Debt for pension becoming trendy

Essentially, that’s what Canadian Pacific Railway (CP Rail) did — at a corporate level — when it announced it was using a debt offering to boost its company pension plan.

CP Rail used a subsidiary to issue $350 million of 4.45% Notes due in 2023, using the extra cash to make a huge lump sum payment now ($650 million) in its defined benefit (DB) pension plan.

Tax law expert Gary Nachshen cautioned that the above explanation is a bit of an oversimplification of the process, but at its core, the analogy is fair.

“I would speculate that they’ve concluded it’s beneficial from a tax perspective,” said Nachshen, who heads up the national pension and benefits practice group at Stikeman Elliott.

“There’s value from a cash flow perspective, and perhaps it provides a stabilization of funding to make a large contribution to the pension today.”

“You worry less about funding tomorrow,” he said.

Like many companies, CP Rail is dealing with a substantial DB deficit and wants to take advantage of low interest rates.

“With this prepayment, and if market returns are stable or improved, CP’s annual cash contributions to the plan can be maintained at current levels for several additional years, or even reduced,” the company said in an email.

Nachshen said the case is the first he’s heard of, where the company takes out a loan to make a voluntary lump sum payment.

Other experts seem to agree that this could become the start of a new trend in the pension industry.

“Issuing debt for the primary purpose of funding of corporate pension liabilities is, I think, a fairly new development,” said pension consultant Greg Hurst.

“If it is used in a de-risking strategy, volatility of pension expense and the net pension obligation can be reduced in a tax-effective way. If de-risking is not an objective, then the debt is, in effect, being used under a somewhat leveraged investment framework.”

Taking advantage of low interest rates, it seems, is vital to ensuring the success of such a strategy.

But if voluntary lump sum contributions in a low-interest environment are all the rage, how much is too much?

The last thing you’d want is the pension deficit to turn into a surplus, Nachshen said.

“[That’s why] a lot of employers are reluctant to fund their pension plans more than they have to.”

“[But] from a plan member’s perspective, knowing there is additional money in the pension plan today is a good thing.”

Especially when the latest pension headlines continue to raise fears about rising DB deficits around the world.