The pension mess

One group of people who must have shuddered when the March unemployment figures came out was pension fund managers. They are being beset from all sides and even lower interest rates will not help their situation.

The reality is that the pension industry is in a mess, and not just in Canada. I have written about this before but nothing is being done to deal with the situation and our legislators seem to be turning a blind eye to it, in contrast with the U.S. where it has become a political hot button.

Pension plan managers, who tend to invest conservatively, are facing an uphill battle in their efforts to generate the returns needed to provide the benefits guaranteed under defined benefit pension plans. The bear market of 2000-02 combined with a long run of low interest rates has left them struggling and, in many cases, they have not been able to cope with this double whammy.

The much-publicized Air Canada situation is a classic example. The company’s pension plan, which is benefits-rich but cash-poor, has become the central issue in efforts to resurrect the company, which is teetering on the brink of liquidation. The big unions have so far refused to budge on ts issue, even though Air Canada’s demise would deal a huge blow to current and future plan beneficiaries.

There are a surprising number of people who have the rather naïve belief that the pension crisis will somehow sort itself out. Recently, I wrote an article about the threat posed to individual pension plans (IPPs) by the budget’s restriction on income trusts, I received the following e-mail from a financial professional who disagreed with my analysis. She wrote:

“One of the major differences between RRSPs and IPPs is that the IPP is required to have achieved a annual 7.5 per cent rate of return, based on an actuarial evaluation conducted every three years. If that rate of growth has not been attained, the sponsoring corporation is REQUIRED BY LAW to put in additional funds to bring the asset value up to that level. This means that there is no chance that the IPP will not be able to meet its obligations. In essence, because the IPP is an RPP, and, therefore, a defined-benefit plan, there is no question that the pre-determined amount of capital and the pre-determined annual pension income stream will be there, all other things being equal.” – C.B.

The point made by the writer is technically correct. A sponsoring organization is indeed be required by law to top up a pension plan. But what happens when the money required to top up the plan isn’t there? We are seeing exactly that situation in the case of Air Canada. We have seen it in the U.S. in such high-profile pension plan debacles as Bethlehem Steel.

In the case of a small IPP, there isn’t even a big company to go after if the plan comes up short. Consider, for example, a doctor who incorporates and sets up an IPP. He then retires and lives off the pension it generates. The plan is unable to meet its obligations and there is now no active source of new revenue to top it up. What happens then? We all know the answer to that.

Many smaller pension plans have been using income trusts to get them over the bear market/interest rate hump. So have a few of the larger plans; the Ontario Teachers Pension Plan says it is already well over the proposed 1 per cent limit. Now that option is being removed. A bad situation is being made worse.

In the U.S., they are at least trying to figure out a solution. A recent study by Milliman USA showed that at the end of 2003, the total shortfall for 100 of the largest pension plans in the country was US$114.1 billion, with steel companies and airlines being in the worst position. That was an improvement over the previous year, thanks to the stock market recovery, but still a worrisome figure. The survey showed that the companies surveyed contributed $56 billion to top up their plans last year, with General Motors alone contributing almost $14 billion.

The U.S. Congress is now studying pension relief measures that would ease the financial pressure on corporations. If a bill is not approved, some companies are saying they will have no choice but to freeze benefits.

This is a crisis that is not going to go away, and the Liberal government has only exacerbated it with its budget announcement. It’s time that our legislators, federal and provincial (pensions are a shared responsibility), started to take it seriously. Failure to do so could lead to financial and societal problems in the future on a scale that we can only begin to imagine.

This article originally appeared in the Internet Wealth Builder.