The International Association of Machinists and Aerospace Workers (IAM) represents 400,000 active members and about 200,000 retiree members in North America. We represent workers in a wide range of sectors, and in almost every jurisdiction in Canada.
We have over 10,000 active members in Ontario, as well as several thousand retired members. Most of our members belong to single-employer workplace pension plans. For over 30 years, the IAM has sponsored a jointly-trusteed multi-employer pension plan, registered in Ontario, but also with members in other Canadian jurisdictions.
Our interest in the issues concerning retirement income and pensions is longstanding, and we are pleased to have the opportunity to present our views to the Ontario Expert Commission on Pensions.
The Pension Context
The terms of reference of the Expert Commission focus primarily on workplace pension plans, particularly defined benefit plans. While workplace pensions are a very important source of income for retirees in Canada, accounting for over 20% of seniors’ total income, they are secondary to our public pension system (C/QPP, OAS, GIS) which accounts for about half of seniors’ income. Our public pensions provide the majority of income for over two-thirds of Canadian seniors, and this will certainly continue to be the case in the future.
In any discussion of retirement income in Canada, it is essential to note the key role of our public pension system, and we hope that this Commission will, in its report, point up the importance of maintaining and improving that system.
Much of the discussion around pensions focuses on the “coverage” of private, or employment-based, plans. While this is important, the key question is not coverage rates, but whether seniors will have enough income in retirement to live in dignity and comfort. If the incomes of Canadian seniors are inadequate, the most effective way to deal with those shortfalls is through our public system, which is highly efficient, and already provides near universal coverage.
That being said, workplace plans are important. There has been a slow but steady decline in their coverage rates over the last twenty or so years, with a particular decline in the proportion of workers belonging to defined benefit plans, though a large majority of plan members are still covered by defined benefit plans.
Defined benefit pension plans have important advantages for plan members – a clear benefit promise, a pooling of risks – which, notwithstanding their greater administrative complexity, make them the retirement income vehicle of choice. Conversely, defined contribution plans transfer risks to the individual, make retirement planning more difficult, and generally have higher investment costs.
Multi-employer plans, union- or jointly-trusteed, can offer advantages which are similar to those of defined benefit plans, while limiting employer obligations. They are, we believe, the only vehicle for significant growth in defined benefit pension coverage in the future.
The recent decline in workplace plan coverage is largely a reflection of the shifts in the workplace – with a decreasing share of stable, unionized employment, where workplace plans have primarily been found.
Defined benefit plan coverage, particularly in non-unionized settings, has also been affected by the shift, over the last decade, from a situation in which employers could frequently take contribution holidays to a situation in which many, if not most, plans require special payments to cover solvency deficiencies.
These developments have caught the attention of corporate financial executives, who, over the previous quarter-century, had become accustomed to viewing their defined benefit pension plans as a cheap, if not free benefit (or even as a profit centre), ignoring the fact that economic conditions should occasionally be expected to create pension deficits, as well as surpluses, with an impact on corporate financial obligations.
Representatives of employers frequently refer to pensions as a “voluntary” benefit, suggesting that making pension plans more “attractive” to employers is the key to maintaining or increasing pension coverage. The truth is that attractiveness to employers has had relatively little to do with pension coverage.
There has never been a period in which the majority of Canadian workers have been members of workplace-based plans, particularly defined benefit plans. The majority of unionized workers are members of workplace plans. The majority of non-unionized workers are not. Workplace pensions are in place because workers want them, and when they are in a position to get them, as in a unionized setting, they do. Employers have not generally provided good pensions voluntarily to anyone but senior executives.
In this light, the changes to pension law, both legislative changes and court decisions, over the last couple of decades, that have brought an increasing degree, and sense, of security and fairness to pension plans, have been crucial to maintaining pension coverage. Members will not trade off current income for a pension promise which they do not perceive to be fair. It is essential that security and fairness not be lost in search of a chimera of “attractiveness” to corporate executives, which will do little to maintain or increase coverage.
While a thorough review of Ontario’s pension legislation is an important exercise, changing the regulatory environment will not bring about a major increase in defined benefit plan coverage in Ontario, unless there are major changes in the underlying workplace trends, such as a substantial increase in stable, unionized employment.
The Legal Framework for Pension Plans in Ontario
Before responding the questions raised in the Commission’s discussion paper, we should begin by saying that we believe that the basic legal framework for workplace pensions in Ontario is sound and has, for the most part, worked well for the last twenty years. While there is room for improvement, the Pension Benefits Act provides an important set of minimum standards, and the funding rules for defined benefit plans have provided a pretty good guarantee that, for the most part, benefit promises will be fulfilled.
We note that there are other important areas affecting pensions in Ontario, outside of the Commission’s mandate – federal legislation like the Income Tax Act and Bankruptcy law, pension legislation in other Canadian jurisdictions, and other Ontario legislation in areas like family law, labour law and workers’ compensation. We hope that the Commission will not feel restrained from making comments, if not recommendations, in these areas, where they have a serious impact on pensions in Ontario.
We are also pleased to see that the Commission’s mandate extends to the regulatory institutions involved in pensions. It is essential when setting standards to consider who, both within and outside of pension plan administration, is responsible for administering and enforcing those standards, on whose behalf are they employed, and what resources do they have?
We also appreciate that the Commission has commissioned a major research program, which, we hope, will bring to light a body of data and facts against which to check the assertions of the various parties to pension debates.
Minimum Standards
When the last major revision of the Ontario Pension Benefits Act (PBA) took place over two decades ago, there were major advances in minimum standards that promoted fairness and helped maintain support for workplace pension plans, particularly among younger members. Shorter maximum vesting periods, portability requirements, and mandatory pre-retirement survivor benefits ensured that even relatively short service employees would benefit from their pension plan participation.
There have been few changes since the mid-1980s, and it is now time to move further in upgrading minimum standards in the PBA.
With technological change, there is no longer a significant administrative impediment to immediate vesting, as is already the law in Quebec.
The PBA already contains a requirement to provide cost of living protection to pension benefits, but successive Ontario governments have unfortunately never followed through and introduced the regulation required to make the indexing requirement effective. The failure to index was a major source of surpluses and contribution holidays through the 1980s and 1990s, inequitably transferring income from retired plan members to plan sponsors. As lifespans lengthen, even moderate inflation rates eat deeply into benefits over 20 years or more of retirement.
We believe that the indexing requirement should now be activated, even on a partial basis.
In recent years, the legislation has been amended to allow more unlocking of earned pension benefits, in cases of financial hardship or shortened life-expectancy, and most recently, in allowing a 25% unlocking at the time of purchasing a Life Income Fund. Some groups are proposing further steps in this direction. We believe that this would be unwise.
The locking-in provisions were introduced to ensure that retirement savings would be used for retirement. Extending unlocking provisions would benefit no one, and would reduce retirement income.
Funding Rules for Defined Benefit Pension Plans
Defined benefit pension plans promise benefits to be paid out many decades in the future. Before there were rules requiring pre-funding, the fulfillment of a pension promise depended on the continued long-term existence and financial solvency of the employer making the promise. The introduction of minimum funding requirements greatly enhanced the likelihood that the benefit promise would be kept.
Currently, the Canadian framework for funding defined benefit plans generally operates as follows:
Plan sponsors (and possibly members) are required to make contributions to a trust fund in each year sufficient to provide in the future all of the benefits earned in that year. The amounts of required contributions are estimated by actuaries based on rules which are a combination of legislated standards and accepted actuarial practice.
As demographic and economic factors which would affect these cost estimates are constantly changing, actuaries regularly (at least every three years) recalculate the costs of providing benefits as they are earned and estimate whether the fund now contains more or less than required to provide the benefits earned to date. Required contributions must be adjusted to reflect the new valuation and shortfalls in the fund made up through prescribed special payments.
Since the mid-1980s, actuaries have been required to perform two valuations – a going-concern valuation based on the assumption that the plan will continue indefinitely, and a solvency valuation, as if the plan had terminated on the valuation date. The rules governing solvency valuations are stricter than those governing going-concern valuations - there is less leeway in allowable assumptions – and solvency valuations are particularly sensitive to relatively small variations in long-term market interest rates. Shortfalls in solvency valuations are to be funded in five years or less.
The solvency valuation provides an indication of the likely status of the plan, not only if it were to terminate, but also the potential impact of major “traumatic” events short of a wind-up, like a dramatic decline in, or aging of, plan membership. It can act as a sort of “stress test”.
In general, this framework has been successful in increasing the security of the benefit promise. For most of the first fifteen or so years after the introduction of the solvency valuation requirement, the fact that long-term interest rates were well above the investment return assumptions for going-concern valuations meant that the solvency deficits were relatively rare occurrences, and special payments for solvency funding uncommon. At the same time, consistently high investment returns created surpluses in most plans, and led to frequent contribution holidays for employers.
A couple of years of poorer investment performance at the beginning of the millennium and lower long-term interest rates created unprecedented solvency deficits and requirements for extra payments, leading to outcries from corporate financial officers who had forgotten that market conditions can change.
Pension funding involves trade-offs between current cost and pension security. It is clear that the more money that goes into a pension plan (and the higher the current cost) the more secure the pension promise. In the current system, the risks are broadly shared. Employers are generally able to use plan surpluses for contribution holidays, but are required to fund deficits. Plan members and pensioners face the possibility that unforeseen inflation will undermine the value of their promised benefit. They also face the risk that their benefits will be cut if their plan terminates with unfunded liabilities and their employer is insolvent (with limited protection under the Pension Benefits Guarantee Fund) or in the case of a multi-employer plan, where there is no responsible employer and no PBGF coverage.
The truth is that, for the most part, in ongoing plans, deals are made (explicitly in collectively bargained plans, implicitly in non-union settings), where risks, gains and losses are traded off. The trading-off of current income for a defined benefit promise to be paid out over many decades in the future is far from an exact science.
In a unionized environment, the existence of a pension surplus or deficit affects negotiations for pension improvements and the broader settlement. Such trade-offs can become more problematic in situations like plan wind ups and mergers, where the balance of power is particularly tilted towards employers, and there may be less flexibility for dealmaking.
Prior to the Dominion Stores decision in 1986, it was common for the regulator to allow the removal of surplus from plans without even requiring the notification of plan members and benefits.
Since that time, the courts and the regulations on surplus distribution have brought some transparency and balance to pension funding, though employers as plan administrators still have most control of the process. There is now a relatively clear set of rules that have facilitated the striking of deals in wind ups and partial wind ups. The process could be simplified somewhat by making it explicit in the legislation that any distribution or removal of pension surplus must be the subject of a negotiated agreement between plan sponsors and beneficiaries, with clear time limits and a binding arbitration process, without going through the arcane legal process of assessing historical trust language.
There is less clarity in the legal situation of surplus rights in relation to plan mergers. A requirement for the distribution of surpluses (or at least the adjudication of surplus rights) when plans are merged would prevent employers from use mergers simply to avoid sharing plan surpluses with plan members and beneficiaries.
Some employers have argued that giving employers easier access to plan surpluses would encourage the maintenance and creation of new DB plans. On the contrary, the availability of a surplus “bonus” would provide an additional incentive for employers to terminate their existing DB plans.
The creation of earmarked contingency reserves, again to give employers easier access to plan surpluses, has been proposed as an incentive for employers to fund over the minimum. Frankly, such reserve funds would have little impact on funding levels, or DB coverage, but their separation from the pension trust or the regular assets of the pension plan would invite future legal problems over ownership of these reserves.
The most important element is creating clear minimum funding standards that will provide a high degree of pension security. In the light of history, it is clear that any extra funding by employers will be driven by unrelated corporate objectives – tax or profit numbers – that have nothing to do with concerns about long-term plan solvency.
There are a number of interconnected factors that affect the security of earned benefits: funding rules and the range of latitude allowed to the various actors, how responsibilities are shared, who makes funding and related decisions, the transparency of the process, and how the process is regulated. These factors may vary between plans, and particularly between single and multi-employer plans.
We would ask this Commission, in its recommendations, to make proposals that will, overall, if not increase benefit security, at least not reduce it.
We believe that transparency is a key element. The legislated requirement, over 25 years ago, to provide actuarial information to plan members lead to an enormous improvement in honesty and understanding. We support the requirement that every defined benefit pension plan have a clear, explicit and public funding policy, as the CIA has recommended. It is important, however, that employers not be given unilateral authority to set funding policy. Funding policy must be subject to agreement of plan members, or the relevant union.
The current requirements for funding solvency deficiencies have become a central concern for many plans and regulators across Canada. For some plans, solvency funding may place a heavy cost burden and even create serious financial problems for employers. Many sponsors of multi-employer plans have argued that solvency funding requirements are unnecessary as multi-employer plans, particularly in the public sector, are highly unlikely to be wholly wound up.
While there is considerable truth to these arguments, it would not be prudent to simply do away with or ignore a solvency type of valuation, even for large public sector multi-employer plans. Wind up is not the only risk that such plans may face. Restructuring that reduces plan membership, perhaps raising average ages and costs per active member, which may also be happening at a time when investment returns are low, can together dramatically increase pension costs per active member.
It is important to continue to perform a valuation that estimates the impact of major traumatic events on pension costs, and projects potential future funding requirements using a range of negative assumptions. Plan funding policies should reflect the risk profile of the plan. It is clearly less prudent to take contribution holidays or make major improvements to vulnerable plans.
Multi-Employer or Jointly-Sponsored plans are the only vehicle for significant growth in Defined Benefit coverage. The law must require clarity in each plan as to responsibilities with respect surpluses and deficits and the method by which decisions to amend contributions or benefits are to be made. The law should also clarify that employer liability in a MEPP is limited to paying the negotiated contributions, unless the plan explicitly provides otherwise.
To the extent that there is a loosening of the requirement for solvency funding, as in the recent regulation allowing some multi-employer plans to opt for a three-year moratorium on solvency funding, these must be offset by other measures that increase pension security – for example, a requirement that prohibits contribution holidays unless a plan has a surplus over 10% of total plan liabilities. If the long-run probabilities of pension deficits and surpluses are in fact equal, contribution holidays are imprudent and need to be restricted.
There is certainly a strong consensus (including virtually everyone except the federal Finance Department) for a change in the federal Income Tax Act to increase the current 10% surplus cap for continuing contributions to pension funds.
The Discussion Paper asks whether funding requirements could be tied to a sponsoring employer’s “financial strength”. We do not believe that this is workable.
Even leaving aside employers that are private corporations, the true financial state of public corporations is often difficult to ascertain and may change dramatically overnight. Monitoring the financial health of plan sponsors is not something pension regulators will have the capacity to do effectively. In fact, the identity of the sponsoring “employer” may not be clear. We have similar concerns with the use of letters of credit in the place of funding. Certainly, if extra monitoring responsibilities are to be placed on the regulator, extra resources must also be provided.
The Discussion Paper asks whether there should be special rules for “riskier” investment strategies. It is not clear what constitutes a “riskier” strategy. What has become clear, with the increase of pension investments in private equity, derivatives and various complex strategies, and particularly with the asset-backed commercial paper situation, is that there is an increasing loss of transparency in investment, and that trustees and even investment professionals, let alone plan members in DB or DC plans, often do not know or understand where and how pension money is invested and what the true risks are.
While not a central component of the Commission’s mandate, we would suggest that the Commission comment on the problems inherent in the Capital Accumulation Plans (CAPs), the DC plans, RRSPs, and mutual funds that are in direct competition with DB plans. There needs to be much greater required disclosure of the risks and (the world’s highest) fees in such plans. The Regulators Joint Forum CAP guidelines are far from adequate.
There is, in general, a need for much greater transparency in pension fund investment, particularly investment outside of exchange-traded public companies and government and corporate bonds.
Ontario’s Pension Benefit Guarantee Fund provides valuable protection to plan members in bankruptcy situations. The PBGF benefit limits have not been increased since the Fund’s inception. If only to reflect the impact of inflation, the limits should be substantially increased, and indexed going forward. This will necessitate a corresponding increase in contribution rates.
The Discussion Paper notes the push from some employer groups to abolish partial wind ups, citing the Quebec example. Quebec is not a suitable comparator, since it has (amongst many other legislative differences) immediate vesting and no grow-in provisions, two of the key elements that give value to the partial wind up in Ontario. It is important to preserve our grow-in provisions, which have proven a valuable mitigating factor for people in Ontario facing shutdowns or major lay-offs.
Partial wind up requirements recognize that pension plan members are affected in the same way as members in a full wind up, whether or not every plan member is terminated. Partial wind ups provide the regulator with flexibility, and prevent an employer from keeping a plan active simply to avoid windup responsibilities. Partial wind up provisions in the PBA should stay in place.
Pension Plan Governance
Currently, most pension plans are administered by boards of trustees. In multi-employer plans, the trustees are either all union appointees or a mix of union and management representatives. Plan member representation on boards helps ensure that the interests of plan members as a whole are the central concern of the boards. This is reflected in the special status accorded in the PBA to multi-employer plans with a minimum of 50% member representation on their boards.
In single-employer plans, trustees are typically company managers, who may have difficulty reconciling their roles as employer with their trust obligations to plan members. Actuarial consultants, who have a key role (recognized in the law) in the funding regime of plans, typically consider themselves to be responsible not to plan members, but to the employer/plan sponsor who hires them. They have strongly resisted any proposals that would explicitly place on plan actuaries any fiduciary responsibility to plan members. The common situation in collective bargaining is for the actuary of the pension plan to sit on the employer’s side of the bargaining table and act as confidential advisor to the employer, while also acting as the certifying actuary for the plan. This is unacceptable.
One possible response would be to require plan member and retiree representation on the pension board of trustees (the Quebec model) for all single employer plans, and to place a fiduciary duty to plan members on all agents of the board (explicitly including plan actuaries). If broader representation is to be mandated, it will be important to deal explicitly with training requirements and liability protection for trustees.
Another, more expensive, option is to require an independent “certifying” actuary to perform the statutorily-required valuations.
As we have said above, it is important the plan’s funding policy be public, and that it be approved by plan members or their union.
Another key element in pension governance is the regulator. Currently, the Superintendent of Financial Services has regulatory responsibilities under the PBA. In addition, the Superintendent and the Financial Services Commission have regulatory responsibilities in other areas, including insurance and mortgage brokers. Decisions of the Superintendent can be appealed to the Ontario Financial Services Tribunal (FST), a part-time board with members appointed for their expertise in the regulated areas. FST decisions can be appealed to the Courts.
While FSCO is the largest pension regulator in Canada, it is also required to supervise the largest pension jurisdiction in the country. Since it (as the predecessor Pension Commission of Ontario (PCO) was told by the Courts in the Dominion Stores decision that it has a fiduciary duty to pension plan members, it has exhibited greater willingness to stand up to employers and act on behalf of plan members – most notably in the Monsanto case in which it held its principled position all the way to the Supreme Court of Canada in the face of a highly-organized employer campaign. The regulator has, however, not always been willing to challenge employers. It is important that the regulator have the resources to support plan members in the face of well-financed employer campaigns and legal actions.
The 1998 replacement of the PCO by FSCO and the FST created a couple of problems. The fact that the FST had to deal with cases other than pension cases has been seen as diluting its expertise in the pension area (as members have to be drawn from other areas such as insurance or mortgages), a situation noted by the Supreme Court in its Monsanto decision. More important, the demise of the PCO left a gap in the policy development area. Neither the Superintendent nor the FST has a mandate to do anything beyond adjudicating disputes arising from the current legislation.
Arguably, one of the reasons we have seen no significant change in pension legislation for many years is that no one has the mandate to study pension issues, do or commission research, bring together the various parties and propose reforms.
A re-constituted Pension Commission, with institutional representation from management and labour and some resources, could perform such an ongoing policy role, as well as filling the adjudicative function currently performed by the FST. It would also be sensible to remove the non-pension roles of the FST or the new body.
In closing, we would like to once more thank the Expert Commission for the opportunity to present our views, and look forward to participating in the future discussions on improving our pension system.
Respectfully Submitted
Dave Ritchie
General Vice President
International Association of Machinists and Aerospace Workers
