The current regime for funding DB pension plans is not working. It doesn’t achieve the goals of either plan participants or plan sponsors. Plan participants want early funding of liabilities in order to enhance the security of their promised benefits. Plan sponsors want to have a smooth pattern of pension contributions.
The current regime works against both these objectives. Because of uncertainty regarding sponsors’ ability to utilize pension surplus, they are encouraged to defer making plan contributions to the greatest extent allowable within the law.
• This deferral of contributions, even though it is within the statutory limits, lowers the security of plan benefits. All else being equal, more money in a pension fund provides more security than less money in a pension fund.
• Also, a practice of making only statutory minimum contributions results in a volatile pattern of contributions. The reason is that no additional contributions are made to provide any cushioning against the effect of capital market movements.
Change is needed, and there are good signs that change will actually be made. Four provinces—Ontario, Alberta, British Columbia, and Nova Scotia—are currently going through a complete review of their pension legislation, legislation that for the most part has remain unchanged for the past 20 years.
What follows is a high level outline of a potentially revised funding regime. This revision, in essence, will create two receiving vehicles for pension contributions—the traditional trust and a contingency reserve.
The traditional trust will hold all assets as of the date of the changeover to the new regime, plus all future contributions required by the going-concern pension valuation. The financial status of the traditional trust will be determined on a going-concern basis only, and any surplus that emerges will be dealt with in accordance with current legislation.
The contingency reserve is a fund separate and apart from the sponsor that will receive any additional contributions required by the solvency valuation, together with any additional contributions the sponsor may choose to make within the limitations of the Income Tax Act. Entitlement to surplus within this reserve will rest with the plan sponsor. However, the only surplus that would be available would be that in excess of a margin. The size of the margin will vary in accordance with the asset/liability mismatch of the investment policy. At one extreme, that of a fully immunized investment policy, the funding target would be 100% of the solvency liability. For a typical asset mix, the funding target might be 110% of the solvency liability. With an extremely aggressive asset mix, the funding target might approach 125% of the solvency liability. These are meant to be examples only, but should reasonably represent the expected range of margins that might be appropriate. Additionally, I expect that it will be necessary to apply to, and receive approval from, the appropriate pension supervisory authority in order to receive any refund of excess surplus from this reserve.
Let me repeat my introduction. The current regime for funding DB pension plans is not working. It is imperative to remove the current disincentives for sponsors to fund their pension plans beyond minimum levels. The best solution will be one that reflects a compromise addressing the concerns of all stakeholders. What I have described here is only one potential solution. If you are interested in further detail, please follow the attached links for a more detailed description.
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