Dealing with pensions in uncertain times: reality check

Steep declines in company asset values over recent months have accelerated pension deficits - significantly affecting the ability of many employers to fund their company pensions. With an increasing number of companies worldwide expected to fail over the course of the next year and many others expected to experience significant financial challenges, sponsors and trustees must consider options for protecting pension assets in these uncertain times.

Countries seek to reduce insolvency risk
Several countries, such as the UK, US, Germany and Sweden have put in place strategies to reduce the insolvency risk. These include implementing pension guarantee programs, early warning programs and risk levies. More recently, Canada has passed legislation to provide a certain degree of protection for wages, vacation pay and certain pension contributions in the event of an employer's bankruptcy or receivership. However, even some of these safeguards may be at risk due to the increasing number of companies on the brink of an insolvency that will further stress pension guarantee organisations.

Dire corporate developments in the financial market have prompted The Pensions Regulator in the UK to release a statement to employers who sponsor final salary pension schemes regarding the impact of economic conditions. The statement highlights that employers need to confirm the current funding scheme is flexible. If a company is under pressure, there is room to renegotiate plans to repair pension deficits. This statement is available online at www.thepensionsregulator.gov.uk and is similar to a statement issued in October 2008 to trustees highlighting steps to take to assure funding requirements are met under their current pension schemes and specifically noting the financial pressures on companies.

The market downturn has also had a devastating effect on the funded status of defined benefit pension plans in the US. The Pension Protection Act of 2006 (P.L. 109-280)(PPA) included specific funding requirements to ensure that defined benefit plans were not underfunded and had the requisite cash to pay for benefits promised to employees and retirees. These funding requirements placed onerous obligations on already stressed companies. In December 2008, Congress enacted the Worker, Retiree and Employer Relief Act (P.L. 110-445) which made several technical corrections to the PPA and contains provisions to reduce the funding obligations of the PPA. While the Worker, Retiree and Employer Relief Act of 2008 reduced these funding obligations, funding obligations for 2009 are still estimated to be, on average, double those for 2008. In some cases, obligations will be much higher.

Pension guarantee programmes available in certain circumstances
In the event of a corporate insolvency, the UK and US have in place pension guarantee programmes - the Pension Benefits Guaranty Corporation (PBGC) and Pension Protection Fund (PPF) respectively.

The PBGC was created by the Employee Retirement Income Security Act of 1974 to encourage the continuation of defined benefit pension plans. When a plan is terminated the PBGC takes over and will pay individual pensions guaranteed up to certain limits by the PBGC. In the UK, the PPF was implemented via the Pension Act of 2004 and the purpose of the PPF is to pay compensation to members of defined benefit plans whose employers become insolvent and where there are insufficient assets to pay levels of compensation.

In Canada, where pensions are provincially regulated, the province of Ontario (but no other province, to date) maintains a Pension Benefits Guarantee Fund (PBGF), which is a publicly sponsored insurance fund that secures payments to a minimum level in the event of employer insolvency and fund deficiency. While employee groups object to what they perceive to be an inadequacy of the PBGF's benefit levels, employers are equally concerned about any suggestion of substantial premium increases to fund the insurance, as such premiums are paid for by employers.

US PBCG at risk
Developments in the financial market have significantly increased the US PBGC risk exposure, which was already in a perilous condition. Pension assets in the US alone declined by at least $1trn and may be down as much as $2trn over the past year. (See, US Congressional Budget Office Report, October 2008).

The U.S. Government Accountability Office (GAO) 2009 High Risk Series Report notes that despite a $2.9bn drop in its deficit for fiscal year 2008, PBGC assets may in fact be lower than reported given the significant stock market decline since the end of 2008. The potential increase in PBGC deficits is cause for concern- and action is required to safeguard the private pension system's role in the US national retirement security.

The UK PPF
Mercer recently noted that the insolvency risk in the UK market for the 10% of FTSE 350 companies most in danger of defaulting increased four-fold in the last quarter of 2008. (See, Mercer Quarterly Pension Update, January 19, 2009).

The PPF in the UK is untested by time and is experiencing its first economic recession. Several large employers have filed for administration and more are on the horizon as potential entrants to the PPF. This could actually jeopardise the fund's ability to provide the support for which it was created.

In reaction, the Society of Pension Consultants (SPC) has recently requested that the UK government implement a short-term plan to assist the PPF and UK companies in meeting their capital contributions to defined benefit schemes, including imposing a temporary funding and levy stay when the sponsoring employer is in financial need or distress and a commitment from the government to stand behind the PPF.

Canada implementing solvency funding relief
In Canada, as stock markets and interest rates declined significantly in 2008, the financial well being of Canadian pension plans was adversely affected to a significant degree. The Mercer Pension Health Index fell to 59%, down 23% from the beginning of 2008. Further, Watson Wyatt has commented on the negative impact which the events of 2008 have had on the solvency of Canadian defined benefit pension plans. Specifically, Watson Wyatt has determined that the solvency funded ratio of the typical plan decreased from 96% to 69% over the course of 2008.

The Canadian federal government and the provincial governments are cognisant of the acute financial problems many plan sponsors are now facing. Relief measures intended to ameliorate the solvency funding requirements for pension plans have been adopted or proposed in various pension jurisdictions in Canada. An extension of the time period to amortise the solvency deficiency of the pension plan and a three-year moratorium from funding solvency deficiencies are the most common relief measures.

In the Province of Ontario, for example, the solvency deficiency of a pension plan must presently be amortised within a maximum of five years. The Ontario government has announced it will introduce legislation in spring 2009 to extend the solvency amortisation period to 10 years with the consent of active members or their collective bargaining agent and retired plan members. Other measures being considered in various Canadian jurisdictions include possible adjustments to asset smoothing rules, consolidation of previous funding schedules and permitting greater flexibility in the use of actuarial gains to reduce annual cash payments by plan sponsors. Subject to certain conditions, letters of credit may now be used in certain Canadian jurisdictions to secure solvency deficiencies (as an alternative to funding), and a number of other Canadian jurisdictions are considering implementing this option as well.

In bringing forward the foregoing measures, the various jurisdictions in Canada are aware of the need to balance relief for employers against protections for the interests of members. With this latter point in mind, additional safeguards for members are being considered/proposed for circumstances in which an employer utilises one of the relief measures, such as enhanced member notice, accelerated funding of benefit improvements and limitations on future benefit improvements.

Transparency, communication, disclosure are essential
Business sense and practical intelligence mandate that employers, sponsors and trustees pragmatically evaluate their pension risks in tandem with company finances and plan for all scenarios, including insolvency. As well, consideration should be given to the extent to which this information should be shared among various interested stakeholders. Employees need to be aware of risks to their plan and ask what will happen to their pension assets if their employing company fails.

Now is the time for complete transparency, full communication and disclosure regarding the status of pension funding levels - and in making determinations as to whether additional security is needed to meet funding requirements. In these uncertain times, all pension plan stakeholders must take responsibility and be aware of risks in order to effectively safeguard pension assets.