Some pension suggestions

Posted by cwaddell under All, Media Commentary, Political Strategy

Christopher Waddell

Further to Elly’s interesting post about pensions, some have been thinking about this for quite a while. Here’s what then Governor of the Bank of Canada David Dodge suggested in a speech in Montreal in November 2005 needed to be done to address some of the concerns Elly quite correctly noted are even more important issues today.

“If defined-benefit plans are to survive, grow, and provide a source of funding for long-term, riskier assets, it is important that Canadian policy-makers consider taking steps to rebalance the incentives for sponsors to operate defined-benefit plans. Let me mention a few of the things that could be done.

First, the provincial and federal governments need to make appropriate adjustments to their pension laws so that the sponsors of defined-benefit pension plans are responsible for all residual risks to the pension plan—both outcomes that lead to deficits and outcomes that lead to surpluses.

Let me be clear. I am not saying that firms should be given unambiguous sole ownership of pension surpluses, but rather that sponsors should have that ownership. There are a handful of pension funds—such as the Ontario Teachers’ Pension Plan—where both the employer and employees are joint sponsors, and share ownership of any surpluses, as well as responsibility for any deficits.

The second step would be to consider rebalancing the tax treatment of employer contributions. Currently, in most circumstances, employers are not allowed to deduct contributions to a defined-benefit pension plan if the going-concern valuation of the plan is more than 110 per cent of expected future liabilities. This has certainly added to the bias against sponsors allowing surpluses to build up in their pension plans.

Third, there are issues with Canadian accounting standards for pensions in terms of valuation that have been posing challenges since they were adopted in 1999. For one thing, changes in the annual discount rate used to value pension liabilities can result in large swings in the amount reported as pension expenses. For another thing, periodic actuarial valuations of defined-benefit plans also flow through firms’ income statements. Both of these issues lead to volatility in reported earnings, which investors do not like. So, accounting standards have become another reason for employers to avoid defined-benefit pension plans. I have just listed three of the most serious problems facing sponsors of defined-benefit pension plans. Of course, there are other issues as well.

Nevertheless, addressing these three issues would be helpful in getting the incentives right, so that defined-benefit plans can remain actuarially sound. This would significantly reduce the risk that pension contributions would be insufficient to cover future liabilities should sponsor firms go bankrupt. That said, sponsor bankruptcy remains a risk for members of private sector plans, and some form of risk-sharing arrangement is desirable. There are a number of options as to how to pool this risk, including encouraging the creation of plans sponsored by multiple employers. However, I would argue against the use of pension benefit guarantee funds, since they significantly raise the risk of “moral hazard,” and further increase the bias against employers sponsoring defined-benefit plans.”