Throughout the global recession, Canada has, deservedly, garnered international praise for the relative stability of its banks and financial institutions. But there’s one Canadian institution to which nobody is extending praise: private pensions. Stated simply, the Canadian pension system is a mess. On October 27, the federal Finance Minister unveiled a set of proposed pension law reforms that it contends will clean up the mess. Here’s a look at what the government is proposing.
OVERVIEW OF THE PROPOSAL
The Reform Process:
The proposal incorporates public response to an initial reform proposal that the federal government floated in March. To effectuate the proposal, Parliament must pass a law amending the Pension Benefit Standards Act and the government must adopt regulations to implement the changes.Who It Affects:
The proposed reforms would apply only to federally regulated pensions. But they parallel and are bound to influence provincial reform measures across Canada. Reforms Proposed:
The government is proposing changes in 5 key areas:
Plan Member Protections:
Under the proposal, sponsors could no longer partially terminate plans and would have to fully fund benefits on total plan termination. Deficits existing at wind-up would have to be amortized in equal payments in 5 years or less. Contribution holidays would be allowed only for plans fully funded by a pre-set solvency margin of 5% of solvency liabilities. The void amendment ratio, i.e., solvency limit below which benefit cuts are void, would be set at 0.85 or less. Benefits would vest immediately, as opposed to under current law in which plans can make members wait up to 2 years for benefits to vest. Plans would also have to disclose more detailed information to plan members.
Minimum funding requirements for Defined Benefit (DB) plans, i.e., plans that guarantee and thus must finance a pre-determined benefit amount for members upon retirement (as opposed to Defined Contribution (DC) plans that provide a benefit based on the investment return of contributions) would be based on average, rather than current ratios, over 3 years. Plans would be able to use letters of credit to finance deficits. And the 10% surplus threshold for employer contributions under federal tax law would increase to 25%.
Workouts: The proposal would provide for workout schemes in which sponsors, current members and retirees of distressed plans could sit down at the table and negotiate special funding arrangements to keep the plan viable.
DC & Hybrid Plans: The proposal would more clearly define the responsibilities of DC sponsors and administrators. DC plans would be able to let members receive Life Income Fund style retirement payments directly from the plan fund. Changes would be made to facilitate the creation and administration of multi-employer negotiated contribution DB plans.
Pension Fund Investments: The proposal would loosen the restrictions on plan investments and give plans more investment options.
Pension laws have been in need of reform for a long time. But the financial quandary faced by DB plans has provided the immediate impetus for reform. The meltdown of the global financial markets left DB plans deficit-ridden and in need of immediate funding relief. Ottawa responded by including temporary funding relief, such as the extension of deficit amortization from 5 to 10 years, in the 2009 budget. Many provinces did likewise.
But while recession brought the problem to a head, the DB’s future has long been in question. For more than a decade, the financial burdens associated with DBs have prompted employers to move to DC and hybrid plans. Probably not coincidentally, less than a week before the Proposal, the Office of Superintendent of Financial Institutions, the federal institution that regulates pensions, announced that while the number of Canadian workers who are members of Registered Pension Plans (RPPs) has increased significantly from 1997 to 2007 (5.8 million, as compared to 5.1 million), the percentage of RPP members who belong to a DB over the same period has declined from 84% to 77%. Time will tell if the proposed reforms, assuming they’re adopted, will succeed in halting the DB’s decline.