Funding Regulations: Secondly, sponsors can be hampered by regulations that do not always take sufficient account of their ability to make contributions in the future. Regulators typically determine funding adequacy in one of two ways. One method assumes that the sponsor could become insolvent at any time, and so sufficient funds to cover actuarial liabilities must always be available to cover that risk. But this may place an inappropriate burden on sponsors that are unlikely to become insolvent. When asset values are temporarily depressed relative to liabilities, the sponsor could be required to make a special contribution. But if the sponsor does not have access to the surplus, and cannot reclaim this special contribution once asset markets recover, then the sponsor’s expected costs are raised inappropriately.
Accounting Rules: The third area of concern relates to our use of the accounting rules. This area is becoming increasingly important to pension plan sponsors because international accounting standard setters are examining a move to unsmoothed, so-called “fair-value” methods. If this review results in changes to accounting standards, it could make sponsor balance sheets and income statements much more volatile. So sponsors will have an increased incentive to hold assets with low volatility. This incentive may make pensions more expensive because sponsors would be less likely to take on assets with higher expected returns.
Longevity Risk: A fourth concern relates to the group-longevity risk. Increased longevity poses a tremendous risk for sponsors. This risk can be mitigated by adjusting contribution rates to reflect changes in average life expectancy, or the level of benefits can be adjusted, as can the date at which a person becomes eligible to collect a pension. Making these changes is often unpleasant, but it is necessary. And so sponsors and plan members both need to have the incentives to deal with group-longevity risk properly.
Funding Benefit Improvements: The fifth concern relates to the fourth. In the past, there have been labour agreements that called for improvements to defined benefit pensions, without matching funding provisions. How the cost of a new benefit promise will be covered should be made crystal clear to shareholders, workers and regulators at the time the change occurs.
Multi-Employer Plans: Finally, and very importantly, many sponsors may be too small to adequately manage the risks and costs of sponsoring a defined benefit plan. But risks can be mitigated by sponsors forming multi-employer plans, thus pooling risk across a number of plan sponsors. If structures such as large multi-employer pension plans could be created, this could help smaller employers to pool both costs and risks, making it easier for them to sponsor defined benefit plans. It could also provide a measure of increased pension portability for employees.
Putting defined benefit plans on a sustainable footing involves strengthening the legal, regulatory, accounting, actuarial and economic frameworks that determine how these plans operate. If we get it right, these changes would give sponsors the appropriate degree of flexibility needed to manage risk effectively. And, ultimately, Canada can have a better managed pension system that is good for members, good for employers, good for the economy and good for Canadian society.
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