Where are you investing your assets? What do you see as the greatest growth area?
Terri Troy: We invest in a diversified portfolio of global stocks and bonds. Over the last two years, we have expanded some of the mandates to include short-selling of equities and corporate bonds. We don’t have any exposure to real estate, private equity or hedge funds. As a minimum requirement, all mandates have to provide full transparency of holdings. I can’t go in front of the pension committee and say we’re investing in something but have no idea of what’s in the portfolio.
I am reviewing opportunities in corporate bonds and high yield debt. Many people refer to opportunities in distressed debt, but it is better classified as distressed pricing. One interesting opportunity is to invest in high yield debt and short the associated equities to help hedge the 18% spread.
Most of these opportunities may take longer than three years to realize, which is a challenge for most plans that have to file triennial valuations. For our plan, the requirement to file a solvency valuation every three years puts in place an artificial liquidity constraint, which may prevent us from investing in many of these opportunities that may take five years to realize.
Are you currently investing in alternatives?
TT: No. We’re looking at infrastructure. The Pension Investment Association of Canada is working on a pooling initiative for infrastructure investments so that participants can benefit from reduced costs. Fees are an important consideration in anything we invest in. In this type of environment, I think plan sponsors will question why they are paying high fees for alternative investments.
How does the plan compare to other plans in Nova Scotia?
NF: We have a really strong plan. The funded status as of Dec. 31, 2007 was 101% on a going-concern basis and 86% on a solvency basis. Compared with the provincial plan, we’re certainly much better funded. The province sets the rules through the Pension Benefits Act and exempts itself from them—it doesn’t have to fund for solvency. That’s one of our issues.
What is the HRM’s main challenge?
NF: Funding solvency deficits. Solvency rules do not make sense for plans such as ours that have an extremely low probability of going bankrupt. We’d also like better clarity in pension legislation.
TT: Let me give you an example. The temporary solvency relief regulation allows plans to make amendments as long as the cost is prepaid. While the regulation doesn’t define the cost as solvency or going-concern, we interpreted it to be solvency cost because the entire regulation deals with solvency liabilities. This lack of clarity has proved problematic for us recently when the pension committee wanted to provide a 2% pensioner increase and fix our maximum pension cap issue. We had the money to fully fund both amendments on a solvency-cost basis, but the Superintendent of Pensions denied them because she requires funding to be based on going-concern.
What other issues does the plan face?
NF: In general, our pensioners have not had an increase since 2001. The pension cap has not been updated to move in line with income tax limits. Contribution volatility resulting from current solvency funding rules does not make sense. We want to keep contribution levels steady.
TT: It’s hard to stabilize contribution volatility when you have to file an actuarial valuation report every three years. In Ontario, the Expert Commission on Pensions is recommending that all jointly sponsored pension plans (JSPPs) be exempt from funding solvency deficits because the governance structure associated with JSPPs means that both the employer and employee representatives make the policy decisions—for example, plan design and investment—that may ultimately result in changes to contribution levels and/or benefits. We concur with this rationale.
Is the plan experiencing any negative effects from the ongoing market volatility? If so, how have you coped? If not, how did you manage to avoid this?
TT: The assets in our plan have declined about 16% as of Oct. 31. This is consistent with what other plans experienced. When we file the next valuation report in three years’ time, the asset and liability picture will change. It is extremely difficult to manage contribution volatility over the short term when you have to theoretically assume that you will be winding up the plan every three years. Pension plans such as ours should be managed with a long-term perspective in mind.
NF: The markets are a mess, and this is affecting everybody. But I think we’re very fortunate. We have a DB plan, which has protected our members’ pensions. If our members had a defined contribution plan and were looking to retire now, they could have lost up to 40% of their money and may not be able to retire. It’s [during] times like this that you realize the importance of a DB plan.
TT: A DB plan allows you to spread investment risks over time and longevity risk over a large number of plan members. In general, the majority of pension plans, including the Canada Pension Plan, are assuming that equity markets will recover. However, this may take five years or 10 years instead of three years. It would be unfortunate to increase contribution rates and/or reduce benefits in two years if markets recover shortly thereafter. We would rather take action in five years. However, current pension funding rules will not allow for this.
Are you hopeful that the N.S. Pension Review Panel will find solid solutions to resolve key pension issues?
NF: The pension committee is disappointed with the panel’s recommendation regarding funding rules. We’d hoped for greater harmonization with other pension legislation across the country and consistency with national actuarial standards. Quite frankly, we would prefer to adhere to pension laws in B.C., Alberta, Quebec or Ontario, assuming that the Ontario government implements Harry Arthurs’ recommendations. It seems as if N.S. is headed off on a course all by itself.
TT: The majority of plan members who live in N.S. are actually regulated by pension legislation outside of N.S. That’s why there was a big push in some submissions to ask the panel to consider harmonization with other provinces. If N.S. wants to be unique, what’s going to stop the other provinces from wanting to be unique? I applaud Alberta and B.C. for demonstrating co-operation in such an important area.
If the government plans to implement the proposed significant changes to funding rules, we are concerned that there’s no transition period being proposed. In our case, contribution rates could increase from 10% to 17% in three years.
We’re also quite astonished with the proposed decrease in flexibility. In today’s world, even though you have to file an actuarial valuation once every three years, you can also choose to do an interim valuation during any of the interim years. The panel has stripped this flexibility away. I have no idea what’s going to happen on Dec. 31, 2010, the date when the next valuation is due. It’s an arbitrary date. If markets crash that day and long-term interest rates go down that day, that’s what drives the funding of the plan for the next three years.
If you think about the way CEOs manage corporations, they can put money into reserves for a rainy day and draw on those reserves when needed to smooth out the volatility of earnings. We view this as prudent management. We’re surprised that flexibility has been taken away because if you truly want to encourage the maintenance of DB plans, you need to maintain flexibility or actually increase it, as opposed to decreasing it.
Do you see any positives in the panel’s interim report?
TT: We applaud the panel for recommending the elimination of funding grow-in benefits, because N.S. and Ontario were the only two provinces to have this requirement. We also agree with the proposed elimination of a partial windup, transferring the appeal process from the Superintendent of Pensions to an independent expert pension tribunal, and the elimination of the quantitative investment rules in favour of prudent person principles.
What do these rules entail?
TT: No single investment, with the exception of some Canadian bonds, can be more than 10% [of the] book value of the plan. To be compliant with pension legislation, a plan could invest in 10 stocks with a weighting of 10% each. Clearly, this is not prudent. The 10% issuer rules exempt Government of Canada bonds but does not exempt other investment-grade sovereign bonds such as U.S. Treasuries. This doesn’t make sense.
There are also rules restricting the amount that a pension plan can own in Canadian real estate and Canadian resources properties. However, there are no such rules applicable to foreign real estate and foreign resources properties. This does not make sense. These rules were not updated when the Foreign Property Rule was eliminated.
Pension legislation restricts a plan from owning more than 30% of the voting shares of a company. With some plans wishing to play an increased role in activist investing—for example, taking companies private—this is problematic.
What changes to pension regulation would you like to see?
NF: Municipal plans should be exempt from funding solvency deficits. In general, I think we should have national pension regulation. That, I believe, would help us maintain DB plans. For the vast majority of members, a DB plan gives them better coverage and better security for their pensions now.
> click here for a PDF version of this article