Submission to the
Ontario Expert Commission on Pensions
Prepared by:
Hugh O’Reilly
Partner
CAVALLUZZO HAYES SHILTON McINTYRE & CORNISH LLP
Barristers and Solicitors
474 Bathurst Street, Suite 300
Toronto, Ontario M5T 2S6
Ph. 416-964-5514
Fax. 416-964-5895
Email: horeilly@cavalluzzo.com
Website: www.cavalluzzo.com
I am grateful for the opportunity to make this presentation to the Ontario Expert Commission on
Pensions (the “Commission”). The views expressed in this submission are my own and do not
represent the views of my firm, Cavalluzzo Hayes Shilton McIntyre & Cornish.
Theme of Submission
I believe that my professional experience has allowed me to develop an informed, balanced and
unique perspective on pension plan policy. I say this because I have seen pension plans from all
sides of the policy perspective.
My involvement in pension plans began when I was a senior policy advisor to the Minister of
Financial Institutions in the Rae Government. In that capacity I spearheaded the development of
the so-called “surplus sharing” regulation and the current solvency funding regulation.
After I left government I then spent nine years working on Bay Street in the corporate law
environment. As a Partner at Torys I advised corporate clients on pension matters and became
intimately familiar with the employer perspective on pension issues.
For the past five years I have been a partner at my current firm, a leading union-side labour law
firm. As a result, I am very familiar with the union or employee perspective on pension issues.
When analyzed from any perspective the current legislative regime as set out in the Pension
Benefits Act (Ontario) (the “PBA”) is in need of reform. The current legislation came into force
almost 20 years ago. In my view the PBA has not been amended because pension issues are
divisive and politicians see little to be gained by amending the legislation.
This situation has also given rise to the pursuit of what might be considered the pension equivalent
of the Holy Grail – labour/management consensus on proposed changes. Based on my own
personal experience I do not believe that consensus between the parties can ever be achieved.
Nevertheless, I have attempted to produce a submission that strikes a balance between the
interests of labour and management. If this can be achieved then I believe that both sides will
adapt to the legislative environment and government will be able to avoid the charge that it
favoured one side over the other when it developed its new legislation.
For ease of reference, my submission will address the issues raised in the Commission’s Terms of
Reference in the order in which they are set out in that document.
Pension Plan Funding
I believe that the provincial government must take a radical step to address pension plan funding
issues. The current system is, in my view, flawed from every perspective. In part, this has
occurred because government, pension plan sponsors, members and professionals viewed the
period between about 1972 and 2002 as being a period of normalcy. During this period of
historically high interest rates and equity markets, pension plans were easily and affordably able to
radically improve pension benefits. Matters were worsened by accounting rules that allowed
employers to treat pension surplus as income on their financial statements.
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This led pension plan sponsors away from basing their funding policies on the liabilities of the plan
itself. Increasingly, plan sponsors invested assets in the pursuit of an equity premium, the risk of
which was largely hedged by a high interest rate environment that depressed the value of the
plan’s liabilities. By chasing returns, plan sponsors lost sight of the need to manage the risk of
being able to fund the promised benefits.
The so-called “perfect storm” that took place early in this century laid these issues bare. It is only
in the last few years that there is an increasing recognition of the need to base investment
decisions on the liabilities of the pension plan and to better match assets to liabilities.
The problem now faced by pension plans is that they must transition from the old world to the new
world. This transition will not be an easy one. In both good and bad economic times business
leaders are unwilling to devote corporate resources to pension plans. Employees for their part find
it difficult to trade current wage rates against the deferred compensation offered by their pension
plan.
For these reasons I believe that the Provincial Government needs to play a role in easing this
transition and to ensure that plan are sustainable. My suggestion for how the Province could play
a role in the transition is as follows:
- New funding rules should be established that explicitly require a matching of assets and
liabilities;
- The Province would then issue in series for a period of 10 years, pension bonds with an
interest rate of 6 percent. The bonds would have a term of 30 years. (The current interest
rate for long Ontario bonds is about 5 percent.) The amount issued in each year would be
in the range of one to two billion dollars. These bonds would only be available for
purchase by pension plans and would not be transferable directly or through any derivative
transaction to any entity other than a pension fund. Given the size of Ontario’s public
sector plans consideration should be given to limiting the amount of bonds that can be
purchased by any one fund;
- The proceeds raised through the pension bonds could be used to fund infrastructure
projects in the province, for example. The expenditure of funds could be managed by a
Board consisting of representatives of Government, labour and employers;
- The assets of any pension plan wound up would be transferred to a crown agency.
Pension payments would be made in accordance with the funded ratio of the Plan at the
time of wind-up. There would need to be a regulation change to prohibit the payment of
commuted values from a wound-up plan. In other words, the new agency would only
make periodic payments to plan beneficiaries;
- Pension plans would only be permitted to take contribution holidays or to improve pension
benefits if the funded ratio of the plan on a solvency basis exceeded 125 percent. The
plan sponsor would also have to demonstrate that after the benefit improvements or
contribution holidays were taken the plan would continue to have a funded ratio of at least
125 percent; and
- Existing funding and solvency rules would continue to apply to all pension plans.
The issuance of pension bonds would improve the funded position of every pension plan in the
province significantly. In exchange for significantly reducing or even eliminating a plan’s solvency
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deficiency, plans would be required to transition to a more stable funding regime that ought to
reduce the potential for under-funded plans in the future.
In order to ensure that the parties to the pension promise do not use the new system to further
short term interests, there would be limits on contribution holidays and benefit improvements
unless it could be demonstrated that the plan was fully funded on a sustainable basis. In my view
this would be an appropriate exchange that would protect everyone’s interests.
The issuance of pension bonds would add to the cost of Provincial borrowing and would clearly be
a taxpayer subsidy of the existing pension system. I believe that the additional cost would be offset
by the economic activity derived from infrastructure projects, lower direct and indirect contributions
to public sector pension plans and the reduction in liabilities for the Pension Benefits Guarantee
Fund (the “PBGF”).
PBGF liabilities would be reduced in the short-term because the increase in the solvency rate
would lessen the likelihood of pension plan wind-ups because the pressure on plans would be
reduced. In the long-term, after plans transition to the new funding rules, the risk of under-funded
pension plans of any magnitude would be significantly reduced. Another advantage of the pension
bond is that unlike the current system, its cost to the province would be quantifiable.
The issuance of pension bonds would create distortions in the marketplace that would need to be
managed. One such distortion would be the potential mismatch between the solvency rate based
on Ontario Pension bonds and the annuity rate. It is for that reason that I am suggesting that the
Province take over administration of the benefits of wound-up plans. In order to better manage the
costs of this program I would propose that members would no longer be entitled to the payment of
a commuted value from a wound-up plan. Instead, members would only be eligible to receive
periodic pension payments.
If these reforms were enacted, then the existing solvency and going-concern rules could be
maintained. Under this proposed regime, member interests would be better protected because of
the requirement to match assets and liabilities.
An additional and less costly reform that would alleviate the solvency funding difficulties of pension
plans would be to change the basis of the transfer value calculation developed by the Canadian
Institute of Actuaries for the purposes of a plan’s solvency valuation. The current system places
too much emphasis on current market conditions. This produces both greater cost and greater
volatility in the solvency funding calculation. A system based on the pre-2002 standard would be
less volatile and would significantly improve the solvency position of most defined benefit plans.
Pension Plan Surplus
I believe that this issue needs to be addressed from a practical perspective based on the decision
of Mr. Justice Cory in Schmidt v. Air Products Canada Limited (“Schmidt”). Different rules should
apply when the plan is ongoing and when it is terminated.
When a plan is terminated, I believe that the surplus should only be paid to an employer with the
consent of the members, former members and retirees of the plan. In other words, the current
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Ontario regime. The only changes I would suggest to the current system would be: putting it in
place legislatively; and providing for arbitration if the parties cannot agree.
I believe that surplus rules for withdrawal from an ongoing plan should be different. As long as
there are appropriate safeguards employers should be allowed to withdraw surplus from an
ongoing plan. In my view such a change would promote better funding of pension plans.
If surplus withdrawal from an ongoing plan were permitted, then safeguards would have to be put
in place in order to protect the interest of plan members. These safeguards would include requiring
the plan sponsor to demonstrate to the Financial Services Commission of Ontario (“FSCO”) that
the plan would be fully funded after the surplus withdrawal even if the solvency valuation rate
(without reference to Ontario Pension Bonds if they are adopted) and equity markets fell by 20
percent, and any surplus would have to be repaid to the plan if the plan were fully wound up within
12 months following the date of the surplus withdrawal.
I also believe that sponsors should be permitted to take contribution holidays. However, the right
to take contribution holidays also needs to be subject to certain safeguards. In my view safeguards
should include requiring the employer to match assets and liabilities; and annually demonstrate in
each year that a contribution holiday is taken that the plan will be fully funded even if there is a
twenty percent decline in either the solvency valuation rate or equity markets. This change would
ensure that the taking of contribution holidays would be based on the current position of the plan.
As things now stand employers can continue to take contribution holidays until the next actuarial
valuation is filed. This has allowed for contribution holidays to be taken even though the plan was,
in reality, in a deficit position. The proposed safeguards would avoid this problem.
Pension Benefits Guarantee Fund
My comments are set out above in the funding section. With those reforms in place I believe that
the current system should be maintained.
Pension Plan Wind-ups
The issue of partial wind-ups needs to be addressed. Recent case law has led to losing sight of
the fundamental purpose of a partial wind-up – to protect the interests of long service, older
employees.
In my view, the focus needs to be on the most important protection offered by the current system.
Grow-ins or the “Rule of 55” serve to protect the interests of plan members. These rules did not fall
out of the sky. The Grow-in rules were put in place in response to plant closings in the mid-80’s
that resulted in long service employees receiving only a fraction of the pension that they expected.
This is an important interest that continues to need protection under Ontario’s pension legislation.
As a compromise, I suggest that partial wind-ups be eliminated in the Province of Ontario. In
exchange, any member whose employment terminates and whose age plus years of service total
55 would receive grow-ins. This would further the legislative purpose of grow-ins – to protect long
service members and would do so in all circumstances in which the employment relationship is
terminated.
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In exchange for this enhanced protection employers would be relieved of the regulatory burden
imposed by a partial wind-up. I would also note that this reform will not add any cost on a solvency
funding basis to the pension plan. Under current rules plan sponsors are required to fund on the
basis of the “Rule of 55”. This is not to suggest that this would be cost free. As things currently
stand employees who leave in a situation other than a partial wind-up do not get this benefit. The
value of that benefit would, presumably, be to the benefit of the plan. The point of this proposal is
to maintain balance in the system.
With respect to unlocated beneficiaries I would suggest adopting legislation like British Columbia’s
Unclaimed Property Act. The current system lacks finality and the lack of certainty serves no one’s
interest.
Pension Plan Splits and Mergers
The current system makes it difficult to merge plans or to transfer assets and liabilities from one
plan to another. If the point of the system is to protect pension benefits and to maintain coverage
then the rules need to be modified to allow for this to occur.
The policy position taken by FSCO with respect to public sector plans does not protect the interest
of plan members. Requiring replication of benefits is an impossible standard for a public plan to
meet and means that members will receive part of their benefit from one plan and part from
another. As the public plans are final average plans this means that members will probably receive
a lesser benefit than what they would receive if their benefit was paid from just one plan. Members
in the public sector should be given the choice to determine if they want to transfer their past
service liabilities from one plan to another.
In the private sector steps should be taken to permit transfers and mergers provided that notice is
given to all plan members. Surplus should be transferable and there should be no limits on its use
in the pension plan. Unless and until a pension plan is terminated there is no property interest in
the surplus and this should be expressly recognized under Ontario pension legislation.
The regulatory interest should be limited to ensuring that the transfer is taking place on an
appropriate basis and that the benefits of the exporting and importing plan members are not
adversely affected by the transfer or plan merger.
General Observations
The current regulatory model does not recognize that pensions are the product of the workplace
environment. I believe that we would all be better served if legislative responsibility was moved to
the Ministry of Labour. Labour has the expertise to sort through employee issues. This would
require moving pension regulation out of the Ministry of Finance and away from the Financial
Services Commission and re-creating the Pension Commission of Ontario (“PCO”) under the
auspices of the Ministry of Labour.
I also believe that the PCO should operate in much the same fashion as the Ontario Labour
Relations Board. There should be a full-time chair and vice-chairs that are representative of the
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pension community. This would ensure expert adjudication without fear of conflicts of interest that
are a current impediment to the system.
I also believe that the legislation should be amended so as to allow the parties to the pension
promise to work out their own solutions to issues. Under this model the regulator would act as a
referee and would police the deal to ensure that all parties had expert advice and understood the
consequences of their actions. All legislation becomes obsolete. The trick is to design it in such a
way as to allow it to evolve and to maintain its relevance. I believe that the reform I am proposing
would allow this to occur.
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