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History of the Defined Benefit Plan? What’s Wrong and Why?

Bob Tangney, CEBSCompensation, Pension and Benefits DirectorThe Woodbridge GroupMississauga, Ontario

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History

• Abraham Lincoln once said• “Those who fail to learn from history are doomed to repeat it.”

• Bill Soloman in a recent speech on pensions• To quote from the Ecclesiastes Chapter 1, verse 9-11:

• “Only that shall happen which has happened. Only that occur which has occurred. There is nothing new beneath the sun! Sometimes there is a phenomenon of which they say: ‘Look, this one is new!’—It occurred long since, in ages that went before us. The earlier ones are not remembered; so too those that will occur later will no more be remembered than those that will occur at the very end.”

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History

• Bismarck in 1884 outlined in a speech• “The real grievance of the worker is the insecurity of his existence; he is

not sure that he will always have work, he is not sure that he will always be healthy, and he foresees that he will one day be old and unfit to work. If he falls into poverty, even if only through a prolonged illness, he is then completely helpless, left to his own devices, and society does not currently recognize any real obligation towards him beyond the usual help for the poor, even if he has been working all the time ever so faithfully and diligently. The usual help for the poor, however, leaves a lot to be desired, especially in large cities, where it is very much worse than in the country.”

• In 1889, Bismarck introduced Old Age and Disability Insurance Bill.

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Longevity

• Bismarck’s Program• Normal retirement date —age 70• Life expectancy—late 60s• Few reached age 70 • if they did life expectancy about 3 years

• In the 70s—A53 and 1955 Railroad Mortality Tables• life expectancy for average person—around age 73

• Mortality Tables used since—GAM73, GAM83, GAM 93

• 94 table with projections introduced• Life expectancy for average person—around age 85 and increasing

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Longevity

• Overtime—actuaries, regulators, accountants, etc.• Required we recognize longevity• The cost has been built in within private sector programs

• It has become an issue as if we just discovered this

• It also seems we are just discovering that there was a baby boom

• Why is this being “marketed”• If not prepared (public plans), means to reduce cost are needed• Not popular to delay retirement dates but this may be easier to sell

than reducing benefits

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Governments in Action

• Beginning with Bismarck, governments saw need for retirement policy • To provide minimum protections• To encourage savings

• Most often legislation arose from key events

• Usually legislation implemented about 10 years after• delay is government inaction or best case scenario• not always best outcome

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Government in Action—Gov’t Programs

• After 2nd World War—studies/reports • 1951 - Old Age Security—minimum income needs • Bismarck’s vision, age 70 retirement

• 1957—Registered Retirement Savings Plans (RRSP)• After more studies, Tax Deferred Savings Program• Other recommendations (Mandatory, Funding/creation of

DB plans, etc.)• No political will

• 1966—Canada Pension Plan• Career average type plan, contribution rate of 3.6%• Contribution rate known to be too low to fund benefit promise• This would be addressed at each 5 year review date• Increase to 9.9% in 90s

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Employer Pension History

• While ER Plans existed, many had little assets• Government Annuities/Insured Annuities• Pay as you go programs.

• As the size of ER plans and opportunities grew in the 50s• Move toward self insurance grew, companies took on more risk• Fully pooled moved to self insured with stop loss then to fully self

insured

• Concept of “too big to fail” began

• Impact of events (history) produced change

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Government in Action—Employer Plans

• Pension Benefits Act Ontario 1965• Studies/commissions/reports done in the 50’s• Growth in pensions—self insured and pay as you go• Bankruptcies—Studebakers• Both to promote pensions and to protect plan members

• Why the Growth in self insurance• Annuity Rates—5%• Investment Returns—7% or greater

• Employer View• Better use of Capital• Risk versus Reward

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Government in Action—Employer Plans

• Pension Benefits Act Ontario 1965 requirements• Pension Assets separated from Company (Trust/Insurance contract)• Actuarial Valuations to establish funding requirements

• Unfunded Liabilities—over 15 years• Experience Deficiencies—over 5 years

• Pension Commission standard• Annuity Rates—5%• Investment Returns—7% or greater• Valuation interest rate less than annuity rate

• Valuation Methods—level premium

• Employer does not have the size of insurance industry

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Key Events

• Studebaker (other bankruptcies, plan closures)

• Recession in early 70s

• Massey Ferguson/Iron Ore closures

• Dominion Stores

• Pension Benefits Act, 1987

• Tire Company Closure in 1990

• New rules in 2012

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Key Events—early closures/bankruptcies

• Studebaker (others)

• Pushed introduction of Pension Benefits legislation• In Canada, Ontario 1965, in US in 1974 (ERISA)

• Plan Sponsors• Set up Trust Fund or Insurance Contract• Transferred money from prior arrangements if any• Initial unfunded liabilities to be funded over 15 years• More conservative than insurance assumptions

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Key Event—Recession in Early 70s

• 1st time of significant “experience deficiency”• Required 5 year amortization• Costly especially as companies coming out of recession• Sponsors complain as funding at such conservative assumptions

• Two results• Ontario’s set up Royal Commission on Pensions as they had not

been reviewed for many years• Actuarial Valuations move to become less conservative

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Key Event—Recession in Early 70s

• Royal Commission Report On Pensions—late 70s• 9 volume presentation—review of all aspects- 1980• Deferred Compensation, Family Asset, 2 yr. vesting, etc.• Recommendations implemented—PBA 1987 Ontario

• Funding Change• Move from experience deficiency to solvency deficiency• Address concerns about high cost of experience deficiency• Experience Deficiency based on valuation rates• Solvency deficiency based on Annuity/Market Rates• Since Valuation Rates lower than Annuity/Market,

• On long-term basis less likely to have significant funding payments as in 70s

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Key Event—Funding Change

• Deficiency Funding in 70s along with less conservative assumptions led towards surpluses• Move from experience deficiency to solvency deficiency• Address concerns about high cost of experience deficiency• Experience Deficiency based on valuation rates• Solvency deficiency based on Annuity/Market Rates• Since Valuation Rates lower than Annuity/Market,

• On long term basis less likely to have significant funding payments as in 70s

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Key Event—Changes to Valuation Methods

• Actuarial Valuations• Level Premium methods to Unit Credit

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Key Event—Changes to Valuation Methods

• Interest Assumptions—to demonstrate only Year On-going Rate Annuity Rate Investment Return

1975 4.5% 5.5% 7%

1980 5.0% 6.5% 14%

1985 7.5% 14% 19%

1990 8.0% 10% 12%

1995 8.0% 8.0% 10%

2000 8.0% 7.0% 8.0%

2005 8.0% 5.0% 5.0%

2012 6.5% 4.0% 4.0%

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Key Events—Massey Ferguson/Iron Ore

• Too big to fail—Farm equipment, steel mills, airlines, paper mills, auto industry, etc.• Pension improvements granted in lieu of pay to be funded in future• At bankruptcy, benefit for retirees and actives were reduced

• Pension Benefits Guarantee Fund• Not created by pension folks but by labour ministry• Coverage to provide protection for plan members • Paid for by Plan Sponsors who continue to exist • Concept of “grow in” born

• For Plan Sponsors, new cost

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Key Events—Dominion Stores

• Closing of Multiple stores with less than 50 EEs

• Under Employment Standards Act, • Notice and Severance Rules did not apply• Unhappy union and members decided to find means to get even

• Pension plan had surplus• Application made and was approved by the Pension Commission• Legal Challenge under Trust Laws• Surplus becomes an issue, employers required to pay if deficit but

may not have access to surplus if it existed

• Plan Sponsor response• Was having a well funded plan with surplus a good idea

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Key Events—Pension Benefits Act, 1987

• Improvements adding cost• 2 year vesting• Pre-retirement death benefits• Pension Benefits Guarantee Fund• Transfer rights• Pensions as deferred compensation while accruing• Pensions as family income when paid

• Funding Requirement• Solvency Funding as a long-term more appropriate method• At no point was “grow in” considered as part of Solvency funding

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Key Events—Tire Company Closure

• As slowdown in economy hit, Etobicoke location to close• Many long service employees• Many just short of being eligible to retire• Cost of severances very high• Pension plan in surplus situation

• Solution—Grow In• Those past Special Early Retirement Date to get full benefit• Those who were “Rule of 55”, to get benefit at date they would attain

Special Early Retirement Date• Extra benefits would help replace severance or assist group losing

their jobs after many years of service

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Key Events—Tire Company Closure

• Unexpected outcome• Challenged that as legislative requirement, “grow in” value should be

included in Solvency Valuation• Supreme Court decision created significant problems• Special rules need to be created for some so they did not have to

meet this standard

• Result• Plans with ancilliary benefits had new unexpected costs• Pension benefit Guarantee Fund had new risk• Plan Sponsors with DB plans had to try to deal with combination of

factors leading to desire to eliminate DB plans altogether

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Key Events—Partial Windups/New Rules

• Surplus issues continue• Entitlements on Partial Wind-ups and in plan mergers

• Partial Wind ups• Cost of Annuities and distribution, work involved

• “Grow In” and immediate vesting• Trade off

• Regulations and Interpretations to follow

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Summary

• Concept started well although maybe slow

• Plans well funded could meet the promise• 5, 10 15 year cash flows done to recognize volatility

• Events and rules pushed funding to aggressive• Bankruptcies, aging of population, promises made

• While interest rates and investment results went up, no problems and we stopped concern about the future

• When interest rates, returns dropped, we refused to recognize

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Summary

• Now we are running back to annuities

• Concern is people not saving enough

• PRPP and forced savings in DC arrangement the solutions

• Has anything changed and will we learn form the past

• End result is there is a cost and somebody will have to pay somewhere either in contributions or lower incomes

• While this is about pensions in Ontario, it is much worse elsewhere

• If extended, could this be extended to many other areas

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Summary

• Is there a future for DB Plans?

• In Ontario, for those who survive and keep their DB plans open, the answer is a qualified yes.• Funding requirements especially for “grow in” will likely

produce surplus and reduced cost• DB pension plans have always delivered more income for less

money• Opportunities for turnover/downturns much more opportune for

those with a DB plan

• In other jurisdictions especially public sector plans, where funding less aggressive• The cost to catch up significant

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