Pension Plan Management Reform in Canada
by Erik Andersen
 Numerous public and private Canadian pension plans have recently disclosed large losses from their investments and a state of inadequate funding for their actuarial obligations. To carry on in the fashion of the past decade or two, or just make minor adjustments, is to avoid seeing the “elephants in the room”.
All pension plans should seek to satisfy the following criteria as these monies are “deferred” incomes and the property of the beneficiaries.
First is the “know your client rule”.
Second is that there must not be “discretion” granted to those tasked to select investments for the beneficiaries.
Third is that pension plans must not be allowed to turn plans into “margin’ accounts by assuming liabilities that come attached to specific investments. These Canadian standards exist to protect regular investors and should be forcibly included in the design of all pension plans. Incorporation of these conditions maybe a little awkward but the penalties of not doing so have and are being demonstrated as unacceptable to Canadians.
Pension plan troubles do not appear overnight. What does appear overnight is the realization by the beneficiaries that their pensions are going to be reduced or lost altogether. What also does appear overnight is a political passion to come up with remedies for the victims.
The correct reform response should be the creation of plan/corporate conditions that anticipate trouble in time to remedy a developing problem. Part of the solution is trouble avoidance using the three criteria mentioned above. A second part of avoidance would be to impose non-negotiable harm reduction offsets (a form of risk reciprocity and the principle of symmetry).
In the corporate world the balance sheet, specifically retained earnings, alongside respectable earnings, secures the financial interests of all including the pension accounts beneficiaries. Every time a corporation compromises either of these by misconduct or bad judgments the security of the pension plans are compromised.
Perhaps it is instructive to look at some specific examples. Air Canada is one contemporary example of the successive pillaging of retained earnings accounts that began in the 80s with the PWA takeover of Wardair. The later had negative net equity of $50 million (private information from one of the lending banks), unable to raise working capital from new public investors (marketed out); so was a company that should have gone out of business. Lenders were reluctant to have that happen so put the company on financial life-support long enough to find another with a strong enough balance sheet and enough incentive to take over the debt. By this action PWA reduced its financial strength, a protective condition for all its pension plans. This pattern was repeated with the acquisition of CP Air and then again with Air Canada’s takeover of a bankrupt CP Air. For various reasons, including accumulated debt, Air Canada managed to wipe out all of its retained earnings account and more (about $4 billion). Pension plan protective mechanisms and early intervention would have stopped this tale of woe three decades ago.
Other indicators of brewing trouble are the reckless practice of “vendor financing” and the inability to finalize financial statements. This is the “Nortel” example. Booking sales revenues is important but there is a world of difference when one examines the “quality” of the revenues. Vendor financing has to be one of the most obvious early warning conditions available to any competent observer (Royal Trustco was one that allowed reckless lending to happen in their UK operation. They were ridiculed in the City and for at least two years before bankruptcy were unable to sell short-term paper in the Canadian commercial market.). In Nortel’s case there were years of flawed financial statements that even the least informed would have known about.
Pension plan reform in Canada must introduce fiduciary discipline that the evidence shows to be missing. When decisions are taken that undermine the financial integrity of pension plans there must be non-negotiable consequences known to all. One step in providing remedies is already being considered, that of imposing greater surpluses. Protection should not stop there but include the use of first mortgage bonds on commercial assets, bonds that can be called for redemption when plans are once again sound.
Erik Andersen
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