Private-Sector Pension Plans: Have Recent Pension Reforms Addressed the Needs of Plan Sponsors?

Transcription

1 Private-Sector Pension Plans: Have Recent Pension Reforms Addressed the Needs of Plan Sponsors? Paul W. Litner & Jonathan Marin* Defined benefit (DB) pension plans have historically been an important element in Canada s three pillar retirement income system. However, recessions in the global and Canadian economies have increased pressures on the funding of DB plans, and highlighted concerns about their sustainability developments which have prompted governments in Canada to introduce a number of reforms to pension benefit legislation. The authors, counsel to employers and plan sponsors, provide an overview of the existing legislation and the reform process, with particular emphasis on changes to Ontario s regulatory framework for DB plans as it relates to four key areas: plan solvency and funding, surpluses, partial plan wind-ups, and asset transfers and plan mergers or splits. The paper notes that many if not all of these measures have been well-received by plan sponsors. However, in assessing whether the reforms will have the intended effect of stemming the decline in DB plan participation, the authors question whether the measures taken so far are not too little, too late, and suggest that more far-reaching, and permanent, steps will be necessary. The paper also reviews and comments on the main features of the legislation recently enacted by the federal government providing for pooled registered pension plans. 1. introduction Trends in the Canadian Retirement Income System Pension law is a field which is gaining in importance as more and more people retire and look to their pensions to sustain them during their golden years. The complex exercise of actuarial accounting that determines how pensions should be funded is rivalled only by the complexity of the law determining the pension rights and obligations of employees and employers, which lies at the intersection of contracts, trust law, and statute law. 1 * Paul Litner is a partner of Osler, Hoskin & Harcourt LLP, and Chair of the firm s Pensions and Benefits Department. Jonathan Marin is an associate in that Department. 1 Monsanto Canada Inc v Ontario (Superintendent of Financial Services), 2004 SCC 54, [2004] 3 SCR 152 at para 1 [Monsanto].

2 144 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] Canada s retirement system is often described as a three pillar model, 2 because Canadians look to three pillars of income support in their retirement. The first consists of universal government benefits for seniors which are funded by general tax revenues. It includes Old Age Security, the Guaranteed Income Supplement, and Spouses Allowance. The second pillar consists of mandatory government-sponsored programs financed by employer and employee contributions the Canada Pension Plan and the Quebec Pension Plan. These plans primarily operate to provide a basic level of income assistance to retired Canadians. The third pillar is comprised of employer-sponsored retirement plans registered pension plans and group Registered Retirement Savings Plans (RRSPs), as well as the personal savings of individuals (including savings through such tax-assisted vehicles as individual RRSPs and Tax Free Savings Accounts). It is this third pillar (and in particular, employer-sponsored pension plans) that this paper will focus on in the context of ongoing pension reforms. The two most common forms of registered pension plans are known as defined benefit (DB) plans and defined contribution (DC) plans, sometimes also called money purchase plans. These two plan models have been described and compared as follows: A defined benefit plan is an arrangement where an employee accrues (that is, earns) benefits by a formula that takes into account the number of years during which contributions are made to the pension plan on the employee s behalf and, in most cases, his or her earnings.... Defined benefit pension plans are either contributory or non-contributory. In contributory plans, an employee contributes fixed amounts as prescribed by the plan text (usually determined as a percentage of earnings), and the employer is responsible for the balance of the cost. In non-contributory plans, the employee does not contribute and the employer bears the full cost of the benefits.... The contrasting general plan-design model is the defined contribution pension plan.... In a defined contribution pension plan, the employer contributes a specified amount on the employee s behalf to the pension fund. This 2 See, e.g., Canada, Research Working Group on Retirement Income Adequacy of Federal-Provincial-Territorial Ministers of Finance, Summary Report on Retirement Income Adequacy Research (Ottawa: Department of Finance, 2009) at 3 (Research Director: Jack M Mintz) [Mintz Report].

3 recent pension reforms and the needs of plan sponsors 145 amount is usually determined as a percentage of the employee s earnings and is prescribed in the pension plan text.... The account is invested to earn a return that is determined directly by the investment fund options selected by the employee, in accordance with the plan s rules. This type of pension plan contains no defined formula for calculating a pension. The accumulated contributions, together with any investment returns earned on these contributions (usually net of expenses), provide the financial resources for the employee s pension. 3 Historically, DB pension plans have formed the backbone of the third pillar. 4 However, recent studies have noted two important trends. First, there has been global decline in the coverage of, and participation in, DB pension plans (the so-called extinction of DB plans). 5 In Canada, this decline has manifested itself primarily in the private sector. 6 Second, fewer Canadians are participating in any kind of employer-sponsored pension plan, 7 thereby becoming more reliant on the first two pillars of retirement income support. In this paper, we will examine the relationship between these trends (the decline in DB plans and the decline in retirement plan coverage) and recent pension reforms in Canada. The second part of the paper will provide an overview of the Canadian pension reform 3 Ari N Kaplan, Pension Law (Toronto: Irwin Law, 2006) at [Kaplan]. 4 See, e.g., Ontario, Expert Commission on Pensions, A Fine Balance Safe Pensions, Affordable Plans and Fair Rules (Toronto: Queen s Printer for Ontario, 2008), online: < report/> [OECP Report]. Section of the OECP Report indicated that, at the time, perhaps 90% of Ontario retirees and 80% of active plan members receive or expect to receive pensions classified for regulatory purposes as DB pensions. 5 In the United Kingdom, for instance, over 82 percent of DB plans are now closed as a result of issues which currently affect Canadian private-sector DB plans: market volatility, changes in financial reporting standards, and increases in life expectancy. Heather Wolfe, Look to U.K. innovation for DB de-risking, Benefits Canada (26 March 2012), online: Rogers Publishing < canada.com>. 6 The OECP Report concluded that the decline in DB plans was due to decreased union density. Some doubt is cast on that conclusion by recent studies which show that the decline in DB plans has far outpaced the drop in union density. The latest data available from Statistics Canada, for example, indicate that private-sector membership in DB plans declined by 3.6 percent in Statistics Canada, Pension Plans in Canada (9 May 2011). 7 Statistics Canada s most recent data (ibid) indicate that the number of workers in the private sector with pension coverage has declined by 2.1 percent.

4 146 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] process, focusing specifically on reforms in Ontario. Next, we will identify aspects of DB plan regulation that are of concern to single-employer DB plan sponsors. We will also look at how recent reforms in Ontario have attempted to address these concerns, and whether they have done so in a meaningful way. A recent survey indicates that Canadian private-sector plan sponsors have not been as quick as their counterparts in the United States and the United Kingdom to abandon DB plans. 8 This is an important consideration, as the extent to which the recent round of reforms meets employer concerns may affect the likelihood of DB plans continuing to be offered in Canada s private sector. Lastly, recognizing that most employees in Canada and Ontario are not covered by employer-sponsored pension plans, the fourth part of this paper will examine recent reforms by the federal government aimed at increasing third pillar retirement income support for those employees, through the introduction of the pooled registered pension plan (PRPP). The PRPP is intended to be a low cost, accessible retirement savings vehicle that targets Canadians who do not currently participate in any employer-sponsored retirement plan. 2. Pension Reform (a) Overview of the Pension Reform Process in Canada Pension reform has been long overdue in Ontario and in many other Canadian jurisdictions. Although minor reforms and one-off, band aid solutions have been introduced from time to time to address specific issues or gaps in pension legislation, most Canadian 8 Aon Hewitt, Many Canadian Defined Benefit Pension Plan Sponsors Committed for the Long Haul, According to Global Aon Hewitt Survey, online: < aon.mediaroom.com/index.php?s=43&item=2292>. According to this survey, 39 percent of Canadian respondents have closed their DB plans for existing members, compared to about 80 percent in both the U.K. and the U.S. Closing a DB plan is distinct from winding it up (i.e. terminating it). While there are various means to close a DB plan for new or existing members and to convert it to a DC plan, typically the plan is amended to freeze benefit accruals under the DB component of the plan and to then require those members to participate in DC provisions of the plan on a go-forward basis.

5 recent pension reforms and the needs of plan sponsors 147 jurisdictions have had fundamentally the same pension regime since the mid 1980s or early 1990s. Prior to recent reforms, it had been over 20 years since Ontario s Pension Benefits Act (PBA) 9 or its regulations last saw significant changes. 10 However, the world around us has not been so static; significant changes have occurred in the Canadian and global economies, and employment patterns have changed over time. Recessions in the early 1990s and in , combined with the volatility in capital markets and continuing low interest rates, have put pressure on the funding of DB plans and have caused many employers to question whether such plans are still sustainable. Most pension plans that had funding surpluses in the 1980s and 1990s now have significant deficits. The range of investment products for pension plans has grown, and pension investing is now done on a global basis. In addition, workers have become less likely to spend their entire career with the same employer. These dynamic factors, among others, have increasingly posed challenges to our static system of pension legislation and have illustrated the pressing need for its significant modernization. Nevertheless, pension reform has occurred slowly and in incremental stages across Canada. The recent reform process began with the identification of issues by pension industry organizations such as the Association of Canadian Pension Management, which called for extensive reforms to pension laws to save a failing system. 11 In response to growing public pressures, various Canadian jurisdictions established expert commissions to study the problems identified by pension industry stakeholders and to make recommendations on how to move forward. The first of those jurisdictions was Ontario, which established the Ontario Expert Commission on Pensions (the OECP) in November Alberta and British Columbia appointed their Joint Expert Panel on Pension Standards in the fall of 2007, and Nova Scotia appointed a Review Panel in February Each of these 9 Pension Benefits Act, RSO 1990, c P The last significant reform of Ontario s Pension Benefits Act and its regulations occurred in For example, see Association of Canadian Pension Management, Back from the Brink: Securing the Future of Defined Benefit Pension Plans (August 2005).

6 148 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] bodies published a discussion paper which examined key issues or themes, and solicited industry and public views. 12 Following the publication of those discussion papers, public consultations were held in a number of jurisdictions for example, beginning in October 2007, the OECP held public hearings with various stakeholder groups and each panel or commission then produced a final report. The Ontario 13 and joint Alberta/British Columbia 14 reports were released in November 2008, and the Nova Scotia panel reported in January Later in that year, the federal government and a number of provincial governments finally announced that pension reform was forthcoming. (b) Pension Reform in Ontario Following this lengthy consultation process, many pension reforms have now been introduced and passed into law in Ontario in a multi-stage process. That process began with Bill 236, 16 which received Royal Assent on May 18, On August 24 of that year, the Ontario government indicated that it was going to build upon the 12 Ontario Expert Commission on Pensions, Reviewing Ontario s Pension System: What Are the Issues? A Discussion Paper for Interested Ontarians (February 2007), online: < pdf>; Alberta/British Columbia, Joint Expert Panel on Pensions Standards, A Better Pension System for the Future: Finding a Balance (Edmonton/Victoria, 2007); Nova Scotia, Pension Review Panel, Discussion Paper (Halifax: Department of Labour and Advanced Education, 2008), online: < pensionreview/docs/discussionpaper.pdf>. 13 OECP Report, supra note Alberta/British Columbia, Joint Expert Panel on Pension Standards, Getting Our Acts Together (Edmonton/Victoria: Ministry of Finance and Enterprise/Ministry of Finance, 2008), online: < pdf/2008_1125_jepps_final_report.pdf>. 15 Nova Scotia, Pension Review Panel, Promises to Keep (Halifax: Department of Labour and Advanced Education, 2009), online: < pensionreview/docs/pensionreviewpanelfinal.pdf>. 16 Bill 236, An Act to amend the Pension Benefits Act, 2d Sess, 39th Leg, Ontario, 2010.

7 recent pension reforms and the needs of plan sponsors 149 first phase of reforms introduced by Bill 236, 17 and announced a number of further reform proposals (the August Announcement). 18 Most of the changes described in the August Announcement were included in Bill 120, 19 which received Royal Assent on December 8, On July 1, 2012, a number of the amendments introduced by Bill 236 and Bill 120 were proclaimed into force, in conjunction with amendments to the regulations to the PBA introduced by Regulation 178/12. However, several amendments introduced by Bill and Bill will not be proclaimed into force until accompanying regulations are finalized. While the most significant reforms to Ontario s pension regime were made through Bill and Bill 120, 23 further amendments have been made to the PBA, largely to implement previously announced reforms. Bill received Royal Assent on December 8, 2010, and amended the PBA to revise the portability options available to plan members. Bill 173, 25 which received Royal Assent on May 12, 2011, introduced amendments to the PBA that mostly relate to earlier-announced reforms described in the explanatory notes as technical. Finally, Bill received Royal Assent on June 20, 2012, and mainly serves to clarify previous amendments to the PBA. In addition, a 17 Ibid. 18 Ontario Ministry of Finance, Further Strengthening Pensions: McGuinty Government Making Ontario s Pension System More Sustainable (24 August 2010), online: < 19 Bill 120, An Act to amend the Pension Benefits Act and the Pension Benefits Amendment Act, 2010, 2d Sess, 39th Leg, Ontario, Supra note Supra note Supra note Supra note Bill 135, An Act respecting financial and Budget measures and other matters, 2d Sess, 39th Leg, Ontario, Bill 173, An Act respecting 2011 Budget measures, interim appropriations and other matters, 2d Sess, 39th Leg, Ontario, Bill 55, An Act to implement Budget measures and to enact and amend various acts, 1st Sess, 40th Leg, Ontario, 2012.

8 150 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] number of amendments have been made to the regulations to the PBA in conjunction with the reforms discussed in this paper THE ONTARIO Reforms and Issues for DB Plan Sponsors This part of the paper will review the recent pension reforms in Ontario and assess whether they have adequately addressed the concerns of employers/sponsors of single-employer, private-sector DB plans in the province. The efficacy of such reforms will be 27 Regulation 85/11 permits Ontario to adopt the federal rules on investment of pension fund assets as they are amended from time to time. This means that pension plans registered in Ontario may now use the federal investment rules passed on June 25, 2010, and that future changes to those rules will apply to Ontario registered pension plans. Ontario has also done the following: made certain amendments to the regulations to the PBA concerning jointly sponsored pension plans and plan funding generally (Regulation 177/11); passed new regulations providing temporary solvency funding relief for certain public-sector plans (Regulations 178/11 and 179/12) and a new method of dividing pensions on marital breakdown (Regulations 287/11, 288/11 and 467/11); amended the Pension Benefits Guarantee Fund provisions of Regulation 909 (Regulation 466/11); extended temporary solvency funding relief to eight public-sector pension plans listed in the regulation mostly university plans (Regulation 12/12); extended and/or expanded temporary solvency funding relief to privatesector plans more broadly (Regulations 164/12, 329/12 and 330/12); drafted accompanying regulations to the amendments in Bill 236, Bill 120 and Bill 173 which came into force on July 1, 2012 (Regulation 178/12); drafted regulations to specified pension plans, namely the Abibow Canada Inc. Pension Plan (Regulation 180/12), the General Motors Pension Plans (Regulation 181/12) and the Stelco Inc. Pension Plans (Regulation 182/12); extended temporary solvency funding relief for five years for specified Ontario multi-employer pension plans (Regulation 203/12); passed regulations setting out the regulatory framework for letters of credit (Regulation 364/12); passed regulations relating to actuarial reports in respect of certain pension plans (Colleges of Applied Arts and Technology Pension Plan, Healthcare of Ontario Pension Plan, and the Ontario Public Service Employees Union Pension Plan) (Regulation 447/12); and passed regulations relating to the transfer of pension entitlements to a life income fund as a result of the wind-up of the Nortel pension plans (Regulation 10/13). At the date of writing, Ontario had also published draft regulations which would permit designated public-sector plans to negotiate agreements to give eligible employees an opportunity to consolidate their pension benefits in relation to past government-initiated restructurings.

9 recent pension reforms and the needs of plan sponsors 151 particularly important in light of evidence that participation in DB plans is rapidly declining. In particular, this part will discuss the recent Ontario PBA reforms in four areas that private-sector DB plan sponsors have identified as being of particular concern to them: plan funding and solvency; surplus withdrawal; partial plan wind-ups; and asset transfers, plan mergers and plan splits. While recent pension reforms do respond, in part, to the employer concerns identified during the extensive consultation period, by the time they have (or will) come into force, it may be too little, too late to provide employers with meaningful incentives to retain their DB plans. (a) Plan Funding and Solvency Pension plans are required by the PBA to be funded on both a going concern basis and on a solvency basis, to ensure that employer contributions are sufficient to fund the benefits promised to plan members. Actuarial valuations of a pension plan must be done, typically every three years, to determine whether the plan has enough assets to meet its ongoing liabilities (i.e. a going-concern valuation) and whether it would have enough assets to meet its liabilities if it were assumed that the plan was to be wound up on the date of the valuation (i.e. a solvency valuation). If an actuarial valuation reveals that a plan has a going-concern unfunded liability or a solvency deficiency, the employer is required to make special payments in order to liquidate that liability or deficiency. The PBA typically allows a going-concern unfunded liability to be amortized over a period of fifteen years, while a solvency deficiency must typically be amortized over five years. The 2011 annual report of the Financial Services Commission of Ontario (FSCO) on the funding of defined DB plans in Ontario (the 2011 FSCO Report) highlighted the deterioration in the funded position of DB pension plans. The report revealed that 52 percent of DB plans were less than fully funded on a going-concern basis, and that 88 percent were less than fully funded on a solvency basis. 28 Perhaps 28 Financial Services Commission of Ontario, 2011 Report on the Funding of Defined Benefit Pension Plans in Ontario, Eighth Annual Report: Overview and Selected Findings at 4. By way of comparison, FSCO s 2007 report revealed that 76 percent of plans were less than fully funded on a solvency basis, and 42 percent were less than fully funded on a going-concern basis.

10 152 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] even more concerning was the projection that the median solvency funded position of DB plans would deteriorate significantly (from 87 percent at the end of 2010 to 72 percent at the end of 2011), as a result of the combination of poor investment returns, a decline in long-term interest rates and a move to more conservative mortality assumptions. 29 The volatility in global markets since 2008 has resulted in poor pension plan investment performance and, generally speaking, in the deterioration of the funded position of DB plans. In Ontario, the response to those funding concerns has been to provide temporary solvency funding relief and exemptions from solvency funding for specified plans. 30 Ontario has also tried to adopt a more flexible approach to the funding of solvency deficiencies, by permitting the use of letters of credit. The measures taken to date, especially the extension of solvency funding relief for single-employer DB plans, are in our view a step in the right direction, but no permanent measures have yet been introduced to assist plans with funding concerns. In addition, the reforms have been largely reactive, in that they do not address the underlying causes of such concerns but seek simply to allow pension plans to weather the storm until economic conditions improve. (i) Letters of Credit Before the recent reforms, plan sponsors were not permitted to fund solvency deficiencies through letters of credit. As a result of reforms introduced through Bill (and accompanying regulations), effective January 1, 2013 certain prescribed employers are now permitted to use letters of credit to cover up to 15 percent of a plan s solvency liabilities instead of having to make payments into 29 Ibid at For example, in Ontario Specified Ontario Multi-Employer Pension Plans were temporarily exempt from solvency funding if they filed an election in writing with the Superintendent between September 1, 2007 and September 1, This period has recently been extended for another five years by Regulation 203/12. In addition, eligible Jointly Sponsored Pension Plans (as listed in the regulations to the PBA) are exempt from solvency funding requirements (Regulation 177/11). 31 Supra note 19.

11 recent pension reforms and the needs of plan sponsors 153 the pension fund for solvency payments due after January 1, The introduction of letters of credit has been well received by plan sponsors, but its usefulness to employers may be limited by the fact that obtaining such letters of credit can be prohibitively expensive, in light of the risks they entail for financial institutions that offer them. (ii) Solvency Funding Relief On June 19, 2009, the Ontario government enacted Regulation 239/09, which amended the regulations under the PBA to provide for temporary solvency funding relief for all DB plans, subject to certain exceptions. A pension plan administrator was entitled to choose one or more of the following options by making an election with the province s Superintendent of Financial Services on or before the filing of a valuation report with a valuation date on or after September 30, 2008 and before September 30, 2011: Option 1: Defer for up to a year the start of special payments required to liquidate any new going-concern unfunded liability or new solvency deficiency determined in the solvency relief report. Option 2: Consolidate special payments for pre-existing solvency deficiencies into a new five-year payment schedule that starts on the valuation date of the solvency relief report. Option 3: With the consent of members and former members of the pension plan, extend the period for liquidating the new solvency deficiency from five years to a maximum of ten years. 32 On November 1, 2012, the Ontario government enacted Regulation 329/12, which added the following solvency funding relief options for DB pension plans, for valuation reports with a valuation date on or after September 30, 2011 and before September 30, 2014: Option 4: Consolidate existing solvency special payments (including those consolidated under Option 2 above, but excluding special payments which were extended to a maximum of ten years under Option 3 above, and excluding special payments 32 PBA Regulations, s 5.6(3).

12 154 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] required only by reason of plan wind-up) into a new five-year schedule. Option 5: Extend the five-year period to make solvency special payments of any new solvency deficiency to a maximum of ten years (whether or not there was a similar election under Option 3, above). However, any such election under the Regulation 329/12 measures will only apply to a new solvency deficiency revealed in the new report. Therefore, if a plan administrator has elected to extend the solvency special payments under both Option 3 and Option 5, each solvency deficiency would be liquidated over a different (but overlapping) ten-year period. 33 An industry observer has commented that this form of regulatory flexibility may help to explain why plan sponsors in Canada have not closed DB plans at as fast a rate as in other countries since the global market downturn in In this regard, for many plans that did not take advantage of the solvency funding relief options available for reports prepared prior to September 30, 2011, the extension of solvency funding relief has been warmly welcomed (and, ideally, will encourage employers not to close their DB plans to new members). That being said, temporary solvency funding relief does not represent a complete or permanent solution to DB plan funding concerns. In our experience plan sponsors have explored, and likely will continue to explore, plan de-risking measures (including conversion to a DC plan), despite the extension of temporary solvency funding relief. (b) Surpluses The PBA defines a surplus as the excess of the value of the assets of a pension fund related to a pension plan over the value of the liabilities under the pension plan. 35 Only a DB plan will typically 33 PBA Regulations, s 5.6.1(3). 34 John Keefe, Canada s DB plans decline, Financial Times (19 April 2010), online: < html#axzz1qztnp3ks>. 35 The definition further provides that the value of assets and the value of liabilities are both to be determined in accordance with the regulations to the PBA: PBA, s 1(1).

13 recent pension reforms and the needs of plan sponsors 155 have a surplus, as all amounts in a DC plan (after taxes and expenses) must be paid out to plan members. 36 Surpluses can arise for a number of reasons, 37 but are most commonly the result of a better-thanexpected performance of plan investments. Entitlement to surplus has been one of the most controversial issues in Ontario s pension regime. As one commentator has noted, [n]o subject matter in the area of pension law and policy is more divisive and polarized. 38 Advocates of employer entitlement to surplus have argued that DB plans are intended only to provide the benefits promised to plan members pursuant to the formula set out in the pension plan text, that plan sponsors should be entitled to benefit from prudent investment practices and over-contributions, and that the current pension landscape requires legislative incentives (such as entitlement to surplus) to encourage sponsors to maintain DB plans. 39 This can be contrasted with the following viewpoint (seen by employers as being pro-employee ) articulated by the Ontario Court of Appeal: [P]ension plans are for the benefit of the employees, not the companies which create them. They are a particularly important component of the compensation employees receive in return for their labour. 40 To a very large extent, the issue of entitlement to pension plan surplus, and how to balance the competing interests of employers and employees in such surplus, has been left to the courts to determine. (i) Surplus Entitlement For well over a decade, the pension industry s view on surplus entitlement has been shaped by the analytical approach adopted by the Supreme Court of Canada in Schmidt v. Air Products of Canada 36 Kaplan, supra note 3 at Kaplan has identified several events that can give rise to surplus: the use of conservative financial, demographic or other assumptions by an actuary when determining the annual normal cost to fund benefits; changes in plan benefit levels; changes in annuity purchase rates; reductions in employee participation rates; and events related to the sale or purchase of a business. Ibid at Ibid at For discussion of these different points of view, see ibid at Retirement Income Plan for Salaried Employees of Weavexx Corp v Ontario (Superintendent of Pensions) (2002), 30 CCPB 151 (Ont CA).

14 156 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] Ltd. 41 The Schmidt decision had two significant implications. First, the Supreme Court struck a compromise in distinguishing between actuarial surplus in an ongoing plan, to which employees have no specific rights, and actual surplus on plan wind-up. 42 Although specific entitlements are almost always based on the wording of the plan documents in question, the creation of that distinction has, generally speaking, favoured the taking of contribution holidays by employers, 43 while limiting the circumstances in which an employer can demonstrate entitlement to surplus on plan wind-up. Second, Schmidt dealt with the applicability of trust law to the ascertaining of surplus entitlement. The Court concluded that in pension plans where no trust is set up, the plan documents determine the allocation of any surplus remaining on termination of the plan. However, if the pension fund is subject to a trust, trust law principles will apply, with the general result that surplus will be included in the assets held in trust unless the original trust agreement explicitly states that it will not be. 44 Because of Schmidt, an employer seeking to establish entitlement to surplus must demonstrate, through a trust law analysis, that the original trust agreement did not require the inclusion of surplus in the trust assets. This process has led to considerable litigation. A detailed review of post-schmidt jurisprudence on surplus entitlement is beyond the scope of this paper, but it is important to recognize that trust law analysis has played a pivotal role in the courts assessment of such entitlement where the assets of a pension plan are held in trust. Since Schmidt, an employer has had to show one of the following in order to demonstrate entitlement to surplus assets held in trust: (a) that the employer was made a beneficiary of the trust from the 41 [1994] 2 SCR 64, 115 DLR (4th) 631 [Schmidt]. 42 Subsequent Supreme Court of Canada decisions have echoed the notion in Schmidt that there is a distinction between the use of surplus in an ongoing plan and the withdrawal of surplus on wind-up (with an employer having more restricted entitlement in the latter case). For example, in Buschau v Rogers Communications Inc, [2006] 1SCR 973, [2006] SCJ No 28 (QL) [Buschau], the Court said: Before termination of a plan, a surplus is only an actuarial concept. While the plan is in operation, individuals entitled to the surplus assets do not have a specific interest in them. 43 For further discussion on contribution holidays, see below. 44 Schmidt, supra note 41 at paras 61, 95.

15 recent pension reforms and the needs of plan sponsors 157 trust s inception; (b) that the employer expressly reserved the power to revoke the trust at the trust s inception; 45 or (c) that the employer is entitled to the surplus by the operation of a resulting trust (i.e., if the objects or purposes of the trust have been fully satisfied and assets still remain in the trust fund, those remaining assets may result back to the settlor). It is rare that an employer will have made itself a beneficiary of the trust at its inception, particularly in mature plans where the original trust agreement was established before the notion of pension surplus became common. Historically, income tax law strongly dissuaded employers from expressly reserving the power to revoke a trust at its inception, because a settlor who retains the right to revoke will be taken not to have alienated so that the income and capital of the property remain his, and will be taxed accordingly 46 (although it could be argued that Canada Revenue Agency would now be unlikely to adopt this position in respect of pension trusts). As for a resulting trust, the Supreme Court has stated that one will rarely be found in the pension context. 47 The fact that it was so hard for a plan sponsor to show entitlement to a surplus meant that surplus refunds to an employer, and surplus sharing between employers and employees, were difficult to implement before the recent reforms to the PBA. In addition, the requirement to examine plan documents from the inception of the plan can often be a daunting task, particularly in the case of pension plans established many years ago. Employers have therefore viewed Ontario s surplus regime as asymmetrical: a plan sponsor is responsible for any funding 45 The Court also noted in Schmidt that an unlimited power to amend a trust agreement did not include a power to revoke the trust, and that the latter power could be granted only by extremely clear and explicit language. Ibid at para DWM Waters et al, Waters Law of Trusts in Canada, 3d ed (Toronto: Thomson Carswell, 2005) at In Schmidt, the Court concluded that a resulting trust would rarely be found in the pension context, for these reasons: This may be because the objects of the trust can never be said to be fully satisfied so long as funds which could benefit the employees remain in the pension trust, or because the settlor has manifested a clear intention to part outright with its contributions. The operation of the resulting trust may also be precluded by the presence of specific provisions dealing with the disposition of surplus on plan termination : Schmidt, supra note 41 at para 79.

16 158 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] deficiency that might exist, but the case law and Ontario s legislative regime have significantly restricted the sponsor s entitlement to a surplus, particularly when a plan is wound up. In other words, the risks of underfunding rest primary with the employer, but the employer cannot fully benefit from overfunding the plan. A number of the pension reforms discussed below, such as revising the surplus-sharing regime and clarifying the rules on contribution holidays, have helped to reduce the asymmetry of risk for employers. However, none of these reforms has introduced a legislative override to the requirement to undertake a trust law analysis in order to establish surplus entitlement (i.e., to be entitled to withdraw surplus, an employer will often have to share it with employees). More importantly, market conditions have been such that very few plans now have surplus to which employers could gain access by virtue of the recent reforms. As a result, of all reforms to date that have sought to induce plan sponsors to retain DB plans, the reforms to the surplus regime may be the most striking example of too little, too late. We turn now to discuss reforms relating to surplus withdrawal and to an employer s entitlement to take contribution holidays. However, the issue of surplus entitlement also plays a pivotal role in many of the reforms to be considered later in the paper (most notably, those relating to partial plan wind-ups). (ii) Restrictions on Surplus Withdrawal For an employer to receive a payment of surplus from a pension fund, consent must first be given by Ontario s Superintendent of Financial Services. 48 Before the recent reforms, surplus withdrawals from an ongoing pension plan almost never occurred, because 100 percent of the members had to provide their consent for such a withdrawal. 49 Although a lower consent threshold was applied on the partial or full wind-up of a pension plan, section 79(3)(b) of the PBA prohibited the Superintendent from consenting to an employer surplus withdrawal unless the the plan provide[d] for payment of 48 PBA, s 78(1). 49 PBA, s 79 (as this section read before the reforms).

17 recent pension reforms and the needs of plan sponsors 159 surplus to the employer on wind up of the plan. The courts have interpreted this as requiring the employer to demonstrate legal entitlement to surplus (or to obtain a court order approving a settlement in which the employer was granted entitlement to a surplus payment). 50 Consequently, for a surplus-sharing agreement to receive regulatory approval, an employer had to obtain the consent of the requisite number of plan members, and also to show legal entitlement to surplus in accordance with the principles set out in Schmidt. Generally speaking, the Superintendent adopted a strict approach to the requirement of demonstrating legal entitlement to surplus. In most cases, plan sponsors could not meet this high bar, and would have to obtain court approval before applying to the Superintendent. This added significantly to the cost, complexity and delay associated with surplus withdrawal applications. Where employers could not demonstrate entitlement to surplus (either in an application to the Superintendent or in court proceedings), this did not necessarily mean that employees were entitled to the surplus in question, but simply that sufficient evidence did not exist to permit the payment of the surplus to the employer (i.e., the surplus had to remain in the plan fund). The surplus withdrawal provisions in the PBA were amended by Bill and again by Bill As a result of these reforms, surplus may now be paid to an employer either through consent (i.e. a surplus-sharing regime) 53 or through a court order declaring employer entitlement. 54 The employee consent alternative is available where a plan is ongoing or where it is fully or partially wound up. That alternative requires that an employer reach an agreement with twothirds of plan members (or with a union on their behalf) and with an appropriate percentage of the former members and other entitled 50 For example, see Kent v Tecsyn Int l Inc (2000), 24 CCPB 229 (Ont Sup Ct J) at paras 25-30; Reichhold Ltd v Boyer (2000), 23 CCPB 182 (Ont Sup Ct J) at para Supra note Supra note PBA, s 77.11(7). 54 For continuing pension plans, see PBA, s 79(1). For plans that are being wound up in whole, see PBA, s 79(3). For plans being partially wound up, see PBA, s 79(3.1).

18 160 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] persons. 55 Where the consent regime is used, and the requisite number of consents is obtained, the employer no longer has the obligation to demonstrate entitlement to surplus. Except for the provisions on surplus-sharing agreements from ongoing plans, these amendments came into force on December 8, Amendments to the PBA not yet in force will give the Superintendent a discretion to invoke binding arbitration where surplus issues have not been resolved within a specified period after a plan wind-up. 57 Ideally, this will reduce costs and bring finality in the more complex or contentious surplus cases. However, binding arbitration may discourage the cooperative approach envisaged by the surplus-sharing rules, which now are often used to avoid the uncertainty and costs of protracted litigation. Before filing an application with the Superintendent for the withdrawal of surplus, an employer is required to notify certain individuals that it intends to do so. Recent amendments to the regulations to the PBA (effective July 1, 2012) have somewhat simplified these notice requirements, which should reduce the cost of preparing the application. 58 So far, the most immediate impact of the new surplus-sharing regime has been to facilitate such sharing in the context of partial plan wind-ups declared in the late 1980s and early 1990s. Since few pension plans now have a surplus, the new regime has rarely been used to address surplus issues in ongoing plans or plans that have recently been wound up. 55 See PBA, s 77.11(7)1 for the consent requirements in an ongoing plan, s 77.11(7)2 for the consent requirements for a plan that is being wholly wound up, and s 77.11(7)3 for a plan that is being partially wound up. For a partial wind-up, consent is needed only from those members who are affected by the partial wind-up, or from a union on their behalf: s 77.11(7)3. 56 The provisions on a surplus-sharing agreement from an ongoing plan are to be proclaimed later. See PBA, s 79(1)(b) [not yet in force]. 57 PBA, ss 77.11(9)-(10) and PBA, s 78(2). Notably, an employer will no longer have to include information relating to the surplus attributable to employer and employee contributions. In addition, where the surplus withdrawal application is filed pursuant to the consent regime, the notice does not need to contain a historical plan summary and analysis. Financial Services Commission of Ontario, Questions and Answers relating to Surplus Regulations effective July 1, 2012, online: < fsco.gov.on.ca/en/pensions/legislative/pages/surplustoemployer.aspx>.

19 recent pension reforms and the needs of plan sponsors 161 (iii) Contribution Holidays The term contribution holiday refers to the ability of an employer to use excess assets in the pension fund to reduce or suspend the normal cost contributions 59 it is required to make under the terms of a pension plan and by the PBA. Members contributions can similarly be reduced or suspended. A contribution holiday is permitted only if a pension plan has a surplus, as identified in an actuarial valuation of the plan. Before the recent reforms, the PBA did not clearly address an employer s or member s entitlement to take a contribution holiday. Despite the lack of statutory guidance, the Supreme Court s decisions in Schmidt and in Kerry (Canada) Inc. v. DCA Employees Pension Committee 60 have established common law principles governing the permissibility of contribution holidays. The legality of contribution holidays was addressed by the Court in Schmidt. As part of the great compromise referred to above, the Court concluded that an employer s contribution holidays do not encroach on the pension trust or reduce accrued benefits, because employees have no entitlement to surplus in an ongoing plan. As a result, if the employer s contribution formula gives an actuary the discretion to determine the contribution levels necessary to fund certain plan liabilities, and the actuary takes surplus into account in making that calculation, contribution holidays will be permitted. 61 In Kerry, the Supreme Court revisited the issue of contribution holidays and confirmed the holding in Schmidt that an employer may take a contribution holiday unless the terms of the plan specifically preclude it. 62 In addition, Kerry confirmed that an employer may use surplus to take contribution holidays under the DB portion of a pension plan, so long as the employer s contribution formula allows for actuarial discretion. 63 Importantly, the decision also clarified that in the absence of legislation stating otherwise, members 59 The normal cost (or current service cost) for a pension plan is defined in the regulations to the PBA as the cost of pension benefits and ancillary benefits allocated to a fiscal year of a pension plan, determined on the basis of a going concern valuation. These costs are to be distinguished from special payments SCC 39, [2009] 2 SCR Schmidt, supra note 41 at paras Kerry, supra note 60 at para Ibid at para 69.

20 162 CDN. LABOUR & EMPLOYMENT LAW JOURNAL [17 CLELJ] in an ongoing DB pension plan have no right to require that surplus funding be used to increase their benefit security. 64 Reforms introduced by Bill provide that an employer who must make contributions under a pension plan is entitled to reduce or suspend contributions for the normal cost 66 of the plan if it has a surplus (or if other prescribed requirements are met). 67 In addition, plan member contributions will be permitted to be reduced or suspended if a pension plan has a surplus (and if other prescribed requirements have been satisfied). 68 However, a contribution holiday will be permitted only if the plan documents that create and support the pension plan or pension fund documents do not prohibit a reduction or suspension of contributions. 69 These amendments to the PBA with respect to contribution holidays are not yet in force, 70 and so it is not clear what the prescribed requirements will be for reducing or suspending contributions. However, it would appear that the amendments are simply intended to codify the decisions in Schmidt and Kerry, rather than to expressly permit contribution holidays. While Ontario s 2012 Budget committed the government to releasing regulations on the eligibility for contribution holidays in 2012, these regulations have not yet been finalized and/or released to the public. Although plan sponsors have welcomed the purported clarification of contribution holiday rules, the execution fell short of the objective. At the root of employers concerns is the requirement to demonstrate entitlement (i.e., the absence of trust law impediments) to take contribution holidays. In this regard, the reforms have fallen short of a legislative override of the requirement that an employer review the plan documents and trust documents from the very inception of the plan in order to establish entitlement to a contribution holiday. As a result, the reforms will probably not preclude employer-employee disputes over contribution holidays if DB plans ever return to surplus. 64 Ibid at para Supra note See supra, note PBA, s 55.1(1) [not yet in force]. 68 PBA, s 55.1(2) [not yet in force]. 69 PBA, s 55.1(3) [not yet in force]. In addition, any contribution holidays permitted as a result of these reforms would not be a cessation or suspension of contributions for the purpose of determining whether the Superintendent is entitled to wind up the pension plan (in whole or in part): PBA, s 69(5) [not yet in force]. 70 These provisions will come into force when proclaimed by the Lieutenant Governor.

21 recent pension reforms and the needs of plan sponsors 163 In addition, employers see Ontario s surplus regime as continuing to dissuade plan sponsors from overfunding pension benefits. In this light, it can be argued that the reforms should have gone further to entitle plan sponsors to surplus, as well as to encourage overfunding in order to insulate pension plans from the risk of market swings. (c) Partial Plan Wind-Ups As an employer is not typically under a legal obligation to provide its employees with a pension plan, 71 the PBA permits an employer to voluntarily wind-up (i.e. terminate) its pension plan. 72 In certain circumstances, the Superintendent can also order that a pension plan be wound up. 73 Prior to recent reforms, a pension plan could 71 The ability of an employer to terminate its pension plan may, however, be limited by the terms of any applicable collective bargaining agreement or the terms of the pension plan documents. 72 PBA, s 68(1). 73 PBA, s 69(1) indicates that the Superintendent may wind up a pension plan (in whole or in part) if any of the following events occurs: (a) there is a cessation or suspension of employer contributions to the pension fund; (b) the employer fails to make contributions to the pension fund as required by this Act or the regulations; (c) the employer is bankrupt within the meaning of the Bankruptcy and Insolvency Act (Canada); (d) a significant number of members of the pension plan cease to be employed by the employer as a result of the discontinuance of all or part of the business of the employer or as a result of the reorganization of the business of the employer; (e) all or a significant portion of the business carried on by the employer at a specific location is discontinued; (f) all or part of the employer s business or all or part of the assets of the employer s business are sold, assigned or otherwise disposed of and the person who acquires the business or assets does not provide a pension plan for the members of the employer s pension plan who become employees of the person; (g) the liability of the Guarantee Fund is likely to be substantially increased unless the pension plan is wound up in whole or in part; (h) in the case of a multi-employer pension plan, (i) there is a significant reduction in the number of members, or (ii) there is a cessation of contributions under the pension plan or a significant reduction in such contributions, or (iii) any other prescribed event or prescribed circumstance occurs. On May 3, 2012, the Ontario government introduced regulations that now allow the Superintendent to order a plan wind-up in the additional prescribed circumstances: (a) the plan has no active members (i.e., it has only former members, retired members and beneficiaries who are not members); or (b) the members of the pension plan no longer accrue pension benefits or ancillary benefits under the plan and employees are no longer allowed to become members of the plan.