This is the scenario that solvency funding rules were designed for, and any deficit relief proposals on the table today need to carefully contemplate all their outcomes in order to protect plan members. So far, solutions to address solvency relief are implicitly “one-size-fits-all” and largely focus on lowering cash contributions through a simple extension of solvency deficit run-off periods. In many jurisdictions, this relief is contingent on plan members agreeing to the relief, or on securing a letter of credit for a portion of the deficit.
But if an employer needs cash contribution relief to avoid bankruptcy, then clearly the bankruptcy risk to that employer is real. Why then relax the rules that were designed to protect employees caught in this very situation when they’re needed most?
If recent solvency relief proposals are intended to avoid forcing insolvencies over a contribution spike in defined benefit (DB) plans, then employers should be able to actually utilize some sort of relief. Unfortunately, unsecured deficit relief is not in the best interests of plan beneficiaries, and requiring member consent will result in relief being inaccessible for most companies.
It is clear that given the economic and asset market volatility of the new millennium that more complex and robust solutions are needed to balance and protect the needs of the many stakeholders in a DB plan.
Permanent or Temporary solution?
In today’s complex business environment, with corporate emphasis on risk management, the current temporary DB plan solvency relief measures are largely ineffective. First, they are too simplistic, as they either assume or perhaps hope that all companies will survive in the longer term. Second, they actually mitigate against effective risk management. How do you include the pension plan within an enterprise risk management model when the rules change during a crisis? Do you assume a bailout, temporary relief, or no help at all?
Relief measures are invoked as a temporary solution to an extreme crisis. Yet, if solvency relief is deemed a good thing, why is it only reserved for times of widespread ruin (i.e., a North American economic slow down or a global crisis)? For some companies, their point of ruin may have been reached before economists actually declare a recession. A permanent solution, on the other hand, may help a company survive before a crisis hits, thus enabling them to deliver on their DB promises.
What we need is a solution that can deal with both normal times and crises, made permanent so everybody knows the rules and options well in advance. If temporary relief measures are either inaccessible for many companies or ineffective in protecting member rights, then what’s the point of having them?
In the meantime, if even a single employer could be helped to avoid bankruptcy resulting from contribution requirements to the pension plan, isn’t it worth it to spend some time on a different and more permanent solution? This lets DB plan sponsors make the pension plan a more prominent component of overall enterprise risk management.
With the economic prospects for 2009 unclear and many “experts” predicting more doom and gloom, a permanent solution that is fair to all stakeholders should be put in place immediately as a matter of public policy. Two financial crises this decade are a warning to plan sponsors that market cycles of the future could have shorter periods, of say five years, or that the current market turmoil is more deeply rooted than originally thought. Either way, the result could be tougher economic times in the longer run. We need a more robust funding framework.
Time for a New Framework
Canada’s business climate is far too complex for a simple one-size-fits-all solution. While no solution will be perfect, an overarching framework for strengthening the rules that includes the following may be a starting point towards a more permanent solution.
1. Fiduciary responsibility. Employers with DB plans have a strong fiduciary responsibility to plan beneficiaries, and this needs to be enforced. Actions to stem the flow of red ink cannot be taken at the expense of plan members or their benefits.
2. Contribution holidays & surplus ownership. Restrict employer contribution holidays to fully funded plans similar to that proposed by the Ontario Expert Commission on Pensions (OECP). Also, fix the surplus ownership issue similar to the proposal from Alberta and British Columbia via the Joint Expert Panel on Pension Standards (ABC ECP). This will help to promote stronger funding of pension plans, beyond just the minimum required.
3. Incentives to contribute more. Entice companies who have a strong cash flow or unencumbered assets to top up or “assign” pension fund assets, through tax incentives (how about an additional 10% tax credit against declared profits related to employer contributions in excess of minimum requirements?) or through allowing other balance sheet assets to be legally assigned to the pension plan for purposes of solvency funding (and wind up).
On the other side of the coin, there could be a tax charge on free assets held by the company, up to the amount of the plan’s solvency shortfall, to encourage sponsors to apply those assets to the deficit.
4. Financial strength tests (credit rating). Adopt a standard and simplified method to assess or rate the financial strength of a company that includes corporate auditor sign off. Credit ratings would be used to classify a company’s short-term risk of bankruptcy as low, medium, or high. The accounting profession could help outline an efficient and cost effective process.
The net effect of current solvency relief measures for defined benefit pension plans facing funding deficits largely defeats the purpose of solvency funding, and casts aside the rules at the moment of greatest need. If a company is financially strong and survives long-term, or if equity markets recover, then that’s no big deal. But what about the company that faces failure in the short-term, or if equity markets continue to fall?