Pension plan failures involve consequences that may be both dire and diffuse. Retirees, who depend to a considerable extent on their occupational pensions, are likely to experience an immediate decline in their standard of living with little possibility of finding new jobs to recoup their position. Active plan members confront not only the future loss of their promised pension benefits, but also — because plan failure generally coincides with the insolvency of the sponsor —the immediate loss of their job and the wages and non-pension benefits on which they and their families depend. Local communities in which workers and retirees live — especially “one industry” towns — may suffer a serious economic and social crisis. Governments may have to support retirees who become eligible for needs-related assistance programs as a result of losing their occupational pensions. And taxpayers may not only have to fund those programs but make up shortfalls in tax revenue caused by the fact that retirees pay less taxes on their depleted or discontinued pensions.
Given these sometimes dramatic consequences of plan failures, it seems clear to me that the first priority should be to anticipate and forestall them whenever possible. Of course, notwithstanding prophylactic measures, some plan failures will inevitably occur because the sponsoring employer becomes insolvent. A second priority should therefore be to ensure that a pension plan, its active members and its beneficiaries are dealt with fairly in the context of the sponsor’s insolvency proceedings. However, even if they are, serious financial distress will still befall individuals who did not cause the problem and could neither anticipate it, nor insure themselves against it nor recover from it. Mitigation of their distress and of its social consequences should therefore be a third priority for pension law and policy.
6.2 Enhanced Vigilance
There is an unavoidable interplay between the funding health of the plan and the financial health of the plan sponsor. In effect, plans fail when the sponsor fails.
That is why pension legislation requires not only that sponsors pre-fund their plans at levels adequate to meet their liabilities, but that plan assets be legally segregated and unavailable to sponsors or their creditors. Of course, absolute security against plan failure — “full funding all the time,” favoured by some unions and workers at our hearings — comes at a cost. If the cost is too high, sponsors may be unable or unwilling to continue to support the plan and their creditors may force them to close the plan before insolvency, or may siphon off monies owing to it afterward.
This balance between absolute security and the costs of achieving it is perceived differently by single-employer pension plan (SEPP) participants on the one hand, and multi-employer pension plan (MEPP) and jointly sponsored pension plan (JSPP) participants on the other. Indeed, the balance is often struck at the inception of a SEPP when the choice is made between flat or career average benefit plans on the one hand, and final average benefit plans on the other. The former seem to fail more frequently than the latter and to maintain noticeably lower funded ratios, perhaps because improvements in benefits for past service are not required to be funded immediately. However, regardless of plan design, SEPP sponsors are ultimately obliged to make good all deficiencies. This obligation persists whether a plan is in difficulty but ongoing, or being wound up. In practice, though, if the sponsor is in difficulty, its creditors can almost always claim its corporate assets in priority to claims by the pension plan. In these circumstances, deficiencies are not made good, plans fail and claims are made on the Pension Benefits Guarantee Fund (PBGF).
MEPP and JSPP sponsors must meet their funding obligations as well, but if they fail to do so they have other options. In the case of JSPPs, active plan members as well as sponsors may be called on to increase their contributions in order to make good any shortfall in the funding of ongoing plans. In the case of MEPPs, benefits may be reduced if assets in an ongoing plan are inadequate to pay them. In the case of both MEPPs and JSPPs, benefits may also be reduced in the event of a deficiency when the plan is being wound up. Finally, neither MEPPs nor JSPPs pay into or are “insured” by the PBGF. These different responses of SEPPs, MEPPs and JSPPs to insolvency must not only be reflected in the law — they must be made clear to all beneficiaries from the outset of the plan.
Avoiding plan failure has been a recurring motif of this report. In Chapter Four I made recommendations concerning more accurate and transparent valuations and more stringent funding requirements in the form of a security margin, and in Chapter Nine I recommend the consolidation of small SEPPs into larger units. These recommendations should assist in improving the financial health of pension plans. In addition, recommendations in Chapter Four for enhanced monitoring and interim valuations for faltering plans, and in Chapters Seven and Eight for more effective regulation and more transparent governance, should help to expose problems while they can still be fixed, and thereby reduce the risk that plans will fail if the sponsor fails.
Whatever structural improvements can be made in the funding of plans, however, some are always likely to be in difficulty. The regulator should be poised to intervene in timely fashion.
Recommendation 6-1 — The Superintendent should have the power to establish benchmarks that identify plans “at risk of failure;” to order additional valuations and reports by such plans, if the benchmarks are met; and to require such valuations and reports to be conducted or reviewed by independent auditors and actuaries, or by auditors, actuaries or other staff of the pension regulator, at the cost of the sponsor.
To complement my other recommendations, I now recommend two changes that will encourage the parties to seek, and will empower the regulator to approve, consensual arrangements designed to restore the stability of plans and prevent failures. Such arrangements are not presently contemplated by Ontario’s Pension Benefits Act (PBA), a fact that has prompted ad hoc legislative intervention in previous, high-profile situations. It would be better to confront the possible need to reset the plan, or to implement other sensible compromises, with strict oversight by the Superintendent, so that solutions are available for small and large plans, and so that experience can inform the development of new regulations or practices, if they are needed.
Recommendation 6-2 — The Superintendent should have the power to (a) approve arrangements to reset the funding obligations of single-employer plans at risk of failure, including contributions, payment schedules, amortization periods and premiums to be paid to the Pension Benefits Guarantee Fund, and (b) authorize the provision of additional forms of security, to ensure that the plan does not fail and/or that the interests of plan members are better protected in the event that failure does occur. The Superintendent may exercise this power notwithstanding the provisions of plan documents.
Arrangements submitted to the Superintendent for approval must be agreed to by the plan sponsor and by a union or other organization authorized to represent active plan members and retirees. In the absence of a union or other authorized organization, the arrangements must be approved by a two-thirds majority of active and retired plan members voting by secret ballot. In the event that the arrangements affect Pension Benefits Guarantee Fund premiums or coverage, the administrator of that Fund must also approve.
Recommendation 6-3 — The Superintendent should have the power to initiate, facilitate and approve arrangements relating to all aspects of multi-employer plans at risk of failure or of significant benefit reduction. The Superintendent may exercise this power notwithstanding the provisions of plan documents.
Arrangements submitted to the Superintendent for approval must be agreed to by the plan sponsors and by a union or other organization authorized to represent active plan members and retirees. In the absence of a union or other authorized organization, the arrangements must be approved by a two-thirds majority of active and retired plan members voting by secret ballot.
During the Commission’s hearings, several submissions made the point that some plans were placed at risk — or enhanced risk — because sponsors and unions agreed to initiate benefit improvements at a time when funding was inadequate to support such improvements. Often these improvements tilt the balance of funding toward those who have negotiated them, sometimes to the detriment of retirees and, not infrequently, with extreme prejudice to the plan itself. I seriously considered recommending that benefit improvements under such circumstances should be forbidden. However, I have become convinced that there are circumstances under which such improvements can be justified, and that a total ban may be too draconian a step. Consequently, I am making two more modest recommendations:
Recommendation 6-4 — When a pension plan has been identified as “at risk,” the Superintendent should have power to approve the arrangements identified in Recommendations 6-2 and 6-3, conditional upon the suspension or cancellation of any agreement to improve plan benefits, and/or a prohibition on plan benefit improvements, until funding is restored to a specified level.
Recommendation 6-5 — When a plan fails and is being wound up, payments attributable to benefit improvements initiated up to five years prior to the date of the wind-up should be paid only after all pre-existing benefits are paid in full.
Further, plan administrators have the right under the PBA to sue to recover unpaid contributions. If they decline to do so, the Superintendent has the power “to require an administrator … to take any action … in respect of a pension plan” — presumably including litigation. The Superintendent also has the power to prosecute “every director, officer, official or agent” of a sponsor corporation for contravening the PBA, and to ask the court upon conviction not only to impose a sizeable fine, but to “assess the amount not submitted or not paid” and to order that person to pay the unpaid contributions to the pension fund. In addition, I recommend in Chapter Seven that both the Superintendent and the new Pension Tribunal of Ontario (PTO) should be provided with plenary powers to remedy all violations of the PBA and the regulations. Thus, it should now be possible to put into operation the principle of graduated regulatory responses outlined in Chapter One.
However, effective regulation depends not simply on having powers, but also on using them and being seen to do so. At the moment, the Superintendent relies heavily on informal strategies to deal with delinquent sponsors that have failed to pay their contributions, relatively rarely on prosecution, and seldom on other legal enforcement strategies. While this informal approach does achieve the desired results in most cases, it has two shortcomings. First, those who have violated the PBA and, in some cases, imperilled a pension plan, end up simply doing what they ought to have done in the first place — at no additional cost to themselves, except, perhaps, having to pay interest on overdue remittances. Second, informal disposition does not generate a demonstration effect that might deter other potential wrongdoers. While I certainly do not favour the gratuitous use of remedial or punitive powers, I do think that the regulator ought to adopt a more comprehensive and proactive approach to compliance. The integrity of individual plans, and of the system as a whole, depends if not on total compliance, then as near to it as practicable.
Recommendation 6-6 — The regulator should create an office of compliance to deal with the failure of sponsors to remit contributions and other violations of the Pension Benefits Act that imperil the security of pension plans and impede regulatory oversight of the pension system. That office should also maintain, for its own purposes and for the benefit of interested parties, an on-line register of delinquent sponsors and other offenders, and the measures taken to deal with them.
None of the recommendations in this section deals directly with a situation where the sponsor of a SEPP is insolvent or bankrupt. Such situations must, of course, be dealt with under federal bankruptcy and insolvency statutes, which, however, do not apply to pension plans per se. In the next section of this chapter, I address the interface between these federal statutes and provincial pension law.
6.3 Fair Treatment of Pension Plans and Beneficiaries in the Event of Sponsor Bankruptcy or Insolvency
As I indicated in Chapter One, an important principle shaping this report is the desirability of better coordination among public policies that affect the pension system. The disjuncture between provincial pension law and federal bankruptcy and insolvency law is a prime example of the need for improved coordination.
6.3.2 The protection of pension funds under federal insolvency legislation
Under the federal Companies’ Creditors Arrangement Act (CCAA), companies with debts greater than $5 million are permitted to seek court protection — in effect, a temporary suspension of their obligation to pay their debts — pending approval of a restructuring plan by creditors and/or the supervising court. Restructuring typically involves permanent forgiveness by creditors of some or all of the debt. Arrears of pension plan contributions are treated like any other debt. But while future accruals may be dealt with in the CCAA process, the reduction of accrued benefits may not. That said, active plan members may be willing to surrender some of their rights in order to retain their jobs and keep the company afloat and the plan in force.
If the CCAA process succeeds, the corporation’s debt is restructured; it is discharged from court protection; and it remains a going concern. In these circumstances, it will pay its pension contribution arrears according to regulatory requirements and its other debts under whatever terms are agreed upon or ordered. Moreover, its obligation to pay future contributions will be revived on the original basis, unless the plan has been cancelled by the sponsor, or a reduction in its future terms has been consented to by the active and retired members (usually under pressure) or ordered by the court.
If a company does not qualify for CCAA proceedings, or if those proceedings do not result in successful restructuring, the federal Bankruptcy and Insolvency Act (BIA) comes into play. The BIA also permits restructuring, but if this fails, the insolvent firm is wound up and its assets are distributed among its creditors. Secured creditors must be paid in full before unsecured creditors are eligible to receive payment. If insufficient funds are available to pay them in full, unsecured creditors are paid on a pro rata basis. Crucially, debts owed to a pension fund have up to now been classed as unsecured and therefore, as a practical matter, have often been unrecoverable. However, the new federal Wage Earner Protection Program Act — recently proclaimed in force — will accord pension funds a degree of protection somewhat more consistent with their importance under provincial legislation. Under this new legislation, the “normal cost” of plans — that is, arrears of current contributions as defined by federal regulations — is to be accorded priority over other claims under the BIA, although unfunded liabilities and solvency deficiencies are not.
While it improves the position of pension plans, their active members and retirees, this legislation does not fully respond to arguments made by some in favour of giving higher preference to pension claims in bankruptcy and insolvency proceedings.
The extent to which pension plans and their active and retired members ought to be protected against the consequences of sponsor insolvency is a matter of considerable debate. On the one hand, while employees trade current wages for the promise of future pension income, they may not understand that this arrangement entails the risk that the sponsor may become insolvent or bankrupt. On the other, employees in given circumstances may indeed understand the risk but tacitly or explicitly accept it in order to keep the sponsor in business and avoid cancellation of the plan. Moreover, giving pension liabilities a higher priority in restructuring and insolvency proceedings would likely create private market pressures for better funding of pension plans. While no bad thing in itself, however, this pressure might have a detrimental effect on the employer’s ability to raise capital, stay in business, provide jobs and fund the pension plan; indeed, it might result in lenders and investors more aggressively resisting the establishment or maintenance of pension plans, even if insolvency is not immediately a prospect.
The debate raises complex issues, most of which, however, must ultimately be resolved by federal, not provincial, legislators.
Recommendation 6-7 — The government of Ontario should support recent federal legislation that gives priority to unpaid current pension service costs in the event of bankruptcy. It should also initiate discussions with the federal government concerning the possibility of extending similar priority to all special payments to fund both solvency deficiencies and unfunded liabilities owing to the plan by the sponsor at the time of insolvency.
The recent federal legislation also provides that in the event an arrangement involving the priority claims of a pension plan is reached with the insolvent’s creditors, any change in the priority for current service costs will be approved by a court only if the Superintendent has approved the arrangement.
Recommendation 6-8 — The Pension Benefits Act should be amended to permit the Superintendent to approve arrangements and changes in arrangements that involve the claims of pension plans under federal bankruptcy legislation.
One submission to the Commission from a law firm that represents active and retired plan members proposed that Ontario could take steps under provincial law to treat all unpaid contributions as subject to a trust in favour of the plan and its beneficiaries. Indeed, the PBA deems current contributions to be held in trust for the fund, and subjects the sponsor’s assets to a lien and charge in favour of the plan administrator until payment is actually made. In principle, these provisions — or some revised version of them — might be construed as excluding those assets from the sponsor’s estate and making them unavailable to other creditors in insolvency proceedings. However, provisions of the BIA appear to nullify or take precedence over the PBA provisions. Quite apart from the merits, unless and until this apparent constitutional impasse is resolved, it would be futile for me to recommend further changes to the PBA that are designed to create trusts or liens to withdraw unpaid contributions from the sponsor’s estate, and to provide pension plans with enhanced protection in the event of bankruptcy or insolvency. While I am therefore not prepared to make a formal recommendation concerning this issue, I do urge that this question be studied by the province’s law officers.
Finally, even though the province cannot alter the priorities established by federal law among creditors of the insolvent sponsor’s estate, there is no reason why it cannot determine how a depleted pension plan apportions losses among its active and retired members. Current PBA regulations require pro rata distribution of the assets of the pension fund in these circumstances. For example, if a plan is 75% funded, then all active members and retirees receive 75% of their promised benefit, whatever it might be. However, it may be that different priorities would encourage more vigilant behaviour on the part of those who are in a position to detect or forestall the sponsor’s insolvency, or to protect groups that are particularly vulnerable. For example, in the United Kingdom, retirees’ claims are given priority over those of active members, perhaps on the ground that the latter were in a position to negotiate plan changes that may have affected the funded ratio. Plans might also be allowed to establish priorities specific to their own circumstances, although there is a risk that this might disadvantage retirees and others excluded from plan governance. Or, a third approach: recent benefit improvements could be excluded from payment in the event the plan has to be wound up while in deficiency, as they are under the PBGF. This latter approach was supported in several submissions to the Commission, and seems sensible to me.
Recommendation 6-9 — Plan assets should be distributed on a pro rata basis. However, benefit improvements introduced within the last five years should be postponed until after other benefits are paid, inaccordance with Recommendation 6-5, above.
6.3.3 The representation of pension interests in federal bankruptcy and insolvency proceedings
What priority ought to be given pension funds in the event of the sponsor’s insolvency or bankruptcy raises some difficult issues of public policy; whether the interests of pension funds and those of their beneficiaries should be entitled to effective representation in insolvency or bankruptcy proceedings does not. Clearly, as a matter of basic justice, all interested parties ought to have the right to be heard in any contentious proceedings. However, that right does not now clearly exist, and will not exist until certain modest changes have been made to federal bankruptcy legislation.
The task of protecting pension rights and interests might be assigned to the pension regulator; to the pension fund itself, acting through its administrator; or to the plan beneficiaries acting individually or collectively. However, the status of all three in bankruptcy and insolvency proceedings is unclear.
The pension regulator — the Superintendent — is arguably best placed to defend the interests of the pension fund against the other creditors of an insolvent sponsor. The Superintendent knows, or should know, more about the fund’s claims than anyone else except the administrator, who is often compromised as being the alter ego of the sponsor responsible for deficiencies. The Superintendent also knows more about pension law and the pension system than any other potential litigant, and in defending the fund would be defending the system as well. The Superintendent’s authoritative participation on behalf of the plan may reduce or eliminate the possibility that other parties — active and retired members and their representative organizations — will have to intervene on its behalf. And finally, the Superintendent has — or will have, if my recommendations are accepted — the legal and other resources necessary to negotiate and, if needs be, litigate on behalf of the fund. However, only when the Superintendent is subrogated to the rights of a sponsor whose plan members will be compensated by the PBGF, or when concessions under the regulatory regime are sought, does the Superintendent presently have an unchallenged right to appear in insolvency and bankruptcy proceedings.
Recommendation 6-10 — The Ontario government should seek to persuade the federal government to amend its bankruptcy and insolvency legislation to give the pension regulator the right to intervene in proceedings under that legislation to defend the interests of any pension fund and its members. Provincial law should allow the pension regulator to act on behalf of, and to assert all the rights and powers of, the plan administrator in the context of bankruptcy and insolvency proceedings, if the regulator believes such action is warranted.
If these changes in federal legislation can be negotiated, the pension regulator’s role in proactively defending both pension plans and the PBGF would be reinforced. However, in order to take on these enlarged responsibilities in insolvency-related proceedings, the regulator would have to develop new capacities — the subject of recommendations elsewhere in this report — and to deploy staff dedicated to dealing with potential and actual sponsor insolvencies.
To avoid imposing excessive burdens on the regulator, it would therefore be preferable if plan administrators were able and willing to conduct such litigation on their own behalf. However, there are two potential obstacles to their doing so. The first is the problem of resources. The costs of litigation may be insupportable, especially for small funds already facing financial difficulties because of the sponsor’s failure. The second, already referenced, is that many SEPPs are self-administered. When the sponsor is placed in receivership, or taken over by a trustee in bankruptcy, the receiver or trustee steps into the sponsor’s shoes and becomes administrator of the pension plan as well. This creates an obvious conflict of interest in that, unlike other creditors, the pension plan does not stand at arm’s length from the receiver or trustee whose responsibility is to the insolvent’s estate as a whole.
The Superintendent presently has power to appoint or replace plan administrators in the limited circumstances of a plan being wound up. That power should be extended to ensure that the plan is being administered by someone other than the trustee or receiver of an insolvent sponsor.
Recommendation 6-11 — The regulator should be specifically empowered to replace the administrator of a plan whose sponsor is involved, or is deemed at risk of being involved, in bankruptcy or insolvency proceedings. The Ontario government should ask the federal government to amend the relevant legislation to ensure that the new administrator so appointed can participate in all proceedings on behalf of the plan.
While some individual beneficiaries and organizations representing them have been allowed to appear in proceedings under the BIA or the CCAA, their right to do so is not explicitly guaranteed by the relevant legislation. However, these individuals and groups are profoundly affected by the outcome of such proceedings and they clearly should have the right to participate — individually or collectively — in order to defend their (sometimes conflicting) rights and interests. Moreover, their participation in proceedings may have the desirable side effect of ensuring that the fate of the pension plan is given more serious consideration in negotiations among creditors leading up to the approval of a restructuring proposal.
Of course, participation without legal representation is likely to be futile, and legal representation will be too expensive for almost all individuals and for many groups. At present, the cost of representing active and retired plan members is sometimes borne by unions, and sometimes by individual employees and retirees who pool their modest funds to engage counsel. However, other adversely affected individuals are often effectively barred from participation for lack of funds. A conventional response to this situation is to permit successful litigants to be awarded costs out of a fund if their intervention has led to its successful defence or enhancement. This seems like a sensible, if partial, solution to the problem.
Broadening the range and increasing the number of participants in insolvency proceedings creates a risk that such proceedings will become unduly protracted. Again, there are conventional responses to this problem: a court may make a representation order so that all those with a common interest are represented by the same counsel, or a class of litigants may apply to be certified in order to pursue a remedy in common. These approaches ought to be considered in any reforms that the federal government might choose to pursue.
Recommendation 6-12 — The Ontario government should explore with the federal government the amendment of relevant federal legislation so as to ensure that pension plans, beneficiaries and organizations representing them can participate as of right in bankruptcy and insolvency proceedings. It should also explore ways to facilitate the collective participation of pension litigants in such proceedings by means of representation orders or otherwise. And it should amend the Pension Benefits Act so as to enable courts to order pension plans to reimburse beneficiaries and representative organizations for successfully defending the interests of the plan.
6.4 Mitigating the Effects of Plan Failure: The Pension Benefits Guarantee Fund
During the Commission’s hearings, worker representatives and scores of individual workers appeared to attest to their painful experiences with plan failures. Because plan failure is almost always the result of sponsor failure, the consequences are compounded for SEPP members. Not only are workers’ future pension prospects entangled with the fate of a single plan sponsor; so, too, are their current and future prospects for wages and non-pension benefits. So, too, are the pensions of retirees who have depended on the now-insolvent sponsor not only for a monthly pension cheque, but often for extended health care and drug coverage. So, too, are the prospects for whole communities in which that same sponsor has been a major taxpayer, employer, purchaser of goods and services and civic benefactor.
There are therefore strong moral and political pressures on governments to adopt measures to mitigate the effects of plan failure. In Ontario, these pressures resulted in the creation of the PBGF in 1980. The PBGF ensures that in the event of plan failure, retirees will receive compensation sufficient to bring their pension benefits (subject to some exclusions) up to a maximum of $1,000 per month. The PBGF is funded by a levy on plan sponsors based on a per capita premium of $1 per year plus a risk premium that varies according to the level at which the plan is funded — the higher the level of funding, the lower this portion of the premium — to an annual maximum of $4 million. The PBGF benefit formula has not changed since its inception in 1980, while the premium rates were last revised in 1992.
Not all plans are covered by the PBGF. Plans that have been in existence for fewer than three years are ineligible. Plans established under collective agreements that fix employer contributions at an agreed sum are not covered. Plans in the core public service, and to some extent in the broader public sector, are exempt, presumably on the grounds that they are unlikely to fail or, seen in another light, are backstopped by their sponsor’s assets — and ultimately by Ontario’s taxpayers. MEPPs and JSPPs are not covered, presumably because they are designed so that deficiencies on winding up are dealt with by adjusting benefits downward. And finally, under ill-advised regulations adopted in 1992 to assist Ontario’s major private sector employers, plans deemed “too big to fail” were permitted to elect to be relieved of solvency funding requirements in exchange for paying additional PBGF premiums to a maximum of $5 million per plan (instead of the standard premium maximum of $4 million). Of the relatively small number of plans for which such an election occurred, most have, in fact, come close to failure, sometimes with significant adverse consequences for the PBGF. No new elections are permitted, and properly so.
6.4.2 The case for and against the Pension Benefits Guarantee Fund
The PBGF has been the subject of considerable criticism. One common allegation is that knowing that the benefits are protected by the PBGF, hard-pressed sponsors may be tempted to under-fund their plans, and unions to acquiesce in the risks associated with under-funding, so that money otherwise earmarked for pension contributions can be diverted to business investments or to improving other aspects of the compensation package. The PBGF, in this analysis, creates what is called a “moral hazard” — an inducement to engage in overly risky behaviour because the normal risks associated with that behaviour are mitigated. Some support for this position is found in a study undertaken for the Commission by Norma Nielson, who found that Ontario plans are funded at a lower level — $17,037 per capita less — than plans in other provinces that do not have guarantee funds, although she stops short of demonstrating a causal relationship between the PBGF and lower funding levels.
It must be said that if, indeed, the PBGF represents a moral hazard, it is a rather inefficient one in the sense that it has tempted relatively few employers or unions — at least to the point where they ran risks that led to failure. In fact, for the first 20 or so years of its existence, the PBGF dealt on average with about three plan failures per year. And in almost every case, the problem has not been simply under-funding of the plan, but the failure of the sponsor’s business — in part, perhaps, because Ontario’s funding rules are relatively rigorous, and in part because the PBGF disallows payment of benefit improvements that were agreed to up to three years prior to failure. However, plan failures since 2003 have become much more frequent, especially in the province’s declining steel and auto sectors.
Second, some sponsors have complained that their well-funded plans were obliged to pay PBGF premiums that effectively subsidized employers — including their competitors — by allowing them to continue their plans at lower cost. While there is some justice in this complaint, PBGF premiums are already partially risk-rated so that sponsors that under-fund their plans must to some extent pay for the privilege of doing so. More sophisticated risk-rating would seem to be the proper response to this concern so long as the PBGF remains in force.
Third, for some the PBGF represents a “belt and suspenders” approach to the risks of plan failure — a redundant form of protection. Workers, they note, are shielded twice from the full impact of the failure of an under-funded plan — once by the PBGF, and a second time by the broader Canadian social security systems comprising the Old Age Security (OAS) payment (which includes the Guaranteed Income Supplement, or GIS), the Canada/Quebec Pension Plan (C/QPP) and the Ontario Guaranteed Annual Income Supplement (GAINS). Seen in this light, one of the biggest beneficiaries of the existence of the PBGF may be the OAS/GIS and GAINS programs, which are spared the obligation of supporting beneficiaries who have lost their pensions but have been compensated by the PBGF.
Finally, comparisons with guarantee funds in other jurisdictions may shed some light on the question of whether Ontario’s PBGF should continue. No other Canadian jurisdiction has such a fund. The United Kingdom and the United States do, but the latter’s guarantee fund in particular is in considerable difficulty. Germany, Sweden, Switzerland and Japan also have guarantee funds of varying designs — but all operate pension systems with fundamentally different funding rules. And Finland and the Netherlands, among other European countries, operate successful workplace pension systems without a guarantee fund at all but with very stringent funding requirements. These examples suggest that the existence and the design of a guarantee fund both depend heavily on plan funding requirements. The more rigorous the requirements, the less need there is for a guarantee fund. If that is the lesson to be learned from comparative analysis, I would have to confess that I detected no enthusiasm among Ontario sponsors for replacing the PBGF with a requirement for significantly enhanced funding security and the increased costs they would have to incur to provide it.
Likewise, if the claims of pension funds enjoyed full and pre-emptive priority under federal bankruptcy and insolvency laws, there would be less need for the PBGF. But again I detected no enthusiasm for such an approach (which, in any event, would have to be adopted by the federal government, not Ontario).
For sponsors, then, the PBGF can be seen as a relatively low-cost response to the potential risks of plan failure. Indeed, FSCO data shows that 98% of all plans pay annual PBGF premiums lower than $100,000 per year; that no plans are affected by the normal premium cap of $4 million; and that only two plans are affected by the special contribution cap of $5 million imposed by the 1992 “too big to fail” regulation. For 96% of all defined benefit (DB) plan sponsors, PBGF premiums represent less than 5% of the annual solvency cost of the plan.
On the other hand, active members, retirees and unions criticized the PBGF from quite a different perspective. The problem, in their view, was that the PBGF fails to provide adequate protection for workers. As they correctly note, to simply honour the spirit of the 1980 legislative determination that retirees in failed plans should be eligible for PBGF coverage up to $1,000 of pension benefits per month, the eligibility limit would have to be raised to about $2,500 per month in today’s dollars. They favoured raising contribution levels and, if necessary, the contribution cap.
Some of those who favoured raising benefit limits under the PBGF also favoured — or at least did not disfavour — supporting the Fund with government subsidies, if required, to ensure adequate levels of protection. If, as suggested earlier, the greatest beneficiaries of the PBGF have been government support programs for seniors, this position may have something to recommend it. However, it is hard to make the case that the loss of privately provided pensions should be compensated at public expense when holders of life and casualty insurance policies, bank deposits and trust company investment certificates must look to an industry-sponsored fund. It is equally difficult to argue that the majority of taxpayers who have no occupational pension coverage at all should subsidize the minority who do.
In fact, the exact relationship of the government to the PBGF is somewhat ambiguous. When it was confronted in 2001 with potentially devastating claims as a result of the insolvency of Algoma Steel and the possible failure of Algoma’s pension plan, the government made a loan of $330 million to the PBGF to keep it solvent. While that loan is being slowly paid down, it is not clear that the government could or would stand behind the PBGF in the event that aggregate claims were to significantly exceed its assets in the future. Indeed, if the government did not come to the rescue, it is difficult to see how such a situation would be resolved under the law as it presently stands. The PBA does not specify how the PBGF should deal with its own impending insolvency. Should it pay all pending claims on a pro rata basis? Or pay those who were first in the queue? Or impose a special emergency levy on all plans to restore its solvency?
These questions may turn out to be moot. After all, putting aside three very large plan failures (which among them accounted for almost 70% of all claims to date), the PBGF has pretty much managed to pay its way during its first 30 years. On the other hand, we should be wary of extrapolating from past experience. Both the volume and value of claims has accelerated sharply over the past five years, during which 89% of all PBGF payouts have been made. At the very least, if the PBGF continues for now — as recommended below — clear provision must be made to deal with a possible “shipwreck” scenario.
Recommendation 6-13 — The Pension Benefits Guarantee Fund should be continued in its present form, but with the improvements proposed in Recommendations 6-14 to 6-17 for at least five years or until completion of the review proposed in Recommendation 6-18, whichever is later. On the basis of the findings of that review, the government should determine whether to continue, amend, replace or discontinue the PBGF.
6.4.3 Improving the Pension Benefits Guarantee Fund
The Organisation for Economic and Co-operative Development (OECD) has promulgated principles for the guidance of those responsible for pension guarantee funds:
- Benefit coverage should be limited so that potential beneficiaries share some of the risk.
- Pricing or levies should be risk-based.
- The guarantee fund should have in place accurate and consistent funding rules and should operate under prudent asset–liability management.
- The system must have adequate powers to avoid moral hazard.
I believe that adherence to these principles would assist Ontario in achieving an economically efficient
and financially viable guarantee system.
Who should be responsible for ensuring that these principles are adhered to? There is some logic to integrating the PBGF’s management with that of FSCO, as at present. For example, risk assessment may be useful for both insurance and for regulatory intervention; the avoidance of moral hazard — if it exists — potentially gives rise to both insurance and regulatory implications. However, it is somewhat anomalous to vest both regulatory and insurance functions in a single official or agency, especially given that there is no evidence that the Superintendent has been consciously promoting synergy between them. On balance, I believe that a different approach to management of the PBGF should be tried.
The guarantee funds in the United States and the United Kingdom operate at arm’s length from the pension regulator — a model that would enable the PBGF administrator to assume the enlarged responsibilities recommended below. However, given that the regulator and the PBGF must operate within a common regulatory framework, it is important that their efforts be coordinated and mutually reinforcing. In the United Kingdom this coordination is achieved by mandating the Pension Regulator to protect the Pension Protection Fund, an approach that has much to recommend it. Its corollary, the obligation of the PBGF to contribute to effective regulation, should likewise be acknowledged.
Recommendation 6-14 — The Pension Benefits Guarantee Fund should be administered, preferably at arm’s length from the pension regulator, by an agency with a mandate to:
- manage the Fund so as to enhance its capacity to evaluate the individual and collective risks of plans whose performance is guaranteed by the Fund;
- fix levies, subject to the approval of the Minister, in amounts sufficient to meet claims arising from those risks;
- collect such levies and hold and invest them on behalf of the Fund; and
- undertake systemic analysis to assist the regulator in reducing the number and aggregate value of claims on the Fund.
The regulator’s mandate should be extended to include protection of the Pension Benefits Guarantee Fund, and the mandate of the Fund should include specific reference to its obligation to assist the regulator.
In Recommendation 6-5, I proposed that payment of unfunded benefits agreed within five years prior to the sponsor’s insolvency be postponed until all other benefits under the plan are satisfied. To be consistent with this recommendation, and in response to admonitions about the need to avoid moral hazards, I believe that payment of benefits out of the PBGF should be subject to a similar disqualification.
Recommendation 6-15 — Benefit improvements agreed to within five years prior to the failure of a plan should be ineligible for payment out of the Pension Benefits Guarantee Fund.
The OECD recommends that PBGF levies should be risk-based. This reflects present practice, to some extent. However, I believe that risk assessment can be made much more sophisticated than it now is. For example, in the United Kingdom, the risk assessment on which levies are calculated includes an evaluation of the sponsor’s viability, as well as that of the pension plan itself. Given the close causal connection between the two, this seems highly appropriate.
Recommendation 6-16 — The risk assessment protocol by which levies are established for the Pension Benefits Guarantee Fund should be studied and revised to include not only the funding status of plans but other risk-generating factors such as the asset/liability match within the plan and the sponsor’s financial health.
Despite — or because of — my recommendations to reinforce the administration and funding of the PBGF, I believe that a strong case has been made for restoring the level of guarantees originally provided by the PBGF to their equivalent in current dollars. At present, they are much lower than those provided by counterpart guarantee funds in the United Kingdom and the United States. However, benefits cannot be increased without a full appreciation of the cost of doing so, of how that cost should be distributed among plans covered by the PBGF, and of the effects of an increase on other aspects of the pension system.
Recommendation 6-17 — The level of monthly pension benefits eligible for protection by the Pension Benefits Guarantee Fund should be increased to a maximum of $2,500 to reflect the effect of inflation on the original maximum of $1,000.
The Superintendent (or other agency responsible for the administration of the Pension Benefits Guarantee Fund) should recommend to the Minister of Finance within one year:
- the formula by which benefit levels should be determined on a going-forward basis;
- the basis on which the levy paid by sponsors should be calculated;
- procedures for ensuring that both the benefits and the levy are adjusted at regular intervals; and
- any other matter relevant to the implementation of this recommendation.
The recommendations should be accompanied by a statement concerning the anticipated effects of any such adjustment. The Minister should act promptly upon receipt of these recommendations and the accompanying statement.
Armed with this report, and acting on the advice of the Minister, the Lieutenant Governor in Council will be able to put in place appropriate measures to ensure that active plan members and retirees receive a fair level of benefit protection, approximating that provided by the original statute, and that the levy needed to sustain that protection will be calculated in an objective manner.
Finally, I do not contemplate that MEPPs and JSPPs — plans presently excluded from PBGF coverage — should be included, nor should the proposed JGTBPPs .
6.4.4 The long-term future of the Pension Benefits Guarantee Fund and its relationship to the government
As noted above, the PBGF is somewhat anomalous in that no government agency provides similar guarantees in the pension sector of any Canadian jurisdiction. Functional counterparts do exist in other risk-based elements of the financial sector in Canada, though they are administered either through an arm’s-length Crown corporation (Canada Deposit Insurance Corporation, for bank deposits and trust company investment certificates) or an industry-run not-for-profit organization (Assuris and PACICC for life and casualty insurance companies, respectively). As well, pension sponsors in several European countries have established self-insurance schemes that provide guarantees comparable to those offered in Ontario by the PBGF. Acknowledging that conditions in other financial sectors and in other countries’ pension systems may differ from those of Ontario, it would nonetheless be sensible for Ontario to carefully investigate alternatives to the PBGF.
Recommendation 6-18 — The Ministry of Finance or some other agency, either alone or in cooperation with other Canadian pension authorities, should initiate a study of possible alternatives to the Pension Benefits Guarantee Fund. Unless and until such an alternative that provides comparable or better protection for active plan members and retirees can be identified, the Pension Benefits Guarantee Fund should continue to exist in the form proposed in Recommendations 6-14 to 6-17.
Given that the PBGF is likely to be with us for some time, it is important that the principles on which
it is based should be clearly articulated, preferably in legislation.
Recommendation 6-19 — The Pension Benefits Guarantee Fund should be governed by the following principles:
- The Fund should be self-financing.
- It should not receive government grants or subsidies in order to meet its obligations.
- It should be allowed to borrow funds from the government on a commercial basis, for defined purposes and at defined times.
- The terms on which the Fund itself should be deemed insolvent, and the effects of such insolvency, should be clearly set out in the Pension Benefits Act.
Even if the principles governing the PBGF are embedded in legislation, future governments will likely be unwilling or unable to resist pressures to buffer workers and retirees from the consequences of the failure of a major pension plan. As noted, those consequences are extremely serious, not only for individuals, but for communities, and not only for pension funds, but for government welfare programs that will ultimately be called upon to provide the income lost by retirees in the event of such a failure. However, when and if the government feels it must intervene, it ought to do so outside the framework of the PBGF, which, after all, is based on insurance principles. This may be done by way of grants to the sponsor, the Fund or the local community; it may be done in the context of the restructuring of the sponsor; or it may be done through some adjustment in the eligibility criteria of government income support schemes. But it is inappropriate, in my view, for government to make ad hoc decisions that will affect the solvency of an insurance fund that was carefully built up through a process of sophisticated risk-assessment and paid for by sponsors who have every reason to expect that in the normal course, their contributions will be adequate to the task at hand.
As noted elsewhere, the changes I propose will take some time to implement. Some, especially in matters relating to bankruptcy and insolvency, ultimately depend on the federal government. Others require more extensive study than I could provide. Still others must be postponed to allow sponsors time to rearrange their affairs. However, some changes can be introduced more promptly, particularly those that relate to the powers of the regulator. Since these are mainly designed to promote the first of the three strategies proposed earlier in this chapter — enhanced vigilance and more proactive intervention by the regulator to detect and forestall plan failures — I am optimistic that such measures will produce relatively early improvements in the status quo.
Finally, it is important to place the changes recommended in this chapter in the context of those that precede and follow it. The emphasis in this chapter is on dealing with plans in, or on the verge of, extreme crisis. Understandably, therefore, its recommendations are designed to enhance protection for active plan members and retirees. In Chapters Four and Five, by contrast, the emphasis is on making pensions affordable and on facilitating the corporate transactions that are characteristic of a rapidly changing economy while improving protections for the rights and expectations of pension beneficiaries. In Chapters Seven and Eight, the emphasis shifts to improving the machinery of regulation and governance, which are of such vital concern not only to pension stakeholders, but to the community as a whole.
Hence the need for this reminder to readers: to focus on any one chapter or recommendation in isolation from all the others is to run the risk of missing the point that, taken together, they strike a fair balance between the interests of sponsors and those of active plan members and retirees, between security and affordability, and between effective regulation and respect for the capacity of the pension community to manage its own affairs. Striking a balance comes at a price, however. It requires that widely held understandings about what the pension system is and how it works be re-examined, that some long-established institutions and familiar ways of doing things be replaced by new ones, and that passionate convictions about how best to move Ontario’s pension system forward be modified to accommodate similarly passionate — but opposing — convictions.