Defined-benefit private pension plans are those in which an employer promises a predetermined monthly benefit based on the employee's earnings history, tenure of service and age, rather than depending on investment returns.
In Canada, these plans are under a lot of stress. About 90% of them have a so-called "solvency" deficit, meaning they would come up short if the companies sponsoring them were suddenly to go bankrupt or otherwise cease their operations. When a company goes bankrupt, employees' benefits have to be paid out at once, and retirees' pensions have to be purchased from an insurance company.
The main cause of these solvency deficits is that long-term interest rates are exceptionally low. For example, since 2000, rates have decreased from 6% to 2.5% on long-term federal government bonds and from 4% to 0.3% on real return bonds used in indexed pension plans. This reduces investment returns, but the benefits are not accordingly adjusted.
As I wrote in a column in June, this is another unfortunate consequence of our current monetary policy. It creates a major problem for many Canadian companies that have those types of pension plans. Air Canada, Resolute Forest Products, Canadian Pacific, Bell Canada, Canada Post, Canadian National, are but a few of the companies impacted.
Several of Canada's competitors, including the U.S, have taken concrete steps to help companies cope with the problem, while Canada has not.
For example, American companies that sponsor a defined-benefit pension plan are now allowed to use a discount rate to fund their plans based on the average of corporate bond rates over 25 years. Currently, this produces a discount rate of about 6.5%. Conversely, Canadian pension regulators require a discount rate based on federal government bonds; this rate is currently around 3%.
The discount rate is an assumption made of the rate of return that the plan's assets will earn in the future. The higher the returns, the lower the capital needed now in order to be able to pay the pensions when employees retire.
This means that if Canadian companies that have defined-benefit pension plans were allowed to use the same rules as their American competitors, their liabilities would be reduced by about 50%. Actually, most of them wouldn't even be considered as having a deficit.
The U.K., Sweden and Denmark have also indicated they would follow the U.S. move.
The practical consequence of all of this is that Canadian companies suffer a substantial drain on their cash flows since they have to make important "deficit payments" that sometimes represent up to 30% of their total payroll. This is money that is not available to make investments, give pay raises or hire new employees.
Let's take for example the case of Resolute Forest Products (the former AbitibiBowater). Their Canadian pension plans have performed well, in relative terms, generating a 5.4% investment return in 2011. However, the company's solvency deficit has steadily increased to $1.9 billion simply as a result of the precipitous decline in the yield on government bonds in Canada. Its retirees could lose 30% of their revenues if the company were to cease its operations. Air Canada is another example, with a $4.4-billion pension solvency deficit.
When faced with this issue, Canadian authorities say that they apply those rules in order to protect retirees. This is indeed a laudable goal. However, putting important Canadian companies at a major competitive disadvantage with their American counterparts, harming their cash flow and, in some case, pushing them closer to bankruptcy, won't protect anyone in the end.
- Michel Kelly-Gagnon is president of the Montreal Economic Institute (www.iedm.org). The views reflected in this column are his own.