Market turmoil spells solvency deficiency
The stock market is taking a beating and that spells bad news for employers when it comes to pensions. As the value of investments sink, many defined benefit (DB) pension plans are in deficit positions — and some employers may have to pump significant cash into them to keep them afloat, unless regulators step in to provide relief.
“For every single plan sponsor, the assets are down,” said Laura Samaroo, Vancouver-based retirement practice leader for Western Canada at Watson Wyatt Worldwide.
Telecom giant BCE, for example, said in its third-quarter report it may have to pay much more into its pension plans next year if the downturn in the capital markets continues to the end of 2008.
The biggest challenge is the valuation process, as the funding rules for DB plans, though varying slightly by province, generally use two approaches: A going-concern valuation, which takes a long-term view of funding requirements, and a solvency valuation, which assumes a plan is wound up on the date of valuation. And on a solvency basis, the current interest rate to value liability is quite low, said Samaroo.
“That’s what’s causing all the controversy because the solvency position is going to be very bad for anyone having to do a valuation at the end of this year.”
Any solvency deficiencies must be amortized over five years, so unless there is a change or a relaxation of the rules, “pension plans that have valuations due this year should expect to have a very big increase to their contribution requirements,” she said.
Finance Minister Jim Flaherty said his department is looking at options for federal rule changes, including extending the time period over which companies would need to put in more money.
“What has been done before obviously can be done again,” he said.
This could mean a repeat of steps taken in 2006 for federally regulated DB plans. On one level, sponsors could amortize solvency deficiency over five years, so if they were in the middle of paying off a deficit and still had three years left, they could start at zero and take five years, said Samaroo. The second level allowed plan sponsors to amortize the deficiency over 10 years instead of five, as long as they had a certain level of approval among members. And thirdly, without that approval, plan sponsors could receive a letter of credit to amortize the deficiency over 10 years instead of five.
However, the situation is different this time because of the credit crunch, so letters of credit, which are now allowed in Alberta and British Columbia instead of solvency contributions, are not easily attainable and quite expensive compared to a few years ago, said Samaroo. But regulators might allow for a longer amortization period without requiring member approval. (At Canadian HR Reporter’s press time, it wasn’t clear what — if any — steps regulators might take. Check www.hrreporter.com for updates.)
“Really, I strongly believe that although the solvency rules are there to protect plan members, the best protection for members is to have a financially stable plan sponsor,” she said. “And given the extent of the funding requirements that will arise if there is no relief and given the current economic environment, it would be a good thing to have temporary relief, and regulators will see that.”
The best solution is to backstop the letters of credit, said Jim Murta, immediate past president of the Canadian Institute of Actuaries, which hopes the short-term pension problems will be addressed at the First Ministers’ meeting in November.
“We’re looking for something that the provinces and the federal government could all do and the problem is each of the provinces has different legislation and it always takes all kinds of time to do that,” he said.
The federal government is stepping up to help or backstop other financial institutions and a pension plan is similar to a financial institution, so a similar approach makes sense.
“What we’re trying to do is something with a fairly broad application that could be looked at quickly in an emergency context and would be primarily directed to those that were having serious difficulties,” said Murta. “A lot of them won’t be able to get letters of credit. Those really only were available if the company was in pretty good shape to begin with. And if they have any deterioration, there’s no way they’re going to get them, so you really need the government to step in.”
Amortizing over 10 years should require regulators to be fairly selective and look at each situation on a case-by-case basis to protect the interests of the members, he said.
“Some of the organizations would like to pay things over 10 years because that would increase profits, others would like to pay over 10 years because they really don’t have any money or the extra expense would really push them further towards bankruptcy. But if something’s on the edge, moving toward bankruptcy, the fact they can pay over five or 10 years may not mean a whole lot to things, yet may mean a whole lot as far as pensioners are concerned because they just don’t have the funds going in,” he said. “I’m not sure (companies like) CN or CP or some of those need a huge amount of help — they’re pretty carefully managed operations.”
Another option to consider is changing the bankruptcy rules to give the deficiency payments on pension plans the same priority as wages, said Murta.
Not all agree
However, pensions will be further in jeopardy if the government suspends obligations to fund deficits, according to CARP. The Toronto-based seniors group has called for better protection for pensioners by requiring pension surpluses in good economic times be set aside in contingency funds to be used to fund deficits in bad times. Instead, pension surpluses have been used for contribution holidays, leaving the funds vulnerable in market downturns, said CARP.
“This is the opposite of what pensioners have demanded. Now their pensions are even more at risk,” said Susan Eng, vice-president, advocacy, at CARP.
The group is also calling on Flaherty to place a two-year moratorium on mandated withdrawals from registered retirement income funds (RRIFs) so people are not forced to sell stocks in a severely depressed market. Current tax rules require people to withdraw fixed amounts from their RRIFs after reaching age 71 and many must sell their stocks to fund the tax payable on such withdrawals, said CARP.
The group is right in identifying the problem when a pension plan goes down, as older pensioners have no way to recover the loss, said Murta, and it’s a situation not well-protected in Canada, unlike the United States.
“I’ve got a lot of sympathy for some of CARP’s position on things,” he said. “(The government) had mandated withdrawals because they wanted to make sure people didn’t leave money there and the federal government would get tax off the money they give them tax deferral on. Some of that mandated stuff needs to be looked at again. If people are living longer, I don’t think it works.”
“For every single plan sponsor, the assets are down,” said Laura Samaroo, Vancouver-based retirement practice leader for Western Canada at Watson Wyatt Worldwide.
Telecom giant BCE, for example, said in its third-quarter report it may have to pay much more into its pension plans next year if the downturn in the capital markets continues to the end of 2008.
The biggest challenge is the valuation process, as the funding rules for DB plans, though varying slightly by province, generally use two approaches: A going-concern valuation, which takes a long-term view of funding requirements, and a solvency valuation, which assumes a plan is wound up on the date of valuation. And on a solvency basis, the current interest rate to value liability is quite low, said Samaroo.
“That’s what’s causing all the controversy because the solvency position is going to be very bad for anyone having to do a valuation at the end of this year.”
Any solvency deficiencies must be amortized over five years, so unless there is a change or a relaxation of the rules, “pension plans that have valuations due this year should expect to have a very big increase to their contribution requirements,” she said.
Finance Minister Jim Flaherty said his department is looking at options for federal rule changes, including extending the time period over which companies would need to put in more money.
“What has been done before obviously can be done again,” he said.
This could mean a repeat of steps taken in 2006 for federally regulated DB plans. On one level, sponsors could amortize solvency deficiency over five years, so if they were in the middle of paying off a deficit and still had three years left, they could start at zero and take five years, said Samaroo. The second level allowed plan sponsors to amortize the deficiency over 10 years instead of five, as long as they had a certain level of approval among members. And thirdly, without that approval, plan sponsors could receive a letter of credit to amortize the deficiency over 10 years instead of five.
However, the situation is different this time because of the credit crunch, so letters of credit, which are now allowed in Alberta and British Columbia instead of solvency contributions, are not easily attainable and quite expensive compared to a few years ago, said Samaroo. But regulators might allow for a longer amortization period without requiring member approval. (At Canadian HR Reporter’s press time, it wasn’t clear what — if any — steps regulators might take. Check www.hrreporter.com for updates.)
“Really, I strongly believe that although the solvency rules are there to protect plan members, the best protection for members is to have a financially stable plan sponsor,” she said. “And given the extent of the funding requirements that will arise if there is no relief and given the current economic environment, it would be a good thing to have temporary relief, and regulators will see that.”
The best solution is to backstop the letters of credit, said Jim Murta, immediate past president of the Canadian Institute of Actuaries, which hopes the short-term pension problems will be addressed at the First Ministers’ meeting in November.
“We’re looking for something that the provinces and the federal government could all do and the problem is each of the provinces has different legislation and it always takes all kinds of time to do that,” he said.
The federal government is stepping up to help or backstop other financial institutions and a pension plan is similar to a financial institution, so a similar approach makes sense.
“What we’re trying to do is something with a fairly broad application that could be looked at quickly in an emergency context and would be primarily directed to those that were having serious difficulties,” said Murta. “A lot of them won’t be able to get letters of credit. Those really only were available if the company was in pretty good shape to begin with. And if they have any deterioration, there’s no way they’re going to get them, so you really need the government to step in.”
Amortizing over 10 years should require regulators to be fairly selective and look at each situation on a case-by-case basis to protect the interests of the members, he said.
“Some of the organizations would like to pay things over 10 years because that would increase profits, others would like to pay over 10 years because they really don’t have any money or the extra expense would really push them further towards bankruptcy. But if something’s on the edge, moving toward bankruptcy, the fact they can pay over five or 10 years may not mean a whole lot to things, yet may mean a whole lot as far as pensioners are concerned because they just don’t have the funds going in,” he said. “I’m not sure (companies like) CN or CP or some of those need a huge amount of help — they’re pretty carefully managed operations.”
Another option to consider is changing the bankruptcy rules to give the deficiency payments on pension plans the same priority as wages, said Murta.
Not all agree
However, pensions will be further in jeopardy if the government suspends obligations to fund deficits, according to CARP. The Toronto-based seniors group has called for better protection for pensioners by requiring pension surpluses in good economic times be set aside in contingency funds to be used to fund deficits in bad times. Instead, pension surpluses have been used for contribution holidays, leaving the funds vulnerable in market downturns, said CARP.
“This is the opposite of what pensioners have demanded. Now their pensions are even more at risk,” said Susan Eng, vice-president, advocacy, at CARP.
The group is also calling on Flaherty to place a two-year moratorium on mandated withdrawals from registered retirement income funds (RRIFs) so people are not forced to sell stocks in a severely depressed market. Current tax rules require people to withdraw fixed amounts from their RRIFs after reaching age 71 and many must sell their stocks to fund the tax payable on such withdrawals, said CARP.
The group is right in identifying the problem when a pension plan goes down, as older pensioners have no way to recover the loss, said Murta, and it’s a situation not well-protected in Canada, unlike the United States.
“I’ve got a lot of sympathy for some of CARP’s position on things,” he said. “(The government) had mandated withdrawals because they wanted to make sure people didn’t leave money there and the federal government would get tax off the money they give them tax deferral on. Some of that mandated stuff needs to be looked at again. If people are living longer, I don’t think it works.”
