Defined benefit plans running $160-billion shortfall: study

Accountants call for clarification of surplus ownership, new standards to encourage firms to inject more cash into DB plans

Nearly 60 per cent of all defined benefit pension plans in Canada are now running deficits that will require $160 billion to cover the total shortfall, according to a new study by the Certified General Accountants Association of Canada (CGA-Canada).

The study of 847 defined benefit plans points to a looming social and economic crisis for Canada’s defined benefits pension plan holders and plan sponsors if the situation is not addressed. The study warns that pensioners may have their benefits sharply reduced, and that inadequately funded pension plans may go bankrupt. Shortfalls will also negatively impact corporate financial results and share prices, CGA-Canada said.

“The Canadian pension landscape is changing,” said Anthony Ariganello, president and CEO of CGA-Canada. “Where previously many large and well-established employers provided generous pension plans and employees fully expected to receive their benefits as a matter of course, we are now faced with a fluid and shifting environment.”

The study, supported by data and research provided by Mercer Human Resource Consulting, estimates that Canadian firms would need to make special payments totalling $15 billion a year for five years to make up the current deficits on a solvency basis. That would equal 10 per cent of each company’s payroll in each of the next five years — a significant drain on a company’s cash resources.

The study said that, in the short-term, it’s unrealistic to expect stock market returns alone to correct the situation. Considering that the long term best estimate of future market returns for a balanced pension fund is about 6.5 per cent, it would be overly optimistic to look to investment returns alone to cover the shortfall, CGA-Canada said.

Accounting standards also a concern

The study also noted that accounting standards are a source of concern. The use of an “expected rate of return” and smoothing mechanisms allow for the recognition of pension plan gains immediately, with shortfalls booked over time. This can distort the true picture of a pension fund’s performance by keeping losses off the balance sheet in the short term.

The study notes that such amortization of gains and losses, and amortization of past service costs, can cloud a plan’s actual performance and recommends another look at pension-related accounting standards in Canada.

Who owns pension plan surpluses?

The study also references issues related to the ownership of pension plan surpluses. While ownership may be defined in law in some jurisdictions, there are also ambiguities in some situations.

Thus, legal disputes have arisen between plan sponsors and plan members about who owns a plan’s assets. Historically, it has been thought that ownership of surpluses should lie with plan members, while deficits are seen as a sponsor’s responsibility.

Until this ownership is resolved in a fair and equitable fashion for all stakeholders, it may be difficult for plan sponsors to contribute significant dollars toward correcting the situation.

How to improve pension plan management

The report makes several recommendations to improve pension plan management:

•Workplace pension arrangements should be fully communicated as should the roles, responsibilities, and obligations of the various participants involved in the management of pension plans.

•Accounting standard-setting bodies should be encouraged to analyze and report back on alternative reporting standards which reflect modern economic principles based on fair value.

•Pension fund administrators should be required to better justify investment mix and how anticipated risk is measured and managed.

•Regulators should continue to explore the alignment of national and provincial jurisdictional provisions.

•Regulators should address pension surplus entitlement. Within the current landscape, surplus distribution is not seen as fair, equitable, and reflective. An opportunity exists to establish time-weighted formulas which take into account the contribution values of members and sponsors.

•Sponsors and bargaining units should revisit early retirement schemes adopted under circumstances which were substantially different from current-day realities.

“The pension situation in Canada presents an opportunity for meaningful reform,” said Ariganello. “If we are to assure sustainability and confidence, it will be necessary to bring about change that produces greater clarity, certainty, and credibility.”

CGA-Canada represents 62,000 CGAs and students in Canada, Bermuda, the Caribbean, Hong Kong, and China. The association sets standards, develops and maintains education programs, publishes professional materials, advocates on public policy issues, and represents CGAs nationally and internationally.

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