Canada: Pension Fund Deficits — The Next Big Thing

Volatile stock markets, corporate accounting scandals and a depressed US economy are among the factors that have had a significant negative effect on pension plan funding. In fact, according to a recent study by three Canadian consulting firms, that may be an understatement. The study estimates public and private pension plans in Canada face a combined funding deficit of $225 billion. The Office of the Superintendent of Financial Institutions (OSFI) also confirms that funding shortfalls have reached critical levels. It found over 50% of Canada’s 1,205 pension plans in a deficit position. Of those, 55% are underfunded by 10% or more.

With this new reality comes even greater risk of litigation against not only employers, administrators, and sponsors, but also actuaries, trustees, custodians, investment advisors, directors and other participants in the pension industry. Already, there are clear signs that pension deficit litigation will be a major driver of pension-based lawsuits in Canada. Understanding what is prompting these court actions, and how the courts and regulators are handling them, may help everyone involved be more vigilant.

Breaches of statutory requirements relating to funding under federal and provincial pension legislation may result in prosecutions under the legislation and related civil actions for damages. Prosecutions and civil actions can arise in many areas, five of which are noted below:

Contribution Obligations. Typically, costs for plans increase as investment goals fall short of expectations. Substantial increased sponsor contribution requirements occur in the form of higher current service costs, the loss of contribution holiday entitlements and the requirement to amortize unfunded liability or solvency deficiency. In each case, a plan’s failure to make the appropriate contributions can result in both prosecutions and civil actions.

Proper Disclosure. These days, particularly, it will be important that all accounting expense numbers be checked thoroughly to ensure that any higher current service costs reflecting the lower investment return assumptions for assets are recognized and that there is an amortization of these losses. Failure to make proper disclosures may lead to prosecutions and civil actions.

Additional Valuation Requirements. Generally, an actuarial valuation report for defined benefit pension plans is required by law within three years of the previously filed actuarial period. Regulators may request reports more frequently. The rules vary among the pension regulators. These valuation reports are an important management tool, but they also involve a significant cost to the plan sponsor or the plan itself. If regulators believe a pension plan is underfunded, expensive regulatory action may be taken to enforce these valuation report requirements.

Transfer Restrictions. Underfunded pension plans may be prevented from transferring out 100% of the commuted value of pension entitlements. Again, various rules prevail in each jurisdiction. To the extent that errors are made in the transfers and excess commuted values are moved out, the plan’s sponsor may be liable for those differences. If the plan sponsor cannot cover the differences, litigation can ensue against not only the sponsor but also others, such as plan trustees and actuaries.

Regulatory Monitoring & Intervention. Lately, regulatory authorities in every jurisdiction have been playing a more active role in monitoring funding situations. OSFI, for example, is taking a more interventionist approach. In at least 12 specific cases lately, OSFI has performed its own estimates indicating that a plan is in a deficit position and, if the plan sponsor was taking a contribution holiday based on the last filed actuarial report, it would request that the sponsor restart contributions. OSFI is also seeking new powers in 2004 to prohibit plan amendments where a plan is in deficit and to require funding of a plan by a plan sponsor on a plan wind-up.

There have already been a number of high-profile court cases dealing with plan deficits that demonstrate the trends, circumstances and types of issues that can be expected, including:

Regulatory Intervention. Air Canada is the administrator and sponsoring employer of 10 registered, defined benefit pension plans and a number of unregistered supplementary pension plans and several registered pension plans through Jazz Air Inc. In 2003, OSFI analyzed the financial information provided by Air Canada and discovered a solvency deficit in each of the airline’s pension plans, which was contrary to an aggregate surplus of $915 million stated in its valuation reports.

OSFI issued a "temporary direction" suspending the airline’s contribution holidays and ordering actuarial valuations to be prepared in order to determine the extent of any pension shortfall. It was expected that such valuations would show solvency deficits at $1.3 billion for Air Canada and $3 million for Jazz. The airlines became liable to pay at least $135 million in 2002-2003 as a result of the OSFI temporary direction.

Soon after, though, Air Canada sought protection from its creditors and backed away from OSFI’s demands.

OSFI, however, did not back away and it has aggressively pursued Air Canada on behalf of plan beneficiaries. OSFI has set out stringent requirements for funding the shortfalls and is an active advocate in both the insolvency hearings and negotiations with new investors.

Air Canada provides some pointed lessons for employers on the interventionist stance that can be expected of regulators.

Regulatory Assistance. As part of Algoma Steel Inc.’s plan of arrangement under federal creditor protection legislation, the company received significant relief from its retiree pension obligations. Algoma also got substantial assistance from the Ontario government for its ongoing pension plans for active hourly and salaried employees. Funding for this assistance will be paid directly or indirectly out of the Ontario Pension Benefits Guarantee Fund. The Ontario Superintendent of Financial Services assumed ongoing responsibility for the administration and payment of Algoma’s retiree obligations up to the Fund’s maximum benefit levels. On the bright side, this suggests regulators are also willing to step up to the financial plate in special cases and help rescue plans.

Claims Against Actuaries. Several actions have involved actuaries, including a potentially interesting BC suit against the actuary and plan trustee for the shortfall in a bankrupt company’s pension plan. Sadler v. Watson Wyatt & Co. has yet to move beyond preliminary motions, but should be watched closely. A 1993 BC case, Wynne v. William M. Mercer, illustrates another claim against actuaries in the case of an underfunded pension plan. The plaintiffs sought damages arising from an actuarial valuation report that failed to disclose an unfunded liability and instead disclosed an $11.75 million surplus. The court found that the actuarial error had not caused any damage in the circumstances.

Claims Against Almost Everyone. Case law shows there is increasing litigation risk for almost anyone connected with plan management, including trustees, custodians, investment advisors, directors, unions, and employers in multi-employer pension plans. Corporate reorganizations, for example, have attracted litigation where representations and warranties as to funded status were given to acquisitors or new investors. Even governments have been targeted. In one case, the question was whether the legislature could reduce plan benefits in the face of the unfunded status of a plan. In Rossiter v. Prince Edward Island (Attorney General), the government retroactively reduced pension benefit indexing to 1984 levels. In this 1996 case, the court ruled against the applicants.

There has been tremendous growth in the number of class actions launched in Canadian courts. Class proceedings are swiftly becoming a common vehicle for members and former members of pension plans to make claims.

In at least one Ontario case, Ormrod v. Etobicoke (Hydro Electric Commission), the judge referred to a claim by a group of former employees for post-retirement benefits as the "quintessential class action." Many courts are likely to approach pension-related claims with a similar mind set.

More recently, an Ontario class action proceeding was certified in Givogue v. Burke against both plan trustees and actuaries involving a $4.3 million shortfall. Though undecided, this case also illustrates the growing use of class actions in pension litigation.

Pension fund deficits are the new reality in this economic environment. Given the financial magnitude of these shortfalls, the other new reality is that litigation will almost certainly ensue if plans fail to take steps to deal properly with unfunded liabilities.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.