IN ITS FIRST BUDGET, THE NEWLY-ELECTED HARPER government made an announcement that it would make the solvency funding rules for federally regulated defined benefit (DB)plans more flexible. For plan sponsors, this is a welcome reprieve. For plan beneficiaries, the rules are fair and balanced. For regulators, they could serve as a catalyst for pension reform.
As long-term interest rates have drifted ever lower, the value of pension liabilities has grown higher. This “squeeze” has led, in part, to significant solvency liabilities for DB plans. In the past, federal funding rules required plan sponsors to fund this liability over five years. But that led many sponsors to conclude that this funding regime could affect the very sustainability of their DB plans. As a result, plan sponsors sought funding relief.
An easy response for the federal government would have been to extend the amortization period for the funding of a solvency deficiency. While this would have given some relief to plan sponsors, it would have done so in an unbalanced way.
That is because employees and pension plan beneficiaries are turned into involuntary lenders if employers are given the unilateral right to decide to extend the amortization period for the funding of a solvency deficiency. The reason is liabilities are paid over a longer time period and members are exposed to a greater risk of loss. Members then become creditors of the plan sponsor. Unlike other creditors, the consent of members is not sought when an amortization period can be extended by the unilateral action of the sponsor.
SOLVENCY PERIOD EXTENDED
This provision is empowering to plan members as it allows them to play a role in the decision to extend the amortization period. In addition, the proposed rules provide members with a form of security with regards to the difference between the value of payments that would have been made over five years and the payments now made over 10 years. This difference between payments is subject to the deemed trust provisions of the federal pensions act. It grants a level of comfort to plan members and beneficiaries over the payments that would otherwise have been made to fund the solvency liability.
The new federal funding rules create a balance. Plan sponsors get the ability to have a longer period to fund a deficiency, but they can only do so with the consent and involvement of plan members. In this way, members do not become involuntary creditors. In order to ensure informed consent, consideration should be given to requiring the fund to pay for expert advice for plan members.
The 10-year funding option is not the only option granted to plan sponsors under the proposed federal rules. Plan sponsors could choose to consolidate past solvency payments over a new five-year period. Another alternative allows the sponsor to extend the solvency period to 10 years so long as the difference between the five and 10-year required payments is secured by a letter of credit.
In order to work, pension regulation needs to allow the parties to the pension promise to work out their own solutions. The proposed federal rules are a good example of a fair and flexible system that should be followed by other pension regulators.
Hugh O’Reilly is a partner with Cavalluzzo, Hayes, Shilton, McIntyre and Cornish in Toronto. firstname.lastname@example.org