Tuesday, January 16, 2018

Underfunded Pensions

The plight of Sears Canada pensioners has been in the news lately. After reading about the hardships created by pension cuts, it’s natural to think about what we should do to prevent this in the future.

Some, like Jen Gerson, question whether pension plans should have higher priority than they do now when divvying up the assets of a bankrupt business like Sears Canada. However, the side effect of doing this is that suppliers would be less willing to extend credit to any business with an underfunded pension, and this would drive struggling businesses into bankruptcy sooner. This is a difficult choice to make when you’re still hoping that a weak business can get back on its feet.

However, the Sears Canada case looks far different from a plucky business doing all it can to survive. “While Sears’ shareholders pocketed payouts of $3.5 billion, the chain’s pension plans remained underfunded to the tune of $270 million.” Why are owners allowed to pull assets out of a business that owes money to its pension plan?

I can see where a company with a regular modest-sized dividend might be harmed if it’s forced to suspend the dividend. However, in this case, Sears Canada paid special large dividends. It seems appropriate to me to limit a company’s ability to pay dividends while its pension plan is underfunded. By itself this won’t prevent all cases of pension cuts, but it would make it harder to drain assets from a business at the expense of pensioners.

12 comments:

  1. Michael good comments. The pensions are part of peoples pay and they really do not realise how unprotected they are. If this is going to continue then companies should just do group RSP or pay people more so they save themselves ( of course most wouldn't.........different subject ) I moved to Canada from the UK in 2004 and we had some huge scandals like this in the 1990's and supposedly legislation was introduced to stop it. Most famously Robert Maxwell who moved 1.6 billion out of the Mirror Group ( newspapers) pension to shore up his failing empire and fund his lavish lifestyle. He died so was never called to account. Recently BHS a huge department store like Sears Sir. Philip Green asset stripped it and sold it for $1 leaving the pensioners stuck. He has been thoroughly questioned and beaten up by the House of Commons investigating committee and required to put some money back in. They threatened him with losing his knighthood and he is now collectively known as Sir Shifty so he blew his reputation up. Mind you does that matter as he sits on his 600 mill yacht off of a Greek island? This week Carillion, who were a huge supplier of government infrastructure projects has gone down with debts of 1 billion despite having been paying an increasing dividend to shareholders. 28,000 jobs and 13 DB pension plans affected.
    This will be back stopped by a government plan thats is currently 121% funded so they may be in a better position than the Canadian pensioners.
    Its time business stopped gambling with employees pensions.
    http://www.telegraph.co.uk/pensions-retirement/news/carillion-collapse-will-pensions-still-paid/

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    1. @Kathy: I agree that it would be best to stop such problems, but this can only happen if we get the law right. Businesses will never volunteer to have less money, but they will comply with laws.

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  2. Such schemes must classified as fraud by government and reversed.

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    1. @AnatoliN: The challenge is to create laws that can't be easily circumvented, and that don't have significant negative secondary effects.

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  3. I think the key that everyone is missing is that all workers need to educate themselves and understand all the rules of their company plans.
    If the options are so that the possibility of this (or a Nortel) can occur, you need to opt out or ask if there are any other options available that are more diversified and that you are immediately 100% funded and vested with no possibility of a future cutback like this.
    Even if it means you get a smaller benefit. One has to view this like a person simply loading up 100% of their investment in a single stock? That's a huge risk, that could pay off or bust.
    Some companies (like one telecom I know) pay bonuses in shares. You have to hold them for a certain period of time before you can sell them. People that work in this environment should also learn from this. As much as you love your now decent stock with a nice 4%+ dividend you need to sell some and diversify away from it. Even if it feels wrong.

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    1. @Paul: I'm not sure I follow you completely. You seem to be talking about cases where employees own shares in their employer. The case we're talking about here is a defined-benefit pension plan whose investments are independently-managed and any assets in the pension plan are protected from the employer going bankrupt. Opting out amounts to giving away the contribution of the employer, so that's not a good idea in this case. There are rarely other options other than taking the commuted value at some point. However, few people are able to invest the proceeds better than the pension plan. Their resulting retirement spending is likely to be worse than whatever reduction Sears Canada employees face now.

      In the case where employees own shares in their employer, I'm 100% with you that they should diversify into other investments.

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    2. Hi Michael,

      I thought DB pensions were funded by the company setting aside money in a pool, then paying it out directly to its eligible recipients later.(Like social security in the USA) I tried to do a google search on DB construction/composition but could not find any explanation of how that works. So from what you write, companies will fund a third party that makes investments, hope it grows then pay out retirees? Is that right? My bad then.

      When I refer to other options, I refer to personal experiences with colleagues. If an employee is truly valuable, a trip to HR could result in some kind of alternative plan. It can't hurt to ask. Maybe that does not fly at Sears, but using this as an example of what may happen, it sheds a light on what has happened at some of our strongest and oldest cornerstone businesses.
      But I also get what you mean about picking a worse investment even after the 20% haircut. People can be their own worst enemies.

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    3. @Paul: There are many different arrangements, but typically with DB pensions, the assets in the plan are not accessible to the employer. The employer is responsible for contributing enough assets to the plan to cover promises, but the employer cannot take back assets once they are in the plan (an exception is the government who can make up just about any rules they like).

      It's true that a minority of employees who are very valuable can write their own tickets, but the thundering herd have to take what comes.

      The typical returns that Canadians get after commissions, etc. are enough lower than what pension plans get that being in a DB plan vs. investing a commuted value on your own can make a big difference to your retirement.

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  4. Sure, you can ban dividends but what about share buy backs? Ban that, the company can still use the money in very many legal ways to increase shareholder value in preference to pension funding, e.g. “investment”.

    The only transparent approach is to kill DB pensions, but that’s not happening.

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    1. @BHCh: I agree that it's challenging to plug every available hole. I also agree that different pension arrangements (i.e., some sort of DC or shared-risk scheme where employer annual payments are fairly constant) should be the way of the future. However, many DB pensions exist today and we have to deal somehow with businesses that seek to renege on their commitments by underfunding their pensions and draining the business of assets before bankruptcy.

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    2. Well, the minimum funding requirement for DB pensions is postulated by the government. I think its like 50%, so Sears Canada was rather responsible compared to most of them.

      So they could say "100% funding requirement". ...and instantaneously bankrupt all the private companies with DB pension schemes.

      If it was up to me, I would force all companies to publicize %DB pension that is funded in the annual pension statements to employees and disclose this information to potential hires. That's all we can without causing damage.

      A separate issue is government employees who have DB pension schemes. That's a hidden tax on our kids; redistribution of dollars and risks from future generations to government workers of today. There is zero justification; government DB pension schemes should be killed.

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    3. @BHCh: As you says, it's not feasible to demand 100% funding immediately. However, new laws could block the draining of business assets while the funding is less than 100%. Your publicizing idea works for me. When it comes to government DB pensions, there are many issues. These pensions are more expensive than advertised. This along with other factors make government workers overpaid, on average. Then there's the fact that there are more public-service workers than are needed to do the work that needs doing.

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