It s Time to Retire the Current Pension System

Transcription

1 It s Time to Retire the Current Pension System A view of the Ontario Pension Benefits Act, by Canada s largest single-profession pension plan and fund Ontario Teachers Pension Plan Submission to: Professor Harry Arthurs, Chair Expert Commission on Pensions October 15, 2007

2 INTRODUCTION: The Ontario Teachers Pension Plan (Teachers or the Plan) is Canada s largest singleprofession pension plan and fund, with assets currently in excess of $105 billion (as of Dec 31, 2006). The Ontario Teachers Pension Plan Board (the Board) was established as the Plan s administrator in its current form as an independent corporation in In 1992, Teachers became jointly sponsored by the Ontario Teachers Federation (OTF) and the Ontario Government (through the Minister of Education). The OTF and the Government (the Partners) established a governance model under which the Partners are responsible for Plan design decisions (benefit levels and contribution rates). The Board, on the other hand, is responsible for investing the fund s assets, administering the Plan and reporting on its funded status, and for paying entitlements to Plan members and their survivors. Teachers currently provides for retirement income for over 285,000 Plan members (active, deferred and retired) and their survivors. As the assets of the Plan grow, and the number of beneficiaries covered by the Plan increases, Teachers continues to mature. The ratio of active Plan contributors to pensioners has decreased from 10:1 (in 1970) to 1.6:1 currently. This has created many challenges for Teachers, from both a funding and an investment perspective. Nonetheless, an effective governance structure, economies of scale, a professional Board, and the expertise of those charged with administering the Plan and investing the assets of the fund have enabled Teachers to address such challenges as they arise. In fact, Teachers ranks quite highly amongst its peers internationally, both in terms of effective service to members and efficient costs of administration and investment. Given Teachers varied mandate as a large plan administrator as well as a significant investor and shareholder, we have a multi-dimensional view of the issues facing the Ontario pension system: its administration, its regulations, its relationship with other authorities, and its overall strengths and weaknesses including its sustainability. The following submission is based on the view that the current pension system model is unsustainable, and that the time is right for the public and private sectors to work together to revitalize the system and devise a new model designed for Ontario s evolving markets and demographics. a new model that supports realistic and affordable pension contributions and benefits through the foreseeable future, and that shares the burden of risk fairly across generations and among private and public employers. We appreciate the opportunity to present our views, and we offer our experience and expertise as a resource to the Commission s deliberations. For example, an expert panel has been established, by the Board and the Partners, to review the assumptions used for Plan funding valuations. This review is currently underway and we would be pleased to share the findings of the expert panel

3 TEACHERS POINT OF VIEW: The major issues that we face as a plan administrator and fund manager, under the current Ontario Pension Benefits Act (PBA), fall into three categories: 1. FUNDING: i. Fair sharing of surpluses and deficits ii. Income Tax Act barriers to building a surplus iii. A pension plan s dependence on a third party actuary iv. One size cannot fit all: the vastly different risk factors of public and private sector pension plans v. Shifting risks to those who are least equipped to manage them 2. INVESTMENT RULES: i. Unnecessarily restrictive investment rules 3. ADMINISTRATION: i. Cumbersome administration ii. Lack of consultation before changes are adopted - 3 -

4 1. FUNDING: i. Fair sharing of surpluses and deficits The sharing of pension fund surpluses needs to be clarified. Surpluses should be fairly allocated among the parties who assume responsibility for the funding risks associated with a defined benefit pension plan. Under current rules, a pension fund deficit must be financed by the plan sponsor (typically the employer) over 15 years (5 years for a solvency deficit). Under current rules (coupled with case law), however, pension fund surpluses are typically considered to belong to employees. The Monsanto decision illustrates this issue: the partial wind up of the company s pension plan resulted in the required distribution of surplus to employees affected by the wind up even though, at the time of payout, there could be a deficit in the pension plan for the remaining members. In other words, a pension plan can be treated like a chequing account, with no consideration for future possible rainy day needs. Therefore, the current regime effectively encourages employers to underfund their plans, as they are responsible for deficits but are not necessarily entitled to a share of surpluses. Underfunding of defined benefit pension plans, however, is not indicative of a healthy, sustainable pension system. The current regime also explains why institutional investors, such as Teachers, view companies with defined benefit pension plans as unattractive potential investments. The unknown liabilities risk associated with the funding of such plans reduces the potential upside of investing in such companies. ii. Income Tax Act barriers to building a surplus The major barrier we face as a registered pension plan in working within the limits of the federal Income Tax Act (ITA) is the excess surplus rule. This rule precludes further contributions to a pension plan once the plan s surplus hits 10%. In our view, this ITA rule is counterintuitive as it limits the opportunity to enhance pension plan funding when the investment climate is conducive to growth. We experience this obstacle not only as a plan administrator, but also as an investor in companies which face the same constraint in funding their defined benefit pension plans. Although this ITA rule was modified somewhat after submissions by some large public sector pension plans (including Teachers, OMERS and HOOPP), the changes only - 4 -

5 applied to cost-shared plans. Consequently, the changes, which further complicated an already complex process, only benefited a small number of plans. While we appreciate that possible changes to the federal ITA are beyond the scope of the Expert Commission s mandate, and indeed Ontario s jurisdiction, we believe that the excess surplus rule should be recognized for the detrimental impact that it can have on the funding of pension plans in the Province. iii. A pension plan s dependence on a third party actuary From a pension plan funding perspective, we have two concerns with the current regime regarding actuarial methods and standards. First is the position of conflict in which many pension plan actuaries can find themselves. As they are hired by the employer, they may feel pressure (real or perceived) to provide the answer they know the employer wants to hear (regarding short term plan funding obligations), rather than the information and advice that plan stakeholders need to receive (regarding the long term sustainability of the plan given existing benefit levels and contribution rates). Also, the actuary s advice would likely be improved by completing multi-year projections for the pension plan; however, the employer is unlikely to be willing to pay the costs associated with such analysis. In order to resolve these conflict issues, we believe that the legislation needs to clarify the role and accountability of the plan actuary. Also, if the legislation required a written funding policy to be developed by the plan sponsor and communicated to all plan members, this could provide better guidance (and transparency) when it comes to funding issues, the choice of assumptions and the preparation of valuation reports. The second issue concerns the standards of practice for pension actuaries, and the time it takes the actuarial profession (through the Canadian Institute of Actuaries) to create new standards, or update existing ones, as pension plan funding evolves. The standards are also silent with respect to the important process of how the economic assumptions, contained within the funding valuation, should be developed. Consequently, the application of such assumptions can vary significantly between individual actuaries and between actuarial firms. iv. One size cannot fit all: the vastly different risk factors of public and private sector pension plans Intergenerational issues represent one of the greatest risk factors for public sector pension plans: future plan members and taxpayers may be left to pay the bills if the risk of future liabilities is not shared equitably between older and younger members

6 In the case of private sector pension plans, however, employer bankruptcy represents the greatest risk factor for the long-term viability of the plan. Consequently, the legislation should recognize the vast difference in the risk profiles of public and private sector plans, and should differentiate between the two on a most fundamental basis as follows: 1) There should be long-term funding rules for public sector plans, and valuations should include projections for a more comprehensive and realistic funding outlook. On the other hand, short-term solvency valuations, which focus on the contingency of wind up, are inappropriate for public sector plans. 2) Solvency rules should apply to private sector plans only. Employers should not be permitted to avoid funding obligations on wind up. In the event of employer bankruptcy, however, any necessary reduction of benefits should first be applied to benefit increases that were granted within a specified number of years (perhaps five) prior to wind up. Valuations containing projections would also help provide a more comprehensive assessment of the funding risks involved. v. Shifting risks to those who are least equipped to manage them With the continued trend of private sector employers moving from defined benefit to defined contribution plans for their employees, many risks are being shifted to individual plan members. As life expectancies increase, one of these risks (longevity) is that defined contribution plan members will outlive their retirement funds. In addition, these members do not always have sufficient expertise to make prudent investment decisions, nor do they have the efficiencies of scale to minimize the fees charged by financial institutions to manage their investments. Consequently, such members must bear the longevity, investment and financing risks all on an individual basis. At the same time, the government faces the moral risk that some citizens will outlive their savings, while others - many of whom are in the public sector - are protected by the defined benefit umbrella. What is perhaps most troubling is the fact that the private sector s shift to defined contribution plans has not been widely recognized for the social costs that this trend will likely impose in the future, as members of such plans begin to retire with inadequate retirement incomes. Their combined individual defined contribution shortfalls will likely dwarf the valuation shortfalls of defined benefit plans, possibly imposing obligations on future governments (and taxpayers) for further retirement income assistance

7 2. INVESTMENT RULES: i. Unnecessarily restrictive investment rules The current investment rules in the PBA were designed with the typical singleemployer private sector pension plan in mind. They do not reflect the reality of the Ontario pension environment in which super funds with sophisticated investment operations and capabilities, such as Teachers and OMERS, have created the need for large placements in the capital markets. As an example, the 30% limit, on a pension fund s investment in the securities of a corporation to which are attached the right to vote to elect directors, inhibits major funds such as Teachers from taking leadership investment positions. As a direct investor, which helps minimize our investment costs for the benefit of our members, we find this 30% investment limit unduly restrictive and outdated. It forces us to develop cumbersome investment structures, the time and effort of which would be more efficiently spent on investment management. More importantly, it forces us onto an uneven playing field, since many of our competitors for investment opportunities here in Canada and abroad do not face such restrictions. It is our view that the 30% limit should be eliminated. Foreign jurisdictions do not have a similar restriction; the limit presents difficulties in attracting investment partners; and, it puts Canadian pension plans, charged with investing beneficiaries savings, at a significant disadvantage in both the domestic and global marketplaces. In our view, the prudent investment test would provide a more appropriate and tailored regulatory standard, without the existing qualitative and quantitative restrictions that simply limit, and inflate the cost of, appropriate investment opportunities

8 3. ADMINISTRATION: i. Cumbersome administration Pension administration in Ontario is unnecessarily complex and would benefit tremendously from reform, so that resources (both at the regulatory level and the plan administrator level) could be redirected to offering pension plan members additional service. Three areas, in particular, where administration could be simplified and clarified are as follows: a. Marriage breakdown The existing provisions of the PBA do not provide an adequate framework for the division of pension assets in the context of a marriage breakdown. This lack of regulatory guidance, coupled with court cases and differing methods of pension division, results in unnecessary complexity at the expense of plan members, their ex-spouses, and plan administrators who must implement pension splits. Our previous submissions to the Ontario Ministries of Finance and the Attorney General on this matter are attached. b. Transfers to and from other pension plans Provisions in the PBA that were intended to provide for the portability of pensions are inflexible and restrictive, and place much of the administrative burden on the plan administrator. For example, in the absence of a reciprocal transfer arrangement, pension assets cannot be transferred on behalf of a plan member between Ontario and other Canadian jurisdictions unless the plan administrator receiving the funds agrees to administer them in accordance with the pension legislation of the province from which the funds were transferred. Given the lack of uniformity in pension legislation across the country, most plan administrators would not be willing to accept this additional burden of administration, thereby frustrating the plan member s desire for portability. In our view, the fact that the funds will remain within a locked-in pension regime should be sufficient. As another example, the impact of certain court cases, coupled with interpretations of the PBA by the Superintendent of the Financial Services Commission of Ontario (FSCO), effectively means that asset transfers between pension plans cannot occur unless unrealistic conditions are met (for example, the terms of the plans must be identical). This affects the ability of companies, in - 8 -

9 which we invest, to properly manage pension issues, when economic realities necessitate corporate restructuring. More importantly, however, the inability to transfer pension assets and liabilities precludes plan members from consolidating their pension assets when their plan membership changes as a result of corporate changes. In many cases, this result will not be in the best interests of plan members. c. Shortened life expectancy (SLE) This provision, which was added to the PBA in 2000, makes sense for active and deferred members, but is completely inappropriate for pensioners. The fact that pensions terminate upon the death of the pensioner (in the absence of a survivor) allows a defined benefit plan to spread mortality risk. Under current rules, a pensioner who has a shortened life expectancy of less than two years can apply for an SLE benefit. Under our current practice, we would provide that pensioner with the present value of four months of pension payments (plus any remaining payments under the member s 10 year guarantee period, if applicable). If the pensioner has a spouse, we would also pay out, as part of the SLE benefit, the present value of the survivor pension otherwise payable to the spouse upon the death of the member (subject, of course, to the spouse s consent). If the spouse is also in poor health, there is a strong incentive to apply for the SLE benefit in order to effectively cash out the survivor pension that would otherwise be payable for the life of the spouse. In our view, post-retirement death benefits should be limited to the 60% survivor pension required by the PBA and any other death benefits (such as return of contribution guarantees, or minimum guaranteed periods) that may be provided by the terms of the pension plan. As an investor in large companies that operate across Canada, we understand the complexities they face in trying to administer multi-jurisdictional pension plans. The issues discussed above simply add to that complexity, the costs and inefficiencies of which affect the profitability of such companies and our investments in them. ii. Lack of consultation before changes are adopted We are encouraged by the process of consultation that the Commission has adopted in conducting its review, before extensive changes are made to the PBA. Input from all stakeholders is a critical first step. In fact, it is a step that has often been missing in the course of past, ad hoc updates to the PBA and its regulations

10 The pitfalls of this lack of consultation were evident in the Jointly Sponsored Pension Plan (JSPP) amendments that were made to the PBA in Draft amendments had already made their way to the Minister of Finance by the time that affected stakeholders were invited to provide input. By this time, it was effectively too late in the process for certain flaws in the JSPP rules to be corrected. For example, the JSPP rules require that contributions of future plan members be included as an asset in a plan valuation, but the rules do not require that the cost of benefits for such future members also be incorporated as a liability in the valuation. How can a funding valuation be balanced when such an inconsistency is permitted? As another example, the JSPP rules require that we effectively maintain two sets of records in order to demonstrate that the actuarial cost method that we use to value the Plan (aggregate) produces the results expected if we were to utilize the cost method that other plans use (projected unit credit), even though both cost methods are clearly permitted by the rules. In our view, there has to be an easier way to demonstrate that the Plan s contribution rate is adequate (such as multi-year projections, coupled with some gain and loss analysis), rather than having to create and maintain what we consider to be phantom valuation records. The SLE issue (noted above) is another example of a lack of consultation. Its application to pensioners is inappropriate and, without any input from affected stakeholders, it was adopted under the erroneous assumption that it would not add any cost to a pension plan, which is simply not the case. In our view, proper consultation with stakeholders can offer further insights, clarify issues, and ultimately lead to a better result

11 CONCLUSION: It is clearly time to overhaul the PBA and to devise a new model for pension regulation in the Province that: (i) shares the burden of risk fairly across generations and among private and public employers, and (ii) supports realistic and affordable pension contributions and benefits through the foreseeable future. Ontario is not alone in its efforts, nor is it necessary to reinvent a system that has already been re-engineered by other pension administrations around the world. Following this report is an appendix of materials and reports that includes the experience and solutions of others, which the Commission may find useful. Teachers looks forward to ongoing discussions with the Commission as its deliberations continue. We offer the information and expertise we have available to help address the issues that the Commission has identified in its discussion paper, as well as other issues that may be raised during the Commission s consultation process

12 APPENDIX 1. Sweden s Pension Antidote Finds a Global Audience by Joellen Perry, March 5, 2007 Wall Street Journal 2. Sharing Risk: The Netherlands New Approach to Pensions by Eduard H.M. Ponds and Bart van Riel, April 2007 Center for Retirement Research at Boston College 3. Pension Plan Governance: An Analysis of Seven Public Sector Plans; Managing Risk; A Report for Treasury Board Secretariat by Rowan & Associates Inc., KPA Advisory Services Ltd., April 6, 2001 (chapters 1-3, 11, 12) 4. Surplus Limit for Registered Pension Plans - Proposal for Change by Ontario Teachers Pension Plan - Discussion with Dept. of Finance February 21, ACME Co.: Simulation Analysis of the Income Tax Act Surplus Limit by Barbara Zvan, Ontario Teachers Pension Plan, February 1, ACME Co.: Historical Analysis of the Income Tax Act Surplus Limit by Barbara Zvan, Ontario Teachers Pension Plan, April 20, Letter from Len Farber, General Director, Tax Legislation Division, Tax Policy Branch, Dept. of Finance, re: Income Tax Act pension surplus rules received August 19, Jointly Sponsored Pension Plan (JSPP) Regulation Highlights by Barbara Zvan, Ken Harrison and Scott Perkin Ontario Teachers Pension Plan, January OTPP s Brief to Expert Review of Actuarial Assumptions March 5, Submission to Ministries of the Attorney General and Finance on Valuing and Dividing Pensions at Relationship Breakdown by Ontario Teachers Pension Plan, March The 30% Limit by Ontario Teachers Pension Plan, October 15,