The game of pension musical chairs

In light of the uncertainty of defined benefit plans under funding, members of these plans must ask themselves if there will be enough money in their pension to pay the benefit they were promised for the rest of their life.

By deciding to remain in a defined benefit plan, are these individuals playing pension musical chairs where the last person in the plan will not get a pension benefit seat at all? Perhaps in the coming years, many defined benefit plan members will take their money out and run.

As the population ages, unsustainable benefits promises are emerging as the main source of retirement insecurity in most industrial countries.

When the baby boom generation retires in big numbers, starting in 2010, Canada could see combined pension and healthcare costs exceed 25 per cent of total gross domestic product by 2030. This may not be maintainable or sustainable.

Canadian companies and employees have seen pension assets plummet from $614 billion at the end of 2000 to $541.6 billion in 2002. According to Statistics Canada, two-thirds of pension plans in Canada are in the red. This shortfall has been sparked by the collapse of the dotcom bubble, the stock market decline and accounting fraud. Over the last three years, stock markets have declined a staggering US$8 trillion. The rich who play the markets aren’t the only losers. Public and private pension funds are the largest institutional investors in the stock market.

Pension funds grew during the stock market boom of the ’90s to the point where many became over funded. As a result, many companies did not have to make large contributions to plans and could afford generous benefit increases to retirees.

The market meltdown has drastically changed the equation for many pension funds. The problem started when the investments in these plans failed to generate enough income to meet projected future obligations. When that happens, companies have to start making additional contributions to the funds, money that many do not have in the current economic climate. The largest under funded pension plans in Canada are at Nortel Networks Ltd., Alcan Inc., CIBC and Bombardier Inc.

What if there's not enough money to go around?

Pensions, once thought of as charity, are now an essential part of the social responsibility of employers. In a defined benefit pension plan, the employer has promised members of its plan a pension. If a defined benefit plan is under funded and can’t meet its obligations to pay out promised benefits, retirees will get first claim on the assets of the plan. Next to get paid are employees eligible for pensions. The remaining money is divided among the rest. While most members of a defined benefit plan aren’t aware that they might not get the benefits promised by employers, that risk does exist.

Limited protection

Ontario is the only province that has created a fund, called the Pension Benefits Guarantee Fund (PBGF), that offers limited protection for the more than one million defined benefit pension plan members within its borders. If defined benefit plans in Ontario have insufficient funds or are wound-up, the province will guarantee the first $1,000 per month of pension benefit.

The fund was created in 1980 and has an estimated $200 million available to pay new claims. The fund’s assets are invested in fixed income products such as treasury bills and bonds. The funds within the PBGF are raised by fees charged to registered pensions in Ontario and current revenue from its fees stand at about $30 million per year and payouts have been in the neighbourhood of $10 million. Defined benefit pension plan members should be concerned about situations like the Algoma Steel pension that is under funded by $500 million. It is quite possible that a situation like Algoma Steel could claim the entire fund set aside by the province.

Peter Merrick is a certified financial planner. He can be contacted at (416) 677-6611, [email protected] or

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