but the responsibility for administering the benefits remains with the employer/administrator. If interest rates go down, pushing pension liability values up and increasing funding obligations, the insurer bears that risk.
Buyouts: Transfer risk to an insurer. The pension liabilities and assets used to pay the annuity premium leave the plan, but the sponsor may be responsible if the insurer defaults on annuity payments.
Lump-sum transfers: Pay out cash settlements equal to the lump-sum value of the member’s pension benefit.
