Pensions – Paying for them for life

The recent federal budget included some interesting ideas about the correct retirement age and the impact that pensions have on taxpayers. Most post-secondary students are young and really don’t give much thought to pensions—what they are, how they work, or how they affect the finances of a business. Other than tobacco lawsuits, pensions are one of the largest liabilities that a business will ever face, and they impact retirees, soon-to-be-retirees, and young employees alike. In the case of post-secondary institutions, pensions also have a substantial impact on tuition and current students. They are worth paying attention to.

First, let me quickly explain what pensions are and how they impact financial statements. A pension is a future payment to a current employee that is paid out once the employee retires. There are two basic types of pensions: defined benefit (DB) plans and defined contribution (DC) plans. The type of plan (DB or DC) has a massive impact on how we account for the pension plan and its potential effect on financial statements. If you’re comfortable reading IFRS, see IAS 19.43 and 19.48 for more information. For the sake of this discussion we’ll consider DC plans as relatively simple, with few accounting concerns. DB plans, on the other hand, should not be dismissed as quickly.

A DB plan essentially guarantees a current employee a set amount once he or she retires. Hence, it clearly meets the definition of a liability: it’s a current obligation from a past transaction that arises due to the employee working for the employer, and will be settled in the future when the pension is actually paid out. Estimating the amount or the liability is difficult but not impossible. For instance, we need to estimate how long the employee is likely to live. Once the experts estimate the pension liability, the employer and employee must begin saving enough money to eventually be able to pay that liability. This pot of money is referred to as the pension asset. Determining the correct amount to save is difficult as well, since it requires estimating a future rate of return. In a volatile market like we’ve had for the past 5–10 years, this can be very challenging. When the pension liability exceeds the pension asset, it is an underfunded pension since there won’t be enough cash to settle the liability when the employee retires and the employer is on the hook to make up the difference. If the employer only had one employee, an underfunded pension might not be a significant dollar amount. But when thousands of employees are involved, as in most universities in Canada, the underfunded pension amount can be substantial. How much? A recent Globe and Mail article reports that the University of Toronto is facing an underfunded pension liability of almost $1 billion. This works out to about $20,000 per student currently enrolled at U of T. Other schools are not immune, and when scaled by student enrolment are actually in worse shape. The University of British Columbia and some other schools in Canada operate DC plans, and therefore have no underfunded pension liability.

Make no mistake about it, there are a limited number of options when facing an underfunded pension plan. The employer can try to renegotiate the terms of the pension plan with employees (which is VERY difficult) or the employer must generate additional money to save in the pension asset, which reduces or eliminates the underfunding. Post-secondary institutions have limited ways to earn additional revenue, and primarily have to rely on tuition increases. Should students be concerned? Definitely. I don’t think you need to worry about your institution going bankrupt, but I do think you should be informed about where your tuition dollars are spent. Do a quick search and see if your institution has a DB or DC plan. If it has a DB plan, is it underfunded? If so, by how much? What strategies does the institution have to fund that liability and how much are you paying for? To get started, try using the search term <institution name> pension plan news.

As a faculty member, I’m keen to get a pension when I do retire and I don’t mean to bash pensions or pension administrators. In all fairness, the bulk of the underfunded pension liabilities are the result of the financial market crash in 2008 rather than deliberate mismanagement. We don’t necessarily need to blame anyone for the situation we’re in, but we do need to work together—students, faculty, and administrators—to develop a strategy to solve the problem. I hope that you feel more knowledgeable about pensions and how they affect your school, and that you are willing to ask your accounting instructor more about this topic—it does affect you.

Note: This post was originally posted on my blog hosted by Pearson HIgher Education (http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

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