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November 5, 2017

People don't get a second chance at retirement. Getting an annuity less than you counted on is a terrible blow.

The bankruptcy of Sears Canada, and the threat that its underfunded pension plan won't pay what it promised, has caught the attention of members of Parliament. Understandably so. People don't get a second chance at retirement. Getting an annuity less than you counted on is a terrible blow.

After the sponsor of an insolvent pension plan has gone bankrupt, moreover, governments have no happy choices. A bailout – taxpayers paying for the actions of an irresponsible employer – would be unfair, and set a terrible precedent. Some want a national pension guarantee fund that would charge premiums and pay out upon failures. But experience in the United States, Ontario and elsewhere shows that those schemes also tax responsible people to cover costs created by irresponsible people – and anyway, you can't conjure up insurance from nothing to compensate pensioners whose plan has already failed.

What about giving pensioners priority over other creditors? That's not a crazy idea – if done prospectively, so people who have already lent money to organizations with dodgy plans don't pull out, putting the entire operation – current workers as well as pensioners – at risk. But it wouldn't address a basic problem illustrated not only by Sears just now, but by previous pension disasters, such as those of Algoma Steel and Nortel.

Whether because of bad economics, bad management or bad behaviour, defined-benefit pension plans and their sponsors tend to go bust together. The front of a line of creditors fighting for cents on the dollar from a bankrupt company is better than the back of the line. But fighting in court for cents on the dollar from a bankrupt company is not the vision advocates for defined-benefit pension plans promote. Nor what participants in those plans dreamed of doing in retirement.

The question that Sears Canada, Algoma and Nortel – and pension defaults in major U.S. industries, not to mention Detroit, other U.S. cities and, potentially soon, U.S. states – ought to prompt is not how to share shortfalls after a collapse, but why these plans had shortfalls in the first place. Advocates for defined-benefit pensions claim these plans reliably provide comfortable retirements at low cost. But they often don't. Why not?

First, because sponsors of defined-benefit pension plans – business, governments, and other organizations such as universities – face a temptation. Paying employees a dollar now costs … a dollar. Promising them a dollar in the future can look way cheaper. All you need is the right assumptions.

Assume people will contribute to the plan for a long time, assume they won't live too long afterward – and, critically, assume high and reliable returns on investments in the plan – and that dollar in the future seems to come at a discount. And if the people making the deal are close to retirement themselves, expecting to be long gone before anything goes wrong – well, the temptations to underfund defined-benefit pensions are many and strong.

Why don't regulators stop them? The second part of the answer is that most governments, including those in Canada, yield to the same temptations other sponsors of defined-benefit pensions do. The federal government's own plans have assets way short of their liabilities. Most governments give the green light to other employers whose assumptions understate the cost of their pension promises. And while bitter experience has made solvency calculations – working out what a plan would need to meet its obligations if disaster struck tomorrow – common, governments typically let plans hold less than that.

Even as federal MPs argue about the plight of Sears's pensioners, Ottawa and provincial governments are under pressure from defined-benefit pension sponsors reluctant to fund their plans. Experts expect Ontario's forthcoming fall economic statement to announce further relaxation of its requirements to fund solvency deficits – certainly a relaxed multiyear schedule, and possibly no requirement to fully fund at all. It's a virtual guarantee that, over time, more people will join Sears employees in the misery of getting less than they were promised.

The plight of the Sears pensioners, and the dearth of happy options for MPs wanting to help them, recalls the adage that an ounce of prevention is worth a pound of cure. Employers who make pension promises – public or private sector – should fund them. Not just on the basis of convenient assumptions, but on the ability to pay out even when things go wrong. If they won't do it on their own, regulators and voters should force the issue.

Ensuring that your pension plan can pay what it promises – not just when times are good, but whenever the bill comes due – is the responsible thing to do. It is the right thing to do. We shouldn't need a Sears pensioner to tell us that.

William Robson is president and CEO of the C.D. Howe Institute

Published in the Globe and Mail.