- Consulting
with Canadians -
CN's Submission in Response to
Finance Canada's Regulatory Framework for Federally Regulated Defined
Benefit Pension Plans consultation:
September 15, 2005
Ms. Diane Lafleur
Financial Sector Policy Branch
Department of Finance
L'Esplanade Laurier
20th Floor, East Tower
Ottawa, Canada
K1A 0G5
Dear Ms. Lafleur,
Thank you for the opportunity to participate in the
consultation process concerning the legislative and regulatory framework
for Defined Benefit Pension Plans registered under the PBSA.
On balance, we believe that Canada has a very
well-functioning defined benefit pension plan system. The system is
anchored on affordable employee payroll deductions that are matched by
significant corporate contributions and the clear promise to fund future
benefits by plan sponsors. Within a going concern framework, adequately
circumscribed by reasonable actuarial assumptions, the level and security
of benefits are properly safeguarded in the vast majority of instances.
Unfortunately, general media and press accounts would at
times leave some to believe that the Canadian pension system is in crisis.
Nothing is actually further from the truth. By international standards,
the Canadian defined benefit pension plan system is in excellent shape. It
objectively offers very competitive benefits coupled with a high degree of
financial security for plan members.
In our considered view, the overriding issue is not to “strengthen“
defined benefit plans, but rather to ensure that they remain sufficiently
flexible and affordable to corporate plan sponsors. In this regard, the
system is clearly at a crossroad and faces serious risks that must be
addressed forthwith by the regulator.
We have summarized in the attached document our comments
on the key policy issues listed in your consultation paper. However, we
would like to draw your attention to the two most important issues that
must be addressed in priority to maintain a proper balance of pension
regulations. Those two issues are closely intertwined and relate to
excessive cash funding requirements currently imposed on plan sponsors.
Lack of Clarity on Surplus Ownership
Under existing regulations, plan sponsors bear the full
financial burden of any pension deficit throughout the life of the plan.
This is our clear corporate promise and we fully stand behind it. However,
the current regulation and case law are unclear as to who owns the
surplus. This creates an unacceptable asymmetry of risks and rewards which
must be corrected. The lack of clarity on who owns the surplus creates
strong disincentives for corporate sponsors to fund cash deficits in a
timely manner. This issue is exacerbated in situations where funding
requirements arise solely as a result of solvency deficits.
In the current environment of historically low-interest
rates, many pension plans that are in a going concern surplus, like the CN
plan, may nevertheless be required to fund solvency deficits over a very
short period. In these situations, cash funding actually increases the
going-concern surplus without the required clarity on who owns the surplus
in the first place. This is commonly referred to as the “trapped capital”
issue and this problem will be seriously compounded when interest rates
return to more normal levels.
Calculation and Funding of Solvency Deficits
The current solvency rules initially designed to assess
the security of benefits for plan members are fundamentally flawed and the
resulting funding requirements unduly onerous for plan sponsors. The test
is flawed because it is based on unrealistic assumptions and calls for
stark remedies that are not warranted in many circumstances:
-
In its current form, the solvency test is almost
surreal as it attempts to measure the health of a pension plan by
assuming that it is dead. As applied by OSFI, the test fails to
recognize the organic link that exists between a pension plan and the
strength of its corporate sponsor. To illustrate this point, how many
banks would pass an artificial test that assumed a sudden and total
withdrawal of its deposits? How many life insurance companies could
have enough funds set aside to meet an immediate claim on all of their
outstanding life insurance contracts? This simple business reality is
adequately recognized by financial sector regulations which are based
on tests that are more going concern in nature. The same logic should
apply for assessing pension plan solidity on a case-by-case basis.
-
A solvency test slightly below 100% can occur in plans
with going concern surpluses that are also backed-up by financially
strong corporate sponsors. As a reference point, most pension promises
around the world are either simply not funded or often only partially
funded with shares of debt of the sponsors. So what is wrong with
Canadian plans with 90-95% funded ratios that are well invested in
segregated assets and supported by strong sponsors? Objectively,
nothing is wrong! This is why, for instance, the U.S. Labor Department
proposes funding targets that recognize the financial health of the
plan sponsor and accelerate cash funding requirements only when below
a 90% solvency ratio.
-
The use of a discount rate based on life companies’
implicit annuity interest rate is simply unrealistic. Why are
diversified portfolios of assets suddenly exchanged for fixed annuity
quoted by insurance companies that are attempting to make a profit in
a totally different market context? More realistically, solvency tests
should be based on long-term corporate bond rates as is the case under
U.S. pension regulation.
-
For financially strong companies with well-managed
pension funds, there is no reason to arbitrarily require the funding
of solvency deficits in five years as opposed to the fifteen years
allowed for going concern deficits. The foundation of pension plan
management in Canada and a key to its success is the long-term horizon
of its investment policies. In the current low interest rates
environment, the consequences of artificial point-in-time solvency
tests applied indiscriminately can be far-reaching. Indeed, by some
estimates, the total deficit shortfall of Canadian pension plans was
in excess of $150B at the end of 2004. Unless pension rules are
changed, huge cash resources will be diverted away from other
productive uses which would benefit the Canadian economy.
In short, corporate plan sponsors can no longer afford the
consequences of unrealistic discount rates and unduly conservative
amortization periods. Unless the Federal Government acts swiftly to
address these issues, plan sponsors will be forced to curtail benefit
improvements and to consider abandoning defined benefit plans altogether
in favor of other pension arrangements. The serious potential damage to
the financial health of corporate sponsors is not in the interest of
Canada, the employees, and the pensioner of Canadian corporations,
especially at a time of intense international competition from firms that
operate in countries where such rules do not exist.
Accordingly, we urge the Department of Finance to
implement the following recommendations:
We trust that you will receive these comments and
recommendations in the spirit of a balanced proposal to maintain a solid
defined benefit pension plan system in Canada. Finally, we consent to the
public disclosure of our comments and are ready to answer any further
questions that you may have.
Yours truly,
Claude Mongeau
Att.
Defined Benefit Pension Plans under PBSA
CN's Comments on the Department of Finance Consultation Paper
A. Surplus
The Government of Canada is seeking views as to
whether there are any disincentives or obstacles preventing plan
sponsors from adequately funding their plans and building up a
funding cushion. |
Yes, there currently are strong disincentives. The
sponsors find themselves in a situation where they may be forced to give
more than the promised benefits. This situation is likely to result in the
sponsors wanting to reduce risks and the promised benefits in the future.
The disincentives include:
(1) The issue of asymmetry in surplus ownership, which
needs to be clarified. We believe that it is appropriate for a sponsor
to have access to the surplus funds given that it is responsible to fund
deficits as they arise.
(2) The prospect of having to distribute a portion of
the plan’s surplus to those members who are included in a partial plan
termination.
The Government of Canada is seeking
views on whether the dispute settlement mechanism for surplus
distribution contained in the PBSA requires improvement or
clarification. |
Yes, significant improvements are required in this area.
Unless the plan text specifies that plan members are entitled to some of
the surplus, the sponsors should clearly have discretion over the use of
surpluses.
The Government of Canada is seeking
views on whether there should be partial plan terminations under the
PBSA and if so, should there be a requirement to distribute surplus
at the time of the partial termination. |
Partial plan terminations are not only a disincentive to
funding more than the minimum required but also they represent an
important administrative burden for the sponsor. We support the decision
of the Quebec regulator to eliminate partial plan termination, which
require that plan members be immediately vested. We believe that it is
inappropriate to have any part of a surplus distributed upon a partial
plan termination to those members included in the partial termination.
Also, giving partial plan termination members a contingent
right to any surplus distribution on full plan termination leads to
unacceptable administrative issues (i.e., identification of who is and is
not included in such category, and tracking for an indefinite period those
such members who elect lump sum settlements). The only viable solution is
to eliminate partial plan terminations.
B. Funding
The Government of Canada is seeking views on whether
there are alternative financial vehicles, such as letters of credit,
that could allow for greater funding flexibility.
What types of conditions or rules should be required
if greater funding flexibility is given to plan sponsors, to ensure
that the risk to benefit security is minimized? |
Several financial vehicles have been proposed as
alternatives to fund deficits. However, the best alternative is the use of
letters of credit as they promote benefit security while giving employers
greater flexibility in cash flow management. Cash flow management is a
major concern for sponsors operating in asset-intensive industry such as
the transportation industry.
Some of the rules that should apply for letters of credit
include:
(1) The government should not seek higher funding levels
from sponsors who are making use of letters of credit.
(2) The cost of letters of credit and deemed interest
should be tax deductible.
The Government of Canada is seeking views on what the
appropriate amortization period is and whether it is different for
financially vulnerable and financially strong companies. |
Extending the solvency period to 15 years would be more
appropriate for financially strong companies meeting certain criteria.
There is no reason for a different time frame from the going concern
valuation for financially strong companies.
The Government of Canada is seeking views on what types of
conditions or rules should be attached to any extended amortization period
for solvency funding for companies under CCAA or BIA. |
If the objective is to ensure the security of the promised
benefits, it is not appropriate to allow an extended amortization period
for solvency funding only for companies under CCAA or BIA.
The Government of Canada is seeking views on whether there
are alternatives to address funding issues other than relaxing funding
requirements. For example, would special accounts for pension plans be
feasible? |
If solvency contributions could be remitted to such a
special account, it would address some of the asymmetry issues,
specifically the "trapped capital" concerns. It would not,
however, address the need for longer solvency amortization periods. In
addition, as compared to the use of a letter of credit, this alternative
requires upfront cash payments to the separate trust.
The Government of Canada is seeking views on whether there
should be greater disclosure provided to plan members regarding a plan
sponsor’s financial condition, funding decisions and contribution
holidays and how this may be done. |
We support greater disclosure as to the funded status of
the pension plan; however, member disclosure must be limited to data that
can be made available to the investment community. We would also support
disclosure of a statement of funding policy, which would include the
sponsor’s policy regarding contribution holidays. Any information
provided to members regarding the sponsor’s financial condition must be
restricted to publicly available data (i.e., credit ratings).
C. Void Amendments
The Government of Canada is seeking views on its proposal
to implement the void amendments of the PBSA based on a prescribed
solvency ratio level of 85 per cent, and to reduce the priority of
claims against pension plan assets for recent benefit improvements that
have not been fully funded.
Specifically:
-
Is an 85 per cent solvency ratio an appropriate
threshold for applying the proposed controls and conditions on plan
improvements?
-
Should pension plans with solvency ratios below 85 per
cent be permitted to make plan improvements provided that offsetting
funding is provided at the time that the improvement comes into
effect?
-
Would the proposed priority scheme improve security of
longer-established benefits?
|
-
In our opinion, the introduction of a lower priority
claim for more recent benefit improvements would address a potential
inequity between different member classes in the event the plan is
terminated. If recent improvements have a lower priority claim in the
event of a wind up, this information should be disclosed to affected
plan members.
D. Full Funding on Plan Termination
The Government of Canada is seeking views on full funding
on plan termination, and in particular how it should be applied to
financially vulnerable sponsors. |
We support the proposal to require plan sponsors to fully
fund any solvency deficit on plan termination, provided the surplus
asymmetry issue is satisfactorily addressed.
This could be done through a lump sum payment or special
annual payments starting at the effective date of wind up.
E. Pension Benefit Guarantee Fund
The Government of Canada is seeking views on the viability
of a federal pension guarantee fund including any comments on its possible
design, operation, and powers. |
We do not believe that there is a need for a pension
guarantee fund for federally regulated employers. Pension liabilities
among federally regulated employers are concentrated among too small of a
group of companies to allow the operation of an effective risk-based
insurance program that would apply to these employers only. In addition,
if it is assumed that the funding of this Guarantee Fund would come from
pension plan sponsors, it would be far too large of a contingent
obligation and we simply would not be prepared to insure another company’s
risks in this regard.
|