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Defined benefit pension problems

GB Geo-Blog

Defined benefit pension problems

Beware of experts (I, of course, am one of the few exceptions to this rule). A case in point: academics in the field of labor relations. Some have argued that the federal government should not legislate the Air Canada workers back to work. Instead, the government should allow the bargaining process to work itself out.

The editorial board of the Globe and Mail appears to have bought into these arguments. In todays’ paper, the lead editorial, titled “The rush to legislate”, stated that the “circumstances do not yet justify the federal government’s apparent rush to deploy it [back-to-work legislation], especially with regards to Air Canada.” In support of its position, the editorial board claimed, as have academics opposing the legislation, that there is ample competition for Air Canada.

There are two serious problems that are overlooked by both academic “experts” in labor relations and the Globe and Mail editorial board. The airline industry is a network industry, one of four such industries (telecommunications, energy transmission and distribution, and financial services being the others), and as such, it is essential for the economy to function. Furthermore, with most airlines operating with average load factors in the 80% range, there is little spare capacity available to handle any serious disruptions at Air Canada.

Secondly, and more importantly, the collective bargaining process cannot resolve the systemic underfunding of defined benefit pensions. And neither can an arbitrator. The problems far exceed the competence of any arbitrator, and ultimately, the federal government will have to step in and orchestrate a solution.

As I pointed out in my previous blog, absurdly optimistic investment return assumptions by actuaries have ensured that defined benefit plans will be underfunded, except during brief periods of very strong bull markets in equities. Companies taking contribution holidays during these exceptional periods, thus ensuring even greater degrees of underfunding when the bull markets ran their course, have exacerbated the underfunding problem.

The solution requires the five key parties to share the costs. These parties are the companies who took contribution holidays, their employees, the pension committees of the board of directors of such companies, the actuaries who advised companies and the federal government. The federal government is included because it allowed the charade to persist and provided the tax deferrals that encouraged the growth of these plans.

A starting point is to estimate the real level of underfunding for all defined benefit pension plans for companies that are federally incorporated. Then some sharing formula needs to be worked out or legislated. I suggest that each of the five parties assumes an equal share – 20% each – of the total costs of eliminating the deficits in the pension plans.

Going forward, it should not matter over time if companies and their employees opt for defined benefit or defined contribution pension plans, as long as companies can never take contribution holidays or withdraw temporary surpluses from defined benefit plans, and realistic assumptions underlie the plans. Of course, since I favor tax simplification, I prefer that no pension plan be given any tax advantage. Employers and employees should negotiate a plan based on its merits, not on the tax implications.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.


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