Pension meltdown

Quebec City’s mayor, Régis Labeaume, has never been one to mince words. But his statement about pension plans, reported by la Presse last summer, succeeded in focusing the attention of Quebecers on a deepening crisis that’s been decades in the making. Municipal pension plans are getting deeper into trouble and taxpayers — fewer and fewer of whom have pensions — are unwilling to bail them out.

Lawmakers are also beginning to take notice. Just before the provincial election was called, the Marois government introduced a bill that gave Quebec municipalities some tools to deal with soaring public sector pension costs.

Labeaume pegs Quebec City’s deficit at $800-million. In Montreal, the figure is estimated to reach $2.5-billion. The Union of Quebec Municipalities says that 108 cities and towns across the province have a collective deficit of $5-billion in their defined benefit pension plans. “The mayors have definitely reason to be concerned,” says Martin Rochette, a Montreal pension lawyer who was part of a panel of experts chaired by former Desjardins Group CEO Alban D’Amours, author of a report last spring on pension reforms.

La Belle Province is not alone. A combination of longer life expectancy, investment volatility and anemic interest rates has left many Canadian municipalities that operate their own pension plans with gaping deficits. The same holds true in some provinces that have created a single, province-wide pension plan for municipal workers.

Meanwhile, the proportion of Canadians who have workplace pensions continues to shrink. Barely 6.1 million workers, or 38.4 per cent, were covered by a registered pension plan in 2011, down slightly from 2010, according to Statistics Canada.

What’s more, the number of employees with defined benefit pension plans, and therefore a guaranteed annuity upon retirement, has fallen to under 4.5 million people. Employers are actively considering ways to reduce their exposure by moving employees, particularly new hires, to defined contribution plans, which offer no guaranteed income at retirement.

Canadian provinces and municipalities, the vast majority of whom offer DB plans, are following suit. And while it is unlikely that Canadian cities will suffer a similar fate to Detroit, which filed for Chapter 9 bankruptcy last year, it’s worth noting that a federal judge held that pension rights are no different than other contracts: “Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy,” he ruled last December.

It was a stark reminder that the terms of pension funding can be altered by the state.

Sharing the risk

Some Canadian jurisdictions have already decided to tackle the issue head-on.

New Brunswick took the lead two years ago by forging ahead with an innovative but controversial alternative plan design that permits risk-sharing and cost reductions. As cities like Saint John confronted a $195-million pension deficit and Fredericton saw its pension deficit grow from $33-million to $59-million in just one year, there was little choice but reform “or the pensions were simply not going to be paid,” says Susan Rowland, a pension lawyer who headed a three-person New Brunswick pension task force that laid out a blueprint for pension reform.

The shared-risk model is based in part on the Dutch pension regime. It reduces the potential cost to taxpayers by splitting the plan in such a way as to limit the employer’s contribution liability while falling just short of guaranteeing workers basic benefits that could be topped up in the event that the fund performs well.

“Many of the reforms that we proposed were things that we were not happy to do because you don’t want to see people lose what they had already gained,” says Rowland.

But she does approve of some of the new safeguards in place. Under New Brunswick’s Pension Benefits Act, shared-risk plans must be subjected to annual stress testing, like that carried out since 1991 on Canadian banks and insurance companies. Plan administration is handled by a trustee instead of the employer.

Murray Gold, a partner at Koskie Minsky LLP in Toronto, says he doesn’t believe other jurisdictions would enact legislation that sanctions the ability to reduce rights associated with accrued benefits.

“It rests on a morally repugnant proposition,” says Gold, who was appointed by Ontario’s premier to a technical advisory group on retirement security last February. “You have to think it is okay to make a promise as a government — as a moral authority — and have employees work for them for 30 years, and after they have worked, contributed and accrued towards this commitment, you turn around and rip up the promise you made to them.”

But provinces may have no better option to offer workers. “If you don’t have a solution like a shared-risk solution, eventually you will see not only the private sector but governments too starting to freeze and convert their plans,” says Lawrence Swartz, a partner at Morneau Shepell Ltd and chair of the CBA National Pensions and Benefits Law Section. “You’re better off with a shared-risk model that keeps the system going.”

That is what Alberta had in mind when it recently announced plans to scale back its public sector pension regime and introduce elements of the shared-risk model. Encumbered by an unfunded pension liability of $7.4-billion, Alberta wants to implement a new risk management system, modify the early retirement subsidy, put an end to guaranteed cost-of-living adjustments, and place an overall cap on contribution rates for benefits earned after 2015.

“Provinces need to embrace design options outside of DB and DC,” says Jana Steele, an executive member of the CBA pension committee. “The shared-risk model has some of the attributes of the DB type of design but comes with more cost certainty and has a more sustainable long-term design.”

For now, however, Quebec is unlikely to take that route. The report issued by an expert committee chaired by Alban D’Amours bluntly states that DB plans should be maintained because they “provide the type of financial security that should be emphasized.”

Still, the committee did suggest that funding rules should better reflect actual costs and members should assume a greater share of the costs. And the province’s pre-election bill followed many of the report’s recommendations; it would have forced cities and unions to provide for equal cost-sharing and order the restructuring of pension plans that were not 85 per cent funded.

“When you examine shared-risk plans, the measures revolve around the same principles,” notes Rochette. “It speaks of actual pension costs, the possibility of controlling costs through ancillary benefits, and sharing of costs. So while the recipe may not be identical, the ingredients are almost always the same.”

A better pension solution?

For all the talk of shared-risk plans, Murray Gold of Koskie Minsky LLP believes the model that should be emulated is the one already in use by a number of provinces – a single, province-wide jointly sponsored pension plan like

Ontario’s giant municipal pension fund manager OMERS.

“These jointly-sponsored plans work well,” says Gold. “That model is the answer, and has been the answer for the last 20 years and will continue to be the answer to the occupational pension plan coverage.”

“It is a good solution,” says Lawrence Swartz, of Morneau Shepell. “There are economies of scale in the pension industry. If these smaller plans could get together and be part of a big plan, you would get cost-savings in administration and investment. Consolidation is a good way to go.