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For sale: frozen pension plan, liabilities included

Posted by on Feb 1, 2008 in Employee Benefit News, Retirement | 0 comments

By: Sheryl Smolkin

Read this article and comments at HRInsider.ca 

Canadian plan sponsors are monitoring developments in the U.K., where the sale of at least one frozen defined benefit pension plan has been recently approved. There are, however, a number of regulatory and practical hurdles to clear before this option could be readily available in Canada.

As widely reported, Citigroup has taken ownership of Thomson Regional Newspapers’ pension plan in the U.K., assuming sponsorship and liability for the plan’s nearly $402 million in assets. Thomson sold the troubled DB plan to a newly established shell company, which was subsequently purchased by Citigroup.

“There is a whole spectrum of choices for dealing with a legacy DB plan. One is to continue operating it as you always have with a balanced fund to back the plan. The other extreme is to buy group annuities from insurance companies,” says Watson Wyatt Senior Actuary Doug Chandler. “This is just somewhere along the continuum of options, and the more security you build in, the more expensive it is.”

To sell, or not to sell
One reason a company might want to sell a frozen plan is the potential impact on the company’s bottom line.

“If the block of liabilities in the plan goes insolvent, this can create the need for injections of new contributions that will affect cash flow. Also, if an employer is trying to sell a piece of its operations, the balance sheet is cleaner without these liabilities,” says Aon Senior VP John Beaton.

“In the U.S. and the U.K. there are far more plans where the pension is frozen in both dollar and accrual terms, whereas in Canada, members can usually choose to continue accruing DB pension service. In addition, there are a higher number of final average schemes where liabilities are still going up along with salaries. These plans are not so amenable to transfer,” he says.

“More U.K. DB plans have guaranteed indexing, so purchasing annuities can be very costly,” says Chandler. “Investment banks offer less security and face fewer obstacles, but they can offer a better price.”

“Looking at it from the buyer’s perspective, purchasing a pension plan could be attractive to any financial institution that thinks they can run money more effectively than the next guy,” he adds.

Protecting member security
Not surprisingly, the primary concern for regulators is that if a pension plan is sold, there may not be sufficient long-term security for members to receive their defined benefits.

“This fits in between the Cadillac of protection, which is a fully insured plan, and something a little less than that. I’m not sure why regulators would stomach anything less,” says Hugh Kerr, Sun Life’s assistant VP and senior counsel, group retirement services.

The National Bank of Canada is currently developing a platform for customizing pension plan solutions, ranging from single specific risks to a complete buyout situation. Managing Director of LDI Solutions Greg Fenton thinks that benefit security could be enhanced if a closed plan is purchased by a highly rated financial institution.

“Employees are typically exposed to the creditworthiness of their employer going forward. As a triple A’ rated bank in Canada, we would be more highly rated than most corporate employers that are rated triple B’ or double B’ or even lower,” he says.

“The problem is if you are going to open the door to this on a more general basis, you have to create some rules to make sure the transactions you let through benefit all members.”

Legal impediments
Hicks Morley pension partner Elizabeth Brown also points out that because there are several technical legal issues, legislative change may be required to facilitate these transactions.

“There are issues from a tax perspective because, under the Income Tax Act, eligible contributions to pension plans can only be made in regard to employees or former employees,” Brown says. “Since there will not be an employment relationship between the purchaser of the closed plan and the members, at the present time pension contributions by the purchasing organization would not be tax deductible.”

In addition, if the plan has unionized members, Brown says the union might consider it a breach of the collective agreement if the assets and liabilities of the pension plan are separated from the location of the collective agreement, which was with the original employer.

Early days
In spite of the interest generated on this side of the pond by the Thomson sale to Citibank, Beaton says his overall sense is that the appetite for these transactions is weaker in Canada than in the U.S. or the U.K.

“These arrangements would be quite price-sensitive in Canada. If [companies] do not think it is to their advantage and that of plan members to make the transfer, they will not do so,” he notes.

“Our customers are still looking at a very traditional solution from us, which is to buy a single premium group annuity,” says Sun Life’s senior VP, group retirement services, Claude Accum. “We think that protects them better. If schemes in the U.K. fail, there could be recourse back to the trustees who put together the arrangement.”

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