A CONSULTATION PAPER
Ministry of Finance
July 18, 2001
TABLE OF CONTENTS
- INTRODUCTION
Background
Goals of Surplus Reform - SURPLUS DISTRIBUTION ON PLAN WIND UP
Full Plan Wind Up
Partial Plan Wind Up - SURPLUS IN CONTINUING PLANS
Surplus Withdrawals (i.e. Other than on Wind Up)
Contribution Holidays - RELATED ISSUES
Consent for Withdrawals
Dispute Resolution
Mandatory Surplus Distribution on Full Wind up
Surplus Attribution to Employer/Member Contributions - SUMMARY OF PROPOSALS
- GLOSSARY
SURPLUS DISTRIBUTION FROM DEFINED BENEFIT PENSION PLANS
I INTRODUCTION
On December 21, 2000, the Minister of Finance announced that he would consult with stakeholders on possible amendments to the surplus distribution rules in the Pension Benefits Act (PBA) and Regulation 909 under that Act (the Regulation). At the same time, Cabinet extended section 8 of the Regulation (the Surplus Regulation) under the PBA for a further year to December 31, 2001 to maintain the existing surplus withdrawal provisions until the consultation is completed.
Recent court decisions have limited the ability of the pension regulator, the Financial Services Commission of Ontario (FSCO) (formerly the Pension Commission of Ontario or PCO) to approve surplus applications by employers on wind up where the Surplus Regulation has been satisfied by the agreement of two-thirds of plan beneficiaries. The Government does not believe that it is feasible or appropriate to continue to extend the existing Regulation as has been done in the past. In addition, section 10 of the Regulation renders surplus withdrawals from many continuing plans impractical and may encourage plan wind ups. These provisions should be replaced with an improved surplus distribution regime in the PBA.
Entitlement to pension surplus has historically been a difficult and complex issue. Some suggest that, as employers generally bear the risk of defined benefit pension plans becoming underfunded and must make special payments in that event, they alone should be entitled to the benefit of any surplus. Thus, it has been argued that plan members are entitled to receive only the benefits provided under plan documents.
Others see contributions to pension plans as deferred compensation, paid as a consequence of actual or implied employment contract negotiations that would otherwise have been paid in another form. Pension funds are often seen by the courts as "trusts", held solely for the benefit of plan members and former members rather than pre-funding mechanisms for benefit security, required by statute. Still others suggest that pension issues are much more complex than suggested by these positions, and surplus entitlement depends very much on the particular circumstances of the case.
Prior to the enactment of the Surplus Regulation, entitlement to pension surplus was determined mainly by the courts in numerous, high profile "winner take all" legal actions. Most of the affected parties found this process costly, lengthy and acrimonious. In the 1990s, subsequent to the enactment of the Surplus Regulation, negotiated surplus sharing agreements between employers, plan members and former members reduced disputes over surplus distribution. While some employers and employees disagreed with a number of specific details of the surplus distribution rules, there appears to have been general acceptance that negotiated surplus sharing agreements were an improvement over the previous regime.
Indeed, since the introduction of the Surplus Regulation, several other Canadian jurisdictions, including the federal government, have legislated surplus sharing regimes as an alternative to (or in place of) proving entitlements under pension plan documents. FSCO has experienced a significant increase in the number of surplus applications compared to the period before the Surplus Regulation was enacted.
However, the existing surplus distribution provisions lack clarity and are in some ways impractical. In addition, a lack of certainty with respect to surplus entitlement may encourage minimum funding by plan sponsors. The Government proposes to amend the PBA so that surplus distribution can be carried out in a fair, equitable and predictable manner. The proposals in this discussion paper are designed to balance the interests of the affected parties and address a number of concerns about the current surplus regime. They would amend the PBA with respect to winding up and continuing plans, in particular to provide legal certainty.
The discussion set out in this paper provides a possible direction for reform. The Government is interested in the views of stakeholders and will carefully consider all submissions before deciding on a course of action. Several questions have been included to facilitate the Consultation and to solicit submissions from interested stakeholders in the pension community.
Interested parties are invited to make written submissions by September 14, 2001 to: John R. O'Toole, MPP Please note, all submissions received are subject to the access and privacy provisions of the Freedom of Information and Protection of Privacy Act. Additional copies of this Consultation Paper may be obtained from Ontario Government Bookstore, 880 Bay Street, Toronto, Ontario, M7A 1N8. As well, this Consultation Paper is available on the Ministry of Finance website at www.fin.gov.on.ca/ |
Background
When introduced in 1991, the Surplus Regulation was intended as a temporary measure to regulate surplus withdrawals from defined benefit pension plans pending the development of a more permanent resolution of the issue. It was renewed in 1994, 1997, 1998 and, most recently, in 2000.
In 1991, some industry observers contended that where plan documents clearly entitled the employer to surplus on wind up, the Surplus Regulation operated to require the sharing of surplus which belonged to the employer, with plan beneficiaries. They noted that no similar provision required surplus to be shared with an employer where the plan documents stated that surplus must be used for the benefit of plan beneficiaries. They also suggested that the surplus rules in the PBA and the Surplus Regulation were inconsistent.
In administering the PBA and the Surplus Regulation, the PCO (the predecessor to FSCO) adopted the practice of reviewing plan documents in a less stringent manner with respect to technical entitlement if a high level of member and former member consent to a surplus sharing agreement was present. In practice, the withdrawal process often led employees who were entitled to surplus by the pension plan documents to agree to surplus sharing.
The recent decision of the Ontario Divisional Court in Kent et al v. Tecsyn (the Tecsyn decision), released on May 26, 2000, concluded that employers may only withdraw surplus from pension plans in circumstances where both the withdrawal is expressly provided for in the plan documents and the requisite consent of plan members and former members is obtained. Since many plans do not contain text clearly entitling employers to withdraw surplus, the Tecsyn decision is likely to prevent both surplus withdrawals by employers and surplus sharing arrangements.
Further impetus to this consultation has arisen in the area of partial wind ups. In the case of Monsanto v. Superintendent of Financial Services, the Superintendent of Financial Services required surplus to be distributed on a partial wind up. This decision was upheld by the Ontario Divisional Court. An application for leave to appeal Monsanto has been granted by the Ontario Court of Appeal.
Surplus distribution from continuing plans has always presented problems given that surplus is notional until wind up. As a result, the current Regulation has set difficult requirements for withdrawals from continuing plans, but in so doing may have encouraged plan wind ups.
Despite problems with the current surplus regime and divergent views on surplus entitlement, surplus sharing has proved an effective way to enable employer sponsors and pension plan beneficiaries to negotiate agreements.
Goals of Surplus Reform
- Fairly balance the interests of employer sponsors, plan members and former
members in surplus and the withdrawal process.
- Facilitate surplus distribution while safeguarding the security of pension benefits.
- Avoid lengthy, expensive win/lose litigation regarding surplus entitlement.
- Provide more certainty in the surplus distribution process and outcomes for
employer sponsors, plan members and former members.
- Resolve inconsistencies and problems between the PBA and Regulation, and
between the PBA and court decisions.
- Encourage the creation and maintenance of defined benefit employment pension
plans.
- Facilitate negotiations between employers and employees.
II SURPLUS DISTRIBUTION ON PLAN WIND UP
Full Plan Wind Up (Plan Termination)
Subsection 79(3)(b) of the PBA currently permits employers to withdraw surplus on wind up where "the pension plan provides for payment of surplus to the employer on the wind up of the pension plan". Subsection 8(1)(b) of the Regulation states that surplus may be withdrawn by the employer only with the agreement of the collective bargaining agent or, if there is no bargaining agent, at least two-thirds of the members and such proportion of the former members of the plan as the Superintendent of Financial Services (Superintendent) considers appropriate in the circumstances.
It is not possible for employees to initiate the withdrawal process, making surplus withdrawals impossible in the absence of employer involvement. However, the PBA contains a number of restrictions on the withdrawal of surplus by employers. These restrictions do not apply to the use of surplus for cash payments to plan members alone.
Proposal
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Benefits
- Promotes surplus sharing in place of win/lose court cases.
- Rectifies apparent inconsistencies between the Act and the Regulation.
- Provides certainty in the process regardless of plan language.
Questions
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Partial Plan Wind Up
The PBA and Regulation currently do not make a distinction between the distribution of surplus on partial wind up or full wind up. While the surplus share on a partial wind up can be determined based on the proportionate share of actuarial liabilities of the affected members compared to the remaining members, surplus itself is arguably not "crystallized" until the final wind up of a pension plan. As a result, there is concern regarding its distribution prior to full wind up since members who remain in the pension plan after the wind up might be adversely affected. On the other hand, the entitlement to surplus of the employer and members affected in a partial wind up should also be protected.
Proposal
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Benefits
- Introduces clarity for surplus use/ distribution on partial plan wind up in the PBA.
- Clarifies members' and former members' rights to surplus in future if there is no
immediate pay out.
- Acknowledges the notional nature of surplus and allows employers the flexibility to
make choices based on the size of the partial wind up group, the size of surplus and
business factors.
- Allows surplus issues to be settled for affected members at the time of a partial wind up.
Questions
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III SURPLUS IN CONTINUING PLANS
Surplus Withdrawals (i.e. Other than on Wind Up)
By requiring the unanimous consent of plan members, former members and all persons entitled to benefits under the plan, subsection 10(2) of the Regulation has made surplus withdrawals from most continuing pension plans very difficult. This provision may create an incentive, where a pension plan has a significant surplus, for employers to wind up the plan in order to enter into a surplus sharing agreement with plan members and former members. Neither plan members nor the public benefit when pension plans are wound up in such circumstances.
On the other hand, surplus in continuing plans may be temporary. Changes in financial markets can rapidly eliminate surplus. Permitting surplus withdrawals from continuing plans could increase the risk of pension plans becoming underfunded. However, it may be possible to foster the financial soundness of pension plans by limiting surplus withdrawals from continuing plans to those plans which have a significant surplus. This could be achieved by requiring plans to maintain a contingency reserve to minimize the likelihood that the plan will become underfunded in the future as a result of surplus withdrawals today.
Currently, the PBA permits only surplus in excess of the greater of two years of the employer's current service cost or 25 percent of solvency liabilities to be withdrawn, and forbids the withdrawal of surplus attributable to member contributions. Some have argued that these thresholds are too high and make surplus withdrawals from continuing plans very difficult. At the same time, the Income Tax Act (Canada)(ITA) does not permit further employer contributions to the extent surplus exceeds 10% to 20% of the plan's liabilities (the exact threshold depends on the plan's circumstances).
Further restrictions relate to types of benefits that must be provided in a surplus withdrawal from a continuing plan (subsections 10(8) through (10) of the Regulation). These provisions may have been intended to encourage certain types of benefit improvements, but it may be preferable to leave such choices to the employers and plan members involved. With changes to the approach to surplus in a continuing plan, these restrictions may be out of date. In addition, the fact that the Superintendent does not have the authority to review cash payments to members when there is no concurrent payment to the employer, may strike some as a gap in the Act or Regulation.
Proposal
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Benefits
- Balances an employer's and plan members' interests in surplus in continuing plans
while ensuring the security of benefits.
- Introduces realistic access to surplus in continuing plans for employers and
employees.
- Reduces any incentive an employer might have to wind up a pension plan in order
to withdraw surplus.
- Safeguards benefits from sudden decreases in asset values or increases in
liabilities after a surplus withdrawal.
Questions
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Contribution Holidays
Subsection 7(3) of the Regulation permits employers to use surplus to suspend or reduce contributions in respect of normal cost to a pension plan if there is no unfunded liability or solvency deficiency. Contribution holidays are therefore permitted unless expressly prohibited in plan documents.
Currently, the ITA does not permit further employer contributions to pension plans where plan assets exceed liabilities by a specified threshold (the threshold). Some pension plans, however, do not permit employers to suspend or reduce contributions in any circumstances, which could result in the registration of the plan being revoked under the ITA. If a plan is de-registered, the loss of tax-exempt status would have a very negative effect on the plan, and its members and former members.
Contribution holidays present similar problems as withdrawals of surplus from a continuing plan since the surplus remains notional. However, since the amounts are limited to current contributions, there is a lower risk that a contribution holiday could result in an unfunded liability in the near future. As a result, some would argue that there is no need for a contingency reserve when contribution holidays are made.
Proposal
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Benefits
- Clarifies the status of contribution holidays under the PBA.
Questions
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IV RELATED ISSUES
Consent for Withdrawals
The PBA Regulation currently requires two-thirds consent for withdrawals on plan wind up and 100 percent consent for withdrawals from continuing plans. Specifically, on plan wind up, subsection 8(1)(b) of the Regulation requires the consent of the collective bargaining agent or, if there is no agent, two-thirds consent of members; and such consent from former members and other persons entitled to payments under the plan as the Superintendent considers appropriate. In a continuing plan, subsections 10(2) and 10(3) require the consent of all members, all persons entitled to receive benefits under the plan, and all persons in respect of whom the administrator has purchased a pension, deferred pension or ancillary benefit (unless those persons requested the purchase).
The level of consent which is currently required for continuing plans makes surplus withdrawals difficult except for plans with a small number of members or under exceptional circumstances. This provision may be justified by the concerns associated with withdrawal of ‘notional' surplus. However, such issues could be addressed through a contingency reserve.
Many employers and plan members would prefer to avoid having a plan wind up in order to withdraw surplus simply because it is too difficult to do so from a continuing plan. The particularly high level of consent for surplus withdrawal from continuing plans has been a significant barrier to withdrawal of surplus. Since the current level of consent for surplus withdrawal on plan wind ups has been workable, if not ideal from an employer or plan member perspective, it is an obvious starting point for reform of the level of consent for surplus withdrawals from continuing plans. The two-thirds level of consent on plan wind ups has facilitated surplus sharing agreements.
Proposal
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Benefits
- Would ensure that a clear and consistent level of consent was obtained.
- Makes surplus withdrawal from a continuing plan more practical while still requiring substantial agreement between the employer sponsor, and plan members and former members.
Questions
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Dispute Resolution
Within a surplus sharing regime there is the potential for disputes to arise which prevent agreements between the plan sponsor and the members and former members. The federal surplus sharing legislative provisions provide for arbitration when the level of consent obtained is in excess of 50 percent, but lower than the two-thirds required for a straightforward approval. Quebec legislation also provides for arbitration to address disagreements between the parties if 30 percent of members object to the surplus sharing arrangement. Having such an arbitration process may be helpful, but may also be seen as interference in the ability of the parties to negotiate their own agreement.
Proposal
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Benefits
- Provides a non-court dispute resolution mechanism when an agreement is near, based on the requisite level of consent.
Questions
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Mandatory Surplus Distribution on Full Wind up
Even though the plan documents may entitle plan members to any surplus on full plan wind up, only employers currently have the procedural ability to initiate surplus distributions. In some cases, surplus distribution is delayed for years after the members and former members have received their benefit entitlement. Such delays create unnecessary uncertainty for members, and arguably for FSCO.
Proposal
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Benefits
- Will reduce the number of plan wind ups not completed and should reduce the time
for full distribution of plan assets on wind up.
- Provides an incentive for an employer to act to distribute surplus following the full
wind up of a pension plan.
- If an employer has taken no action within a reasonable period of time, this reform would give plan members entitled to surplus a process for surplus distribution.
Questions
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Surplus Attribution to Employer/Member Contributions
Subsections 25(1) and 28(5) of the Regulation currently require employers who apply to withdraw surplus to send notices to members and former members which must indicate the proportion of surplus attributable to employer and member contributions. Subsection 79(1)(e) of the PBA also requires surplus attributable to member contributions to be used in the calculation of how much surplus must remain in continuing plans after any withdrawal of surplus by an employer.
Surplus attribution for defined benefit plans is not a meaningful concept since surplus does not arise from particular contributions, but as a result of more favourable experience than assumed in prior actuarial valuations. Since most actuaries do not consider surplus attribution to plan member and employer contributions a meaningful concept, there is no accepted actuarial practice for performing this calculation. In addition, determining historical contributions for older plans may not be possible.
Similarly, subsections 79(2) and (4) of the PBA prohibit the withdrawal of any surplus accrued after 1986 for continuing plans that do not provide for the withdrawal of surplus by employers. Actuaries have indicated, however, that it is difficult if not impossible to attribute surplus to a particular time period. The changes to the PBA proposed in this paper would lead to surplus sharing agreements in most cases. These proposed reforms would largely reduce the arguable usefulness of the concept of surplus attribution.
Proposal
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Benefits
- Simplifies the surplus process and reduces actuarial costs.
- Acknowledges that the concept of surplus attribution is not meaningful.
Questions
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V SUMMARY OF PROPOSALS
Full Plan Wind Up
- Amend the PBA to allow an employer to apply to the Superintendent to withdraw
surplus if it is able to secure the requisite level of consent of plan members and
former members, even if the pension plan documents do not expressly entitle the
employer to surplus.
- If an employer is clearly entitled to surplus on the basis of plan documents, the
employer would be able to withdraw it with the approval of the Superintendent but
without the consent of members and former members.
- In either case, the employer would be required to notify plan members and former members of the intent to withdraw surplus.
Partial Plan Wind Up
- Amend the PBA to permit, but not require, an employer to withdraw a share of
surplus in proportion to the actuarial liabilities associated with the affected members
on partial wind up, if it is able to secure the requisite consent of the affected
members, even if the pension plan documents do not expressly entitle the employer
to surplus. Specific provisions requiring the distribution of surplus on partial wind up
in plan documents would not be affected.
- Amend the PBA to provide that a surplus distribution on partial wind up would extinguish the rights of the affected members to participate in any future surplus distribution. In cases where surplus is not distributed on partial wind up, affected members would have the right to consent to a future surplus distribution.
Surplus Withdrawals from Continuing Plans
- Amend the PBA to permit employers to withdraw surplus in the same manner as
permitted from plans on wind up, except that the employer would be required to
leave a contingency reserve in the pension plan. The assets retained in the plan
must be at least equal to the greater of:
- assets at market value equal to 115 percent of the plan's wind up liabilities; or
- assets on a going concern valuation basis equal to going concern actuarial
liabilities plus 200 percent of the employer's share of normal cost.
- assets at market value equal to 115 percent of the plan's wind up liabilities; or
- Remove the restrictions in section 10 of the Regulation on the types of benefits which must be provided on the withdrawal of surplus.
Contribution Holidays
- Amend the PBA to provide that contribution holidays are permitted if the plan has a surplus unless the plan documents expressly state otherwise.
Consent for Withdrawals
- Amend the PBA to require the consent of the collective bargaining agent of plan
members or, if there is no collective bargaining agent, from at least two-thirds of
plan members for all surplus withdrawals (including full wind ups, partial wind ups,
and from continuing plans).
- Also require the consent of former members of the plan (i.e. pensioners and persons entitled to a deferred pension) and other persons (i.e. spouses or other dependents) entitled to payments from the pension fund in such levels as the Superintendent considers appropriate.
Dispute Resolution
- Amend the PBA to allow an employer to bring a surplus distribution matter to arbitration when the level of consent to a surplus sharing agreement is less than the level of consent required for an agreement but greater than 50 percent of those members and former members who voted.
Mandatory Surplus Distribution on Full Wind up
- Amend the PBA to provide that, if surplus remains undistributed in a pension plan after a prescribed period of time following full wind up, the Superintendent may issue an order for the final settlement of all remaining plan assets.
Surplus Attribution to Employer/Member Contributions
- Remove all references to the concept of surplus attribution to particular contributions in the PBA and Regulation.
VI GLOSSARY
Ancillary Benefit
Ancillary benefits are prescribed benefits provided by a pension plan, such as disability benefits or early retirement benefits in excess of that required in the Act.
Contribution Holiday
A suspension or reduction of employer contributions to a pension plan permitted because surplus in the plan exceeds the employer's required contributions.
Current Service Cost
Is the actuarial present value of benefits earned in the 12-month period following the valuation date. Also known as the ‘normal cost'.
Deferred Pension
A pension determined when a member's employment or the plan terminates. It is not payable until the member's normal or early retirement date.
Defined Benefit
A defined benefit plan specifies the benefits to be paid to each member, by a formula related to the member's length of service and/or earnings. Employees may or may not contribute to the plan.
Financial Services Tribunal
An independent, adjudicative body that has exclusive jurisdiction to exercise the powers conferred under the Financial Services Commission of Ontario Act, 1997 and other Acts that confer powers on or assign duties to the Tribunal. It also has exclusive jurisdiction to determine all questions of fact or law that arise in any proceeding before it.
Former Member
A pensioner or someone entitled to a deferred pension. A former member currently receives benefits or will at some point in the future.
[Note that pension plan members who transfer the commuted value of their pensions to locked-in accounts, other pension plans or to an annuity are not ‘former members' as defined in the PBA.]
Going Concern Basis
A basis for valuing the liabilities and assets of a plan which assumes that the plan will continue (i.e. projecting salaries, contributions, investment returns, etc.) into the future.
Partial Wind Up
The wind up of a part of the plan and the distribution of the assets of the pension fund related to that part of the plan.
Plan Member
A current employee who is accruing benefits from his or her pension plan.
Plan Text
Documents that detail the specific provisions of a pension plan and bind the employer. These include trust agreements, collective agreements and the by-laws of a pension plan.
Plan Wind Up
Discontinuation of all or part of a pension plan by the employer for one of many reasons and the distribution of the assets of the pension fund. Also referred to as ‘plan termination'.
Solvency Basis
A basis for valuing liabilities or assets of a plan which assumes that the plan is wound up on the valuation date, but excludes certain benefits that would be considered on actual wind up (such as ancillary benefits).
Special Payment
Are the payments required to amortize an unfunded liability or solvency deficiency, if any, over pre-determined periods of time ranging from 5 to 15 years.
Superintendent of Financial Services
The Superintendent of Financial Services administers and enforces the Financial Services Commission of Ontario Act, 1997 and all other Acts that confer powers on or assign duties to the Superintendent. All FSCO staff report directly or indirectly to the Superintendent.
Surplus
Surplus is the excess of the assets (market value of investments plus cash balances, accrued or receivable items) of a pension plan over the plan's accrued liabilities (cost of benefits).
Wind Up Liabilities
The full liabilities (i.e. the cost of pension and ancillary benefits for all active and former members) of a plan as of the wind up date. Wind up liabilities are generally greater than solvency liabilities.