Thursday, August 3, 2017

You Can’t Have Your Sears Cake and Eat it Too

It’s well known that Sears Canada has been having financial trouble for some time. As often happens in these situations, the Sears defined benefit pension plan is underfunded. According to Steven G. Kelman, “Ill-advised government policies” have resulted in former employees getting only “81% of the commuted value of their defined benefit pensions.” What we have here is a tension between trying to keep companies afloat and keeping pension plans fully funded.

It’s easy to decide today that Sears should never have been allowed to delay properly funding their pension plan. But, if Sears had been forced to fully fund the plan sooner, they would have gone bankrupt sooner. If we go back to a time when there was still hope to save Sears, few people would have agreed to force Sears into bankruptcy over their pension funding. But allowing sick companies to let their pension obligations slide inevitably leads to some bankrupt companies with underfunded pensions.

We can agree that it’s unfortunate that some Sears employees won’t get their pensions. But back when Sears was still limping along, who would have decided to force them into bankruptcy and sacrifice jobs to make sure that pensions are topped up? I’m not suggesting that current jobs are necessarily more important than future pensions. But, those who focus solely on pensions need to understand that they are advocating killing off sick companies sooner.

One suggested solution is Kelman’s assertion that “governments, in my opinion, should kick in the shortfalls to make the Sears former employees and others in similar predicaments whole.” This sounds perfect until we realize that governments pay for nothing; taxpayers foot the bill. There’s no free lunch. Why should taxpayers make good on the promises of failed companies?

Another idea to protect pensioners is to put them ahead of other creditors when a company gets into financial trouble. But, then who would want to be a creditor? Any company that has an underfunded pension would have serious trouble getting credit, which would drive them into bankruptcy sooner. I’m not saying this is the wrong approach, but advocates of this idea must acknowledge that it will drive more companies into bankruptcy.

If we’re going to demand that no pension plan ever be underfunded, we have to be prepared to accept that this will bring some companies to financial ruin sooner, and will break some companies that might have survived if they had a little more time to turn around. We have to choose between pensioners and current workers. We can’t have our cake and eat it too.

16 comments:

  1. I am inclined to the point of view that it would have been better for them to go bankrupt sooner rather than underfund the pension. However unpleasant it is, someone still working can get another job. Someone who is past retirement age has fewer options.

    The other facet of all this is the flight from brick and mortar stores to online shopping. It's not going to end well for a lot of these companies, and it's inevitable. Bankruptcy is seldom fair to anyone, except the odd executive or well-placed VC fund :).

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    1. @Anonymous: You may be right, but your point of view is unlikely to carry the day while everyone believes that a company's troubles are temporary and that it will be able to make up a pension shortfall once it's back on its feet.

      I don't know what balance of online stores and physical stores we will end up with, but I've been surprised in the last couple of years how often Amazon has poor prices. It used to be a no-brainer to get what you could from Amazon, but that is far less clear now.

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  2. Being required to fund the pension might have led them to negotiate with employees for lower salaries and/or pension benefits earlier on to avoid bankruptcy. This would have the advantage of employees who don't have a strong knowledge of financial governance being able to choose what they really want. It's hard to see how more transparency would have hurt.

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    1. @Richard: That's certainly a possible upside to facing the pension shortfall sooner. I'm not arguing against transparency. However, if we could go back a couple of years and try to sell this idea, I doubt we could have got a majority of people to agree. It's hard to accept a loss now when there seems to be hope of becoming whole in the future.

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    2. No doubt this is different from what the advocates of pension regulation are hoping for.

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    3. @Richard: Yes. To succeed, they would need strong laws to force weak firms into insolvency rather than let them limp along not making pension contributions.

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  3. Once a company falls behind to a meaningful degree, they've been performing poorly for an extended period of time - the likelihood of turning around the company and not only resuming full contribution but catching up on missed contributions as well as the interest that would have accrued in that period seems diminishingly small.

    I would agree that it doesn't seem appropriate for the government to cover missing payments given the majority of the population aren't fortunate to have defined benefit plans.

    Despite being a center/left citizen recent decades would suggest that defined pension plans aren't sustainable outside of government - even blue chip companies don't see indefinite growth to support them. Even for governments the liability is large as people live longer, and also raises an issue of two classes of retirees as private companies cease offering defined plans.

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    1. @Anonymous: Some governments have been looking at a form of flexible defined-benefit pension where inflation increases can be suspended if market returns disappoint. Some employers are starting to offer these as well. The idea is to have employers and retirees share market risk rather than have employers take all risk (defined benefit) or have employees take all risk (defined contribution). No doubt there are some challenges in designing a hybrid system well, but it seems promising.

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  4. Canada is the only country in G-7 countries that allows reduction in income for old/sometimes sick people-income that was promised to them in writing.Government is actually accepting responsibility that all DB plans are properly funded and then guarantees only pensions in public sector.This put moral integrity of Canadian pension system in question-with exception of province of Ontario.

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    1. @Anonymous: I hear about pension defaults in the U.S. all the time. That appears to directly contradict your claim.

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  5. Sears Canada may have been a sick company for some time, but that did not stop

    them from declaring a series of "extraordinary" cash dividends in recent

    years:

    2010: $7/share, when share price was ~$22. (753 million total payout)
    2012: $1/share, when share price was $10.66 ($102 million total payout)
    2013: $5/share, when share price was $19.19 ($510 million total payout).

    These ultra-generous dividends crippled Sears' cash reserves; reserves needed

    to keep the pension plan above water and improve the company's finances. This

    looks like a deliberate (malicious?) act by the board of directors to enrich

    the shareholders, while shortchanging the company's future obligations to

    retirees and hastening its demise. Big payouts don't help retail sales,

    which is Sears' lifeblood, they just transfer money out of the company. Plain and simple.

    The net result was that the shareholders (the people who are supposed to

    assume the risks) were rewarded handsomely; while the pension plan, which

    should be protected, was starved. Seems criminal, should be criminal.

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    1. @Anonymous: You may be right that some of this money should have been used to top up the pension plan. Shareholders should not be allowed to draw money out of a company to avoid contractual obligations. However, when you say that the cash reserves were needed to "improve the company's finances," it sounds like you're saying they had some obligation to use this money to keep limping along losing money. The cash reserves belong to shareholders and they should be allowed to extract it if they want (unless, as I said, it's an attempt to avoid existing obligations, such as to the pension plan).

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    2. Their annual reports state the pension was not fully funded during the years the extraordinary dividends were paid. And at the same time they were cutting medical & dental retirement benefits. I'm not an expert at the interpretation of annual reports; but from what I can tell, Sears was already starting to "circle the drain".

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    3. @Anonymous: As I said, if the pension plan wasn't fully funded when they paid out dividends, perhaps that wasn't right. However, benefits paid to current employees is an entirely separate matter. Sears is entitled to pay their employees in any way they see fit, as long as they didn't renege on a contractual promise.

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  6. Clarification: The cuts were to the medical and dental benefits of their retirees.
    I'm a regular reader of your blog and greatly appreciate the advice you give. But the Sears issue hits pretty close to home for me. My brother and sister-in-law retired from Sears after they both worked there for about 39 years. And now the financial backbone of their retirement looks like it may be broken.

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    1. @Anonymous: If they broke contractual obligations with the retiree medical and dental benefits, then I agree this looks like something they shouldn't have been allowed to do while drawing money out of the company. I know people who had the same problem with Nortel. One in particular went back to work in his late 60s to make up the shortfall. And he's a fortunate one to still have skills an employer wanted.

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