Chances are the pension battle is going to get ugly.
A month ago hundreds of Montreal municipal employees protested a proposed law by the Quebec government that would compel unions to renegotiate their pension plans to staunch the province’s $3.9 billion municipal pension plan deficit. At around the same time, 85 Montreal firefighters retired immediately fearing that their pensions would be reduced following negotiations between the city and their union. More recently still, Montreal police have begun wearing red baseball caps and jeans or combat pants, a first step in an escalating series of pressure tactics to protest pension reforms. More protests are likely.
There is little question that municipal pension plans are in dire straits. In Montreal approximately 10.5 per cent of the city’s 2013 budget, or $510.3 million of the $4.9 billion budget, will fund the retirement system, including a fee of $256.3 million to cover the plan’s actuarial deficit for a single year. In Quebec City it’s more of the same, with Mayor Régis Labeaume estimating the city’s pension deficit to be around $800 million. All told, the Union of Quebec Municipalities says that 108 cities and towns across the province have a collective deficit of $5-billion in their defined benefit pension plans.
“The mayors have definitely reason to be concerned,” says Martin Rochette, a Montreal pension lawyer who was part of a panel of experts chaired by former Desjardins Group CEO Alban D’Amours, author of a report last spring on pension reforms.
Quebec is not alone. A combination of longer life expectancy, investment volatility and threadbare interest rates, and lax pension management has left many municipalities who operate their own pension plans with gaping deficits. The same holds true in some provinces that have created a single, province-wide pension plan for municipal workers.
Meanwhile, the proportion of Canadians who have workplace pensions continues to shrink. Barely 6.1 million Canadian workers, or 38.4 per cent, were covered by a registered pension plan in 2011, a figure that dipped slightly compared to 2010, according to Statistics Canada. What’s more, the number of Canadian employees who belong to defined benefit pension plans, which provides recipients with a guaranteed annuity upon retirement, too has fallen to under 4.5 million people. Private sector employers, after attempting to manage massive pension deficits for more than a decade, are actively considering ways to reduce their exposure. By and large employers are no longer offering defined benefit plans to new employees. Instead, they are moving them to defined contribution pension plans, which guarantee contributions but not final monthly pensions.
Canadian provinces and municipalities, the vast majority of whom offer defined benefit plans, are following suit. While it is unlikely that Canadian cities will suffer a similar fate to Detroit, which filed for Chapter 9 bankruptcy last year, it’s worth noting that a federal judge held that pension rights are no different than other contracts: “Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy,” he ruled last December.
Sharing the risk
Some jurisdictions have decided to tackle the issue head-on. New Brunswick took the lead two years ago by forging ahead with an innovative but controversial alternative plan design that allows for risk sharing and cost reductions. With cities like Saint John, staring down at a $195 million pension deficit, and Fredericton, whose pension deficit grew from $33 million to $59 million in the space of a year, there was little choice for reform “or the pensions were simply not going to be paid,” says Susan Rowland, a pension lawyer who headed a three-person New Brunswick pension task force that laid out a blueprint for pension reform.
The shared risk pension plan model, in part based on the highly regarded Dutch pension regime, is a flexible hybrid target plan. It essentially splits plan benefits into highly secure base benefits and moderately secure ancillary benefits like inflation protection and early retirement subsidies. Under New Brunswick’s Pension Benefits Act, all accrued benefits can be converted to a shared risk plan, and at the time of conversion a member’s accrued benefits become his base benefits under the new regime.
But while the model is designed to prevent any reduction in the base benefits in a minimum of 97.5 per cent of scenarios, it remains that base benefits too can be reduced just like ancillary benefits. Everything is contingent on adequate funding. “Many of the reforms that we proposed were things that we were not happy to do because you don’t want to see people to lose what they had already gained,” says Rowland. Other changes she had no problem with. Unlike defined benefit plans, which are subject to solvency funding requirements and valuations, shared risk plans are required to file annual funding policy valuations. Shared risk plans are also required under the Act to conduct annual stress testing, a risk management procedure that Canadian banks and insurance companies have been doing since 1991. The legislation also requires that the administrator of the shared risk plan no longer be in the hands of the employer but a trustee, a board of trustees or a not for profit corporation.
The province’s labour unions supported the initiative but now there are murmurs that a legal challenge is impending, none of which surprises pension lawyer Murray Gold of Koskie Minsky LLP in Toronto. He doubts that other jurisdictions would enact legislation that sanctions the ability to reduce rights associated with accrued benefits. “It rests on a morally repugnant proposition,” says Gold, who was appointed by Ontario’s premier to a technical advisory group on retirement security last February. “You have to think it is OK to make a promise as a government, as a moral authority, and have employees work for them for 30 years, and after they have worked, contributed and accrued towards this commitment, you turn around and rip up the promise you made to them.”
Some provinces have nevertheless taken heed, a development that the Chair of the CBA National Pensions and Benefits Law Section expected. “If you don’t have a solution like a shared risk solution, eventually you will see not only the private sector but governments too starting to freeze and convert their plans,” says Lawrence Swartz of Morneau Shepell Ltd. “You’re better off with a shared risk model that keeps the system going.”
Evidently that is what Alberta had in mind when it announced recently that it will scale back its public sector pension regime (that includes municipal workers) and introduce some elements of the shared risk pension plan model. Encumbered by an unfunded pension liability of $7.4 billion, Alberta intends to introduce legislation that will implement a new risk management system, modify the early retirement subsidy, put an end to guaranteed cost-of-living adjustments, and place an overall cap on contribution rates for benefits earned after 2015. Pension lawyer Jana Steele hopes that other jurisdictions will too seriously consider the shared risk model. “Provinces need to embrace design options outside of defined benefit and defined contribution,” says Steele, an executive member of the CBA pension committee. “The shared risk model has some of the attributes of the defined benefit type of design but comes with more cost certainty and has a more sustainable long-term design.” It appears that other jurisdictions are indeed interested. Rowland is expected to advise yet other provinces and municipalities looking at the shared risk pension plan model.
It is highly unlikely, however, that Quebec will take that route. The D’Amours report bluntly states that defined benefit plans should be maintained because it “provides the type of financial security that should be emphasized.” At the same time, though, it recommends that funding rules better reflect actual costs and that members assume a greater share of the costs.
The Quebec government introduced a bill this past June that heeded many of the recommendations made by the D’Amours report, to the delight of mayors and the resentment of unions. Bill 3 gives Quebec municipalities some tools to deal with soaring public sector pension costs. It compels cities and unions to split the costs of pension plan deficits. It also calls for the freezing of indexation of pensions for retirees, which means their pensions will not rise with the cost of inflation. A parliamentary commission will hold hearings on the bill in August, and the government hopes to make it law in December. “When you examine shared risk plans the measures revolve around the same principles,” notes Rochette. “It speaks of actual pension costs, the possibility of controlling costs through ancillary benefits, and sharing of costs. So while the recipe may not be identical, the ingredients are almost always the same.”
Unions are not pleased. They maintain they will be forced to pay for deficits they’re not responsible for. A coalition of municipal unions accused the Union of Quebec Municipalities and “certain mayors” of trying to divert attention from incompetent management of cities by elected officials by attacking the working conditions of municipal employees.
But for all the changes that are taking place in the Canadian pension landscape, Gold believes the model that should be emulated is the one already in use by a number of provinces – a single, province-wide jointly sponsored pension plan like Ontario’s giant municipal pension fund manager OMERS. “These jointly-sponsored plans work well,” says Gold. “That model is the answer, and has been the answer for the last 20 years and will continue to be the answer to the occupational pension plan coverage.”
Swartz concurs. “That is a good solution,” says Swartz. “There is economies of scale in the pension industry. If these smaller plans could get together and be part of a big plan, you get cost savings in administration and investment. Consolidation is a good way to go. The challenge will be how do you get all those plans together.”