Download Broken Promises Insolvency in Defined Benefit Funds

Broken Promises
Insolvency in Defined Benefit Funds
Shauna Ferris
Macquarie University, NSW
[email protected]
Presented at
the Annual Superannuation Researchers’ Colloquium
July 2005
The Scope of the Problem
USA:




Estimated total underfunding is $350 billion
United Airlines (May 2005) :
Fund Liabilities :
$ 17 billion
Fund Assets :
$ 7 billion (42%)
PBGC cost (other funds pay) $ 7 billion
Members shortfall
$ 3 billion (19%)
PBGC deficit is $23 billion and rising
Govt is currently attempting (despite political
resistance) to tighten the legislation
The Scope of the Problem
UK:





Estimated total underfunding £60 billion (top 100
companies only)
DWP estimates approx 65,000 workers pension fund
members have suffered a significant loss (i.e. more
than 20% of their benefits) when under-funded
schemes were wound up by insolvent employers.
35,000 lost more than 50% of their benefits.
Workers at Allied Steel & Wire (insolvent) : will get less
than 20% of their pension entitlements
New legislation coming (Pension Protection Fund)
The Scope of the Problem
Australia:



After poor investment returns in 2001/2002
APRA reported that a “significant number of
funds” were in an unsatisfactory financial
position
ASIC & ICA surveys suggest about 20% of
large funds had a deficit (relative to Vested
benefits) – very likely a higher proportion for
small funds
Press reports of deficits
NAB
$252 million;
News Corporation $468 million;
AMCOR
$120 million
The Scope of the Problem
Australia continued:



One major failure, Ansett: members lost about $150
million in benefits after the 2001 collapse
UniSuper’s actuarial report in December 2002
Fund Liabilities
$ 5.2 billion
Fund Assets
$ 4.5 billion
Shortfall
$ 700 million
Funding Level
87% of Vested Benefits
As a result of good investment performance, the
financial position of many funds has improved (e.g.
UniSuper is up to 94%)
Is the current situation acceptable? Does the
solvency legislation provide a fair balance between
the rights of the employers and rights of workers?

“Those who favour the retention of the laissez-faire
principle in all its vigour argue that the establishment of a
pension scheme is a voluntary act on the part of the
employer. Since the employer does not have to provide a
scheme at all, surely it must have complete freedom to
set the terms of any scheme it chooses to provide.
Though such a proposition still has its advocates, it is not
dictated by either policy or logic. It is perfectly legitimate
to insist that if the employer does choose to set up a
scheme, the bundle of benefits offered to the employees
as an integral part of the remuneration package should be
legally protected and financially secure.”1
i.e. Keeping Promises
1Journal of the Institute of Actuaries, 1994, Goode
Historically:




Superannuation seen as a privilege not a
right
Low levels of vested benefits
Willingness of employers to maintain
funding
Reliance on the integrity of the employer to
make good any deficits within a
reasonable time frame
But now:





Super is seen as deferred remuneration
Much higher levels of vested benefits
Barriers to withdrawal/ownership of surplus
Reduced levels of funding (PUC vs Aggregate)
Possible shift in ethics ?
-responsibility to shareholders is only
responsibility (James Hardie)
-“if you don’t have a legal responsibility, then
you don’t have any responsibility”
In the USA and the UK:




Many employers have deliberately underfund to
the extent allowed by the law
And then close the fund and walk away
Leaving members and guarantee funds (funded
by other employers) to pick up the tab
SO :
Suppose that you are a member of a defined
benefit fund in Australia. Is there anything which
will prevent the employer sponsor from reducing
the level of funding, allowing a deficit to emerge,
and then closing the fund ?
Key questions in assessing the
solvency regime:
1.
2.
3.
4.
5.
6.
7.
8.
Level of protected benefits?
Valuation of Liabilities?
Valuation of Assets?
Minimum level of funding and/or contributions?
Remedial action for deficits (amortisation
period)?
The fund as creditor of an insolvent employer?
Allocation of assets among members on windup?
Well-designed guarantee fund / moral hazard?
A Hypothetical Example: Unisuper



The employer contributions are :
14% into a defined benefit fund
3% into an accumulation fund
The member contributions are
7% into the defined benefit fund
Assume : Assets
Liabilities
Shortfall
4.5 billion
5.2 billion
700 million
Assets = 87% of Vested Benefits.
Is this fund technically solvent (ie does
it meet the minimum funding levels
required by SIS?

Yes, as long Assets exceed the Minimum Requisit
Benefits (as calculated by an actuary).
But:
•
various methods of calculation
•
not shown on Member Benefit Statement
•
total not shown in Annual Report
•
poor disclosure

My rough guess :
•
MRB for Unisuper is probably about 70% ?
•
But the ratio varies for each person from 50%
to 100% (pensioners)
Is the employer required (under SIS) to
make additional contributions to fund the
deficit?

No. The fund is in an unsatisfactory
financial position but as long as the fund is
technically solvent the employer is not
required to do anything about this.
Is the employer required (under the Trust
Deed) to make additional contributions to
fund the deficit?

No. If the fund is still in an unsatisfactory
financial position after 4 years, the trustees
can request the employers to pay
additional contributions. The employers do
not have to agree. If they do, the employee
contributions will also be increased.
What happens if the employers do not
agree to make additional contributions?

After four years, the trustees might decide
to reduce the future benefits.
How much extra contributions would be
needed ?



The deficit is $700 million ($820
grossed up)
Annual employer contributions were
$840 million in 2003
So approx 1 year’s extra cont
Will the deficit disappear by itself?

It might, if investment performance
improves and other experience is as
projected by the actuary.
In 2002 the actuary estimated that there
was a 50/50 chance that the deficit would
disappear within 8 years. (In fact the
funding ratio had improved to 94% by June
2004)
Could the deficit reappear and even
become larger?


Yes, a defined benefit fund has a number of risks
which could create a deficit
• poor investment returns
• higher than expected salary increases
• pensioners living too long
• more people choosing pensions
• higher then expected inflation (indexed pensions)
• large number of people resigning when the fund is
in deficit
• increased tax on superannuation funds
The risk of a shortfall is increased if the employer can
reduce his contribution rates and/or remove surplus
from the fund. In Unisuper the contribution rate is fixed
and in the past the surplus has been used to increase
member benefits.
Worst Case Scenario?





Let’s suppose that the fund is closed to new members.
The number of pensioners has increased, they are
living longer, and due to tax and social security
changes more people are choosing pension benefits
instead of lump sums.
• Pension benefits now amount to $2 billion.
• Benefits for in-service members are $3 billion.
The long term experience has been worse than
expected, and the employer is still contributing at the
same rate (as required by the Trust Deed).
Assets are $4.35 billion,
So the funding ratio has declined to 87%.
For in-service members, the MRBs are just 70% of the
Vested Benefits, so the fund is still technically solvent.
Let’s suppose that in the next year:



investment returns are negative 5%
due to a downturn in the education
industry and/or government cut backs,
10% of in-service members are sacked or
resign and are paid their benefits
the fund is wound up immediately
afterwards
How much would an in-service member
receive?

Pensioner priority
Fund Assets available to pay in-service
members
= 0.95 * 4.35 – 2 - .10 * (4.35-2)
= 1.8975 billion

Vested Benefits for in-service members
= 3* 0.9
= 2.7 billion
Funding Ratio = 70%

Note the “gearing” effect of giving pensioners priority.
*A severe problem in UK pension funds,
* Especially in declining industries
Assuming that the Universities are still
solvent, could the fund claim the
shortfall from the Uni?

Probably not
• Under SIS, the employers are required to pay
the amount required to fund the MRB but no
more.
• Under the Trust Deed, there is no additional
liability to pay (? ask a lawyer)
• Any liability under employment contract?

So basically the in-service members bear the
shortfall.
Does this mean that everyone in service
would get 70% of their Vested Benefit?
Not at all.



Under SIS, they would all receive at least their
MRB.
Due to the way the MRB is calculated, it may be
higher than 70% for some people (e.g. older
members) and lower than 70% for others.
If there is any money left over after this, it is
distributed at the discretion of the Trustees (who
must treat all members equitably)
Should I be worried?