- Consulting with Canadians -

CBA's Submission in Response to Finance Canada's Regulatory Framework for Federally Regulated Defined Benefit Pension Plans consultation:

Box 348, Commerce Court West
199 Bay Street, 30^th Floor
Toronto, Ontario, Canada M5L 1G2
www.cba.ca

Terry Campbell
Vice-President, Policy
Tel.: [416] 362-6093 Ext. 301
Fax: [416] 362-8288
tcampbell@cba.ca

September 29, 2005

Ms. Diane Lafleur
Financial Sector Policy Branch
Department of Finance
L’Esplanade Laurier
20th Floor, East Tower
140 O’Connor Street
Ottawa, ON K1A 0G5

Dear Ms. Lafleur,

The CBA appreciates the opportunity to comment on the issues raised in the Department of Finance consultation paper, Strengthening the Legislative and Regulatory Framework for Defined Benefit Pension Plans Registered under the Pension Benefits Standards Act, 1985. I am writing to you on behalf of the pension plan sponsors of the six largest banks who, together, manage defined benefit pension plans (DBPPs) totalling over $16.5 billion in assets. These plans are well funded and have healthy solvency ratios. Nonetheless we are concerned about recent developments in the DBPP environment such as the decreasing number of DB plans, and the funding challenges faced by many DBPP sponsors arising mainly from the deterioration in financial markets in 2000-01, and the current low interest rate environment. DBPPs have served employees well over many years by offering a relatively secure form of saving for retirement for hundreds of thousands of working Canadians. We strongly support the Finance Canada initiative to explore ways whereby the regulatory regime can become more responsive to the needs of DBPP sponsors who are operating in an external environment that has changed substantially in the last 20 years – changed not only in financial markets, but also in labour markets, demographics, and the increasingly litigious private pension plan environment.

In order to increase and ensure benefit security for plan members in this new environment, plan sponsors need greater regulatory flexibility and support for managing plan funding over the long term. The introduction of greater flexibility into the regulatory regime does not necessarily mean, in our view, deregulation or a reduction in regulatory oversight. But the focus of regulation in the past has been the security of benefits for the plan member and not enough on what the plan sponsor needs to manage funding and the accompanying risk for the long term. We need a better balance, and it appears that this consultation could help lead to that. Our comments are general in that we want to indicate to you what approaches we see as being appropriate for modernizing the regulatory environment for DBPPs. We look forward to working with you in the next stage when more specific recommendations can be discussed within an updated and revised framework. Our comments are organized under four broad headings: funding issues, void amendments, surplus issues, and a Pension Benefit Guarantee Fund.

A. Funding Issues

Asymmetry

The CBA agrees with the views expressed by the Association for Canadian Pension Management (ACPM) in their comprehensive paper, Back from the Brink, Securing the Future of Defined Benefit Pension Plans, that the lack of symmetry in the rights and obligations of defined benefit pension plan sponsors is a fundamental flaw in our regulatory regime that has a detrimental effect on all other funding and surplus issues. As the ACPM observes, the plan sponsor "is responsible for the ultimate funding of pension benefits, the cost of which may be offset by fixed employee contributions; is usually wholly responsible for funding shortfalls; but is prevented or severely constrained from access to or use of any excess funds (surplus) in the plan, other than using it toward benefit improvements (including, based on the Monsanto decision, mandatory distribution of surplus upon partial plan wind up)." If this asymmetry were to be rectified so that the employer’s obligation to fund the full cost of benefits plus funding shortfalls were balanced by the removal of the artificial constraints on the right of the employer to access surplus funds when they occur according to some balanced and reasonable criteria, it is our view that employers would be less reluctant to maintain or initiate new DBPPs and that more effective management would be promoted. In addition, fairness would suggest that the party that bears the financial risks of the pension plan should logically be entitled to the use of surplus funds unless the terms of the plan require otherwise.

Alternative Funding / Financial Vehicles

The CBA supports in principle greater flexibility and relief for DBPPs experiencing solvency deficiencies. Various funding options should be available to plans that have funding shortfalls with a view to protecting and promoting financial health both in the plan and with the sponsor for the long term. In fact we note that the basic factors built into the Air Canada Pension Plan Solvency Deficiency Funding Regulations, although developed specifically for an extreme situation, suggest what could be a general framework for developing a new regulatory approach for more general application. Such factors include:

1. Access to various alternatives for funding deficiencies (e.g., letters of credit);

2. Provision for a longer solvency deficiency amortization period such as ten years in order to reduce the level of annual pension payments over a longer period than the current standard of five years; and

3. The establishment of certain conditions to be met by the plan sponsor such as disclosure to members of the plan for funding relief.

The fundamental principle, also recognized in the Quebec Régie des rentes working paper, Toward Better Funding of Defined Benefit Pension Plans, is that more flexibility in the short-term for effective management and financing of pension plan deficits will improve the future financial prospects of the plan sponsor and the likelihood that the pension deficit will be paid off. This will help to protect the interests and benefits of plan members and former members over the long term thereby ensuring that the promised benefits, both those accrued already and those accruing in the future, will be paid.

We support amending the Pension Benefit Standards Regulations (PBSR) in order to allow various alternative courses of action to be available for funding solvency deficiencies where they exist. A plan sponsor should be able to select, subject to approval by the Office of the Superintendent of Financial Institutions (OSFI), the method best suited to the precise need of the organization, e.g., the degree of the funding shortfall, whether the need is short-term or long-term, etc. Among other things, possible options include:

1. Letters of credit (see below).

2. The establishment of a special account or ‘cushion’ within the pension fund such as is recommended in the Régie des rentes working paper. The ACPM observes that the building of a ‘solvency margin’ would increase short term contributions to plans, but would also increase long-term stability and security and should be supported by longer amortization periods.

3. The development of a fund or special account outside the pension plan so that it could not be commingled with going concern assets. If the plan were ever wound up, this could be used to mitigate a solvency deficiency.

The first option would provide a temporary substitution for cash in making up the deficiency. The latter two possibilities, intended for ongoing, permanent risk management, would need to be accompanied by greater symmetry, that is, if the sponsor had access to surpluses when they arose and could use them towards building the special fund or account whether inside or outside the plan. Each situation would need to be assessed by OSFI on a case by case basis, and the regulations should allow OSFI the flexibility to exercise its discretion.

Letters of Credit as an Alternative Funding Vehicle

Speaking as administrators of large pension plans and not as financial service providers, letters of credit appear to us to be one appropriate alternative to solvency funding for single-employer pension plans. Their potential effectiveness and any conditions or restrictions on the provider that need to be considered should, at the very least, be explored more comprehensively with financial institutions. We agree that letters of credit would constitute a temporary measure so that plans with solvency deficiencies can direct their cash to other needs and market risk can be transferred for a time from the plan sponsor to a much stronger financial institution. Because letters of credit are financial market products, the pricing of the instrument and the credit worthiness of the plan sponsor would be determined according to market factors, i.e., sponsors whose financial condition is very weak would probably not qualify. In fact, the willingness of the financial institution to extend the letter of credit or not would be an important and useful indicator to the regulator of the plan sponsor’s financial position. Probably the key role of these instruments would be to allow plan sponsors who have temporary solvency shortfalls but whose financial outlook is sound to better manage funding contributions, benefit improvements and risk. We agree that letters of credit should not be used as a substitute for going concern funding.

Amortization Periods

As noted above a ten-year amortization period is a key provision in the Air Canada Pension Plan Solvency Deficiency Funding Regulations. The extended amortization in Air Canada’s case is balanced by certain conditions that must be met including: (1) appropriate disclosure of information to plan beneficiaries regarding the proposed funding relief; (2) the filing of a statement with OSFI that plan beneficiaries, through their representatives, consent to the funding of their pension plans in accordance with the regulations; and (3) the remittance by Air Canada to the pension plans of certain outstanding payments, including all current service contributions that are required to be made prior to emergence from the Companies’ Creditors Arrangement Act (CCAA). In our view these particular conditions are appropriate for a plan sponsor under bankruptcy protection and undergoing major restructuring, but they should not be necessary in all cases. The regulations should provide that, depending on the particular situation, conditions would be established at the discretion of the regulator.

Longer solvency deficiency amortization could also help in avoiding the unnecessary build-up of going-concern surplus assets which would be problematic to many plan sponsors under the current surplus ownership rules.

Disclosure

The CBA supports the principle of transparency and access to information about the DBPP for plan members and retirees. However, we feel the current level of disclosure under the PBSA that includes among other things an annual statement of member contributions, benefit entitlements, and the solvency ratio where applicable (if less than 1) is appropriate for most plans.

Certain plan documents are already available to members upon request as required in the Act, but in our experience they are requested only rarely (e.g., one member bank reports only two requests in the last three years; another not more than two in a given year). It is our view that the provision of more information to participants wouldn’t necessarily add to their understanding of the actual financial position of the plan or of the plan sponsor’s business. Currently, matters such as plan valuations and audited financial statements are available to plan members, and these already provide them with a technical view of the financial health of the plan.

We do not support the concept of making a plan sponsor’s funding policy available to members. A plan’s funded status can change substantially not only from one solvency valuation to the next, but also, according to the Canadian Institute of Actuaries (CIA), a solvency deficiency at one date can easily become a solvency excess six months or a year later. A funding policy exists as part of a dynamic process and cannot be captured in a static framework. Changes in the financial position and risk preferences of plan sponsors are two examples of factors that will affect funding policies. We also think it would be difficult to provide even a very broad funding statement in such a way that it would be satisfactory or meaningful.

It does, however, seem appropriate that in a situation where there is an approved restructuring plan in place, there should be a disclosure requirement for the plan sponsor to communicate at least the broad outline of the remedial funding plan to the beneficiaries. The requirement to obtain the consent of plan members for the funding approach seems unnecessary given that the alternative would likely be the termination of the pension plan.

Plan Termination / Wind-up - Full funding Priority of Recent Plan Improvements

The CBA strongly supports the principle of full funding on plan wind-up: employers should be obligated to fulfill their pension promise. At the same time, this concept would have wider support if symmetry were achieved, that is, if plan sponsors could have access to any surplus on wind-up subject to the terms of the plan.

We are also of the view that recent plan improvements should be given lower priority on a terminated plan’s assets (see Void Amendments, below). We agree with the ACPM recommendation that "benefit improvements made within a specified period before a plan is wound up (to be determined) should have a lower priority if there are insufficient plan assets to pay for them. The risk of benefit loss on plan wind up, with respect to recent benefit improvements, should be clearly communicated to plan members at the same time the benefit improvements are communicated to them, especially if the plan is underfunded."

B. Void Amendments, PBSA, S. 10.1 (2)

With respect to the government’s 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, we certainly support the concept of a specific threshold for allowing plan improvements. We note with interest that the proposed level of 85% is somewhat less than the 95% originally proposed by OSFI and then reduced to 90% in 2000. The view expressed at the time by the Canadian Institute of Actuaries (CIA) seems reasonable. The CIA wrote that setting too high a standard for solvency funding before benefit improvements are permitted would unduly restrict the growth and improvement of pensions, and that a lower ratio between 75 and 85% would be more appropriate if combined with certain conditions such as the adoption of reasonable minimum solvency funding standards, the establishment of priorities for retroactively voiding amendments which are not fully funded upon wind up, and clear disclosure to members regarding solvency deficiencies and benefits that may be at risk. We would support permitting a plan amendment with offsetting funding by the employer sufficient to increase the solvency ratio to the level specified in the regulations.

C. Surplus Issues

10% Excess Surplus Limit

Employers require flexibility to manage their plan sponsor contributions within the context of their own business cycles and external economic conditions. By limiting the amount of surplus for which an employer can take a tax deduction, the Income Tax Act (ITA) 10% surplus threshold is an arbitrary and unnecessary constraint on the plan sponsors’ ability to manage effectively. We recommend that the limit be eliminated, raised or made more flexible. For example, an increase in the threshold could be an incentive to sponsors to maintain increased funding within the plan that could help them weather periods of economic downturns more successfully.

Partial Plan Terminations

The CBA is opposed to the distribution of surplus funds on a partial plan termination. In our view surplus, at least in the federally regulated sphere, cannot be properly quantified until all plan liabilities have been crystallized and settled upon full plan wind-up. In our view, surplus is a notional concept until that time and not capable of attribution to only a portion of plan members. Also, surplus distribution on partial plan termination is not equitable for all plan members. It is more a matter of fortuitous or unfortuitous timing. Members affected by a partial termination may have a larger or smaller share of surplus than the remaining members in the plan on a full wind-up when and if that should occur. Retirees and deferred vested members are seldom included in a partial wind-up as they would be in a full wind-up.

We recommend that subsections 29 (2) and (12) of the PBSA be amended so that (1) partial terminations are prohibited, and (2) full vesting is aligned. We believe these steps would be the most effective means of responding to the current uncertainties relating to partial plan terminations, and that, even though there may be some added cost to plan sponsors when they introduce immediate vesting, the long term benefit to the system will be worth the cost. Immediate and full vesting from the beginning of service eliminates the need to have special provisions for partial terminations. This recommendation is in line with the proposal for immediate vesting in CAPSA’s Model Law.

D. Pension Benefit Guarantee Fund (PBGF)

The CBA is opposed to the establishment of a federal pension benefit guarantee fund. We believe that the best means of protecting and securing member benefits for the long term is in the adoption of provisions that will encourage responsible management of solvency deficiencies by plan sponsors through regulatory flexibility and support. The existence of a PBGF could act as a disincentive to borderline plan sponsors to fully fund their plans and manage risk effectively. Furthermore, financially strong plan sponsors pay for the risks taken by weaker ones. It is our understanding that these funds have not been successful in the U.S. or in Ontario where their pension guarantee funds have large deficits.

In conclusion, we hope that these comments will be helpful. As noted at the outset, this initiative by the Department of Finance is a timely and positive step. We look forward to working with you further as you take these concepts to the next level of drafting and design.

Sincerely,