The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management

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May 2007

MEPPs: To Solvency Fund Or Not?

By: H. Clare Pitcher

The most critical issue facing multi-employer pension plans (MEPPs) today is solvency funding. At best, it could mean a substantial reduction in benefits, even accrued benefits, including those of pensioners. At worst, it threatens their very existence. While solvency funding may be the most ʻpolitically correctʼ and ʻregulatory expedientʼ thing to do, it is clearly the very wrong thing to do!

Within the broad range of pension arrangements offered in Canada today, MEPPs are unique. It is that uniqueness which underlies the reasoning to not fund these types of plans on a solvency basis.

Let us first be clear on the types of plans to which we are referring. Essentially, we are including those types of pension plans which are “specified” as per the federal Income Tax Act – the socalled specified multi-employer pension plans (SMEPs). These plans have several participating employers and are typically union-negotiated/ collectively-bargained. They are either joint labour-management or 100 per cent union-trusteed. Employer contributions, typically cents per hour, are fixed as per the negotiated collective bargaining agreement (CBA) and go into the plan on a Defined Contribution basis. Benefits to members, typically flat benefits, are defined by a formula or a scale and come out of the plan on a Defined Benefit basis.

While DB plans define the benefits (with the contributions being variable) and DC plans define the contributions (with benefits being the variable), MEPPs define both the benefits and the contributions. This is the essence of their uniqueness.

The Canada Revenue Agency views these plans as DC, while the pension benefits acts of the various jurisdictions across Canada view them as DB plans. Clearly, they have elements of both. For greater certainty, we are not referring to the large public sector MEPPs, which are essentially DB plans.

In going-concern funding – which applies to all DB plans – the funding target is set assuming the plan will continue into the future indefinitely, actuarial assumptions are long-term, and unfunded liabilities are typically required to be funded over 15 years.

MEPPs solvency fund

In solvency funding, the funding target is set assuming the plan will terminate immediately (as of the valuation date), actuarial assumptions are prescribed based on current settlement rates, and solvency deficiencies are typically required to be funded over five years. Its purpose is to protect the benefits in the event of plan wind-up, which makes sense in the case of single-employer pension plans because of the possibility of a single employerʼs insolvency.

Nature Of Underlying Pension Promise

There are a number of factors that differentiate MEPPs from the typical single-employer DB (SEDB) pension plan, the most fundamental of which is the nature of the underlying pension promise.

Very simply, in a MEPP, the basic pension promise is DC, or ʻcontingent DB.ʼ It is contingent on there being enough assets to fund the benefits so that, even though the objective is DB or ʻtargetʼ benefit, the promise in reality is DC. The employersʼ liability (other than in Quebec) is limited to the negotiated contributions. Therefore, as in the case of DC plans, the members are the ultimate bearers of the risk. They get what their employers pay for, through the negotiated fixed contributions. Effectively, then, the members are the owners, beneficiaries, and risk-takers of these plans. The members, through their representatives (the trustees), determine the (DB) benefit payouts. Furthermore, the trustees have a fiduciary responsibility to the members to ensure that the pension promise is kept.

Reduce The Benefits

MEPPsIn this context, solvency funding has no relevance. On plan wind-up, unlikely as that is, the liabilities of the plan are, by definition, equal to the assets. If the accumulated assets are less than the otherwise-applicable liabilities, the plan has the ability to legally reduce the benefits. Clear and full disclosure and communication to plan members about the nature of the promise and the inherent risks to members is, therefore, very relevant and critically important.

Most, if not all, regulators across Canada will tell you that the reason for solvency funding is to improve the security of the benefits. This is true in respect of single-employer plans (because additional contributions get put into the plan), but it is simply not true in the case of MEPPs.

The reality for MEPPs is that solvency funding does not improve the security of the benefits since, unlike single-employer plans, it does not result in more money being put into the plan (because the contributions are fixed by collective agreement). Solvency ʻfundingʼ is, therefore, a misnomer in the context of MEPPs. What it may do, of course, is force the benefits to be reduced. [Therefore, solvency ʻreductionsʼ is probably a better name for it.] On potential plan windup (the risk against which solvency funding is designed to protect), members simply end up with a higher percentage of a lower benefit, which is exactly equal to a lower percentage of a higher benefit. The illusion of enhanced benefit security simply means less adequate benefits.

So, solvency funding clearly does nothing positive for a MEPP plan member. Tragically, however, it can potentially and has historically, especially over the past few years, very seriously hurt these plans and their members.

Stability Of Contribution/ Benefit Rates

Rate stability – both contribution and benefit – is critical for MEPPs because of the DC/DB nature of these plans. Solvency funding, based on current ʻpoint-in-timeʼ long-term bond interest rates, is extremely volatile and, since contributions are fixed by collective agreement, can and will result in the benefits bouncing all over the map. In whose best interest is this?

Going-concern funding (based on longterm actuarial assumptions for the future) – not solvency funding – enhances the stability of these plans.

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