The future of pensions: Share the risks

Want to fix the pension mess? Go Dutch.

About five years ago, after the 2001-02 bear market, the private pension system in the Netherlands was facing a crack-up. Its pension regulator told companies they needed to put up more cash to back their employee retirement funds. The companies howled, then came up with a solution. Canada could learn from it.

Few doubt that we face a similar crisis today. Finance Minister Jim Flaherty has sent his parliamentary secretary, Ted Menzies, on a tour of the country to ask what should be done about it. About 80 per cent of private sector workers in Canada have no guaranteed company pension, and the number is rising as more businesses ditch their defined-benefit plans. The other 20 per cent do, but many aren't sure they can count on it.

A few companies risk being drained by their pension needs. Air Canada says that under current rules, it would have to pump $800-million into its plan this year; it doesn't have the money. The Ontario government will probably wind up bailing out the pension of General Motors' Canadian unit, at least in part.

It looks bad, but why is it this bad? You can only blame the bear market for so much. Air Canada had a $400-million pension deficit at the end of 2007 - after the Canadian stock market had risen for five consecutive years. BCE's pension plans were already $850-million in the hole before last year's crash. Both companies are now appealing to Ottawa for relief from rules they say will suck too much cash into their pensions this year.

Pension funds are a nifty bargain between companies and their staff, in theory. It's only when you break down how they work in practice that the dysfunction is laid bare.

Companies want them cheap and employees want the benefits lavish, and the only way to square the circle is to put a large chunk of the money (at least half, usually) on stocks.

When markets are up, everything looks swell. Companies often stop paying into the fund; in fact, if they get even a smallish surplus, they may be required by law to do so. Unions and employee groups look for sweeteners. Then the correction hits. The surplus vanishes as though Bernard Madoff were running it. On paper, there may be only 80 or 70 or 60 cents for every dollar needed to pay pensions.

That's when things get absurd. If the company is fairly healthy, it is rewarded by being forced to pay perhaps hundreds of millions of dollars at a time when its cash flows are falling. If it's not so healthy, it goes to the government to beg for help. And if it's really unhealthy, it throws the entire pension scheme into doubt.

Nortel Networks, which filed for bankruptcy protection in January, has already cut off payments to some supplemental pension plans, says Mark Zigler, a Toronto lawyer representing 2,000 Nortel workers and retirees in Canada. It's unknown how much they'll get from their primary pension fund - not as much, probably, as they were expecting.

You can see the problem. Rather than sharing the risk, the burden of a financial crisis or market collapse falls disproportionately on one side or the other. Either the workers and retirees get whacked or the company does.

It's hard to know what's more unfair: That a 70-year-old line worker from General Motors has to worry about his main source of retirement income, or that a company like Air Canada risks running out of cash because of an actuary's calculations. (Count on this: Ottawa will give them a break - because there's no way in this economy that the government will let companies fail solely because of pensions.) No wonder companies are abandoning their defined-benefit pension plans as fast as they can.

"These things are not fixable," says Keith Ambachtsheer, director of the Rotman International Centre for Pension Management, who probably knows more about Canadian pensions than anyone else. When you cut through the jargon about interest rates and solvency funding, it's quite simple. In many cases, the pensions that have been promised are unaffordable, barring a miracle comeback for the stock market.

Take the Ontario Teachers' Pension Plan. The typical teacher in the province now retires at 58, and can qualify for a full pension (average: about $41,000 a year) at that age if they've worked 27 years. But the latest projection is that today's retirees will be drawing from the fund for about 30 years. The math just doesn't work - unless you are earning outsized investment returns, which means taking outsized risks. Say, what's happened to big risk-takers lately?

But the Dutch faced this exact problem. Their answer, Mr. Ambachtsheer says, was to water down pension guarantees without taking away the pension. He calls this a "target" pension scheme. The promise of a $25,000-a-year pension to a GM worker would be replaced by a target of the same. If equities went into the toilet, they might have to make do with $22,500 until the market rebounded. Teachers might have to settle for $38,000 because Ontario taxpayers are at their limit.

But there would be an upside, too. Pension plans would have a better chance of avoiding huge deficits and retirees would be spared the worry of someone taking a chainsaw to their benefits - as has happened in a few corporate bankruptcies. Workers would be accepting slightly smaller pensions (possibly) in return for more secure ones. Mr. Ambachtsheer says: "It's the future." The two sides in the pension bargain would, in essence, be sharing the cost of a market crash - the very definition of going Dutch.