The silver lining of pension disharmony

A unique aspect of Canada’s private pension system is that the responsibility for regulatory oversight falls primarily within the provincial domain, with the federal government having jurisdiction over minimum standards for certain industries (e.g., transportation and banking).

The result is a diverse and relatively complex regulatory framework for employer-sponsored plans.

Over the years, many stakeholders have criticized this multi-jurisdictional pension system.

    • The purpose of the laws of each jurisdiction is the same: to protect the rights of pension plan members. However, there are myriad differences in the details of the various laws that make managing plans difficult for employers with operations in multiple provinces.

    • There is considerable duplication of effort by governments and their regulatory agencies in maintaining and administering the pension laws of the different jurisdictions.

Critics have called for pension uniformity as one of the key reforms to Canada’s employer-sponsored pension system. Unfortunately, there is no indication that pension standards harmonization will be achieved any time soon (if ever).

While pension standards uniformity remains a desirable goal, lack of uniformity is not entirely bad.

For example, one of the merits of a diverse pension system is that it may foster experimentation and innovation in response to regional needs and perspectives.

As the proportion of Canadian workers covered by DB pension plans declines, and the pension system continues to face unprecedented financial strain due to low interest rates and volatile financial markets, many jurisdictions have undertaken in-depth reviews of their pension legislation.

These reviews have generated a number of new approaches to mitigate the financial challenges faced by DB plan sponsors. Here are just a few examples.

In order to reduce employer contribution volatility, the federal funding rules have been changed so that the funding of solvency deficits is based on a three-year average of the pension plan’s solvency funded ratio. Also, at each valuation date, remaining solvency deficits from previous valuations are re-amortized over five years.

Alberta pension legislation was the first to permit the use of a letter of credit to secure a portion of a plan’s solvency liability. A letter of credit can help an employer manage its cash flows and can reduce the risk of trapped surplus developing in a pension plan if interest rates rise in the future. A number of other jurisdictions have followed Alberta’s lead and now permit the use of a letter of credit.

Alberta and British Columbia intend to permit the use of solvency reserve accounts. An employer that contributes to a solvency reserve account to fund a solvency deficit will be able to withdraw excess amounts from the account without following the often difficult process for surplus refunds. Excess amounts are those funds in a solvency reserve account that are no longer needed to secure the plan’s benefits. The solvency reserve account will be another tool that can be used to reduce the risk of developing trapped surplus.

A number of jurisdictions have, or are in the process of, amending their legislation to permit variations of target benefit plans. Target benefit plans can be viewed as a hybrid between traditional DB and DC plans, thereby making the risks associated with sponsoring a pension plan more manageable for employers. The pension plan defines a target defined benefit for plan members. However, employer and employee contribution rates are fixed, and accrued benefits can be reduced in the event that the fixed contributions and investment returns on plan assets prove insufficient to provide the target benefits.

An interesting variation of target benefit plan designs is New Brunswick’s new shared-risk pension plan (SRPP). Although accrued benefits of an SRPP can be reduced, stringent funding and governance rules are intended to make the need for benefit reductions highly unlikely. It will also be possible to convert past service benefits accrued in a traditional DB plan to an SRPP structure.

The pension file is a challenging one for all finance ministers to manage. As we have seen in the recent debates on Canada Pension Plan reform and the introduction of pooled registered pension plans, it is not easy to reach a national consensus on the best way forward for our retirement system.

Meanwhile, certain jurisdictions are trying new approaches to address some of the long-standing weaknesses in our minimum pension standards for DB plans. In time, their successes may pave the way for other jurisdictions to follow suit.

Regional innovation in pension standards is occurring and may be the silver lining of a system that has often been criticized as being unnecessarily diverse and complex.

While some of the new concepts being generated and implemented may prove unsuccessful, I’m optimistic that others may provide solutions to some of the fundamental challenges facing Canadian employer-sponsored pension plans.

It will be up to all key stakeholders (including governments, regulators, employers, unions and service providers) to assess which approaches work, improve on these approaches and implement the successful approaches broadly.

If we all do our part, it may still be possible through new and innovative ideas to create a strong and viable employer-sponsored pension system for the next generation of Canadian workers.