Retirement planning by the Vulcans

“Live long and prosper” is best known as a Spock greeting in Star Trek but may be the new call to arms for retirees, pension plans, and employers.  It seems that on average, we’re living longer.  Surely that’s good news – more rounds of golf, more time with the (future) grandkids, more time to enjoy retirement.  Who can argue against that?!  Of course, those activities, retirement in general, requires substantial retirement savings.  Traditionally those savings have come from employer-organized defined benefit (DB) pension plans.  I’ve written about pension plans before here and here.  Given my prior posts, does pension accounting really deserve another look?  In my opinion, absolutely.  Especially with the latest revelation that we’re living longer.

You may ask yourself, “What impact does average life span have on pension plans?”  That’s a good question, and a bit complex but to keep it simple, if you promise to pay your best friend $100 a year until they pass away you quickly understand how their expected lifespan matters.  Longer life = more money that you owe them.  The same is true for pension plans except that it is on a much bigger scale.

Take the University of Toronto as an example.  They owe their employees over $4 billion for future retirement payments.  If those employees live longer, U of T is on the hook for even more than that.  Now the good news – if you can call it that – U of T has put away $2.9 billion as savings towards that pension liability.  That pension asset doesn’t change as employee lifespan changes.  Perhaps you’ve seen the problem already: $2.9 billion in assets – $4 billion in liabilities = trouble.  Yes, that’s right.  U of T as an unfunded pension plan to the tune of $1.1 billion.  Take a look at the liability portion of U of T’s latest (April 30, 2013) balance sheet below (the columns are from left to right: April 30, 2013, April 30, 2012, April 30, 2011).  What’s the biggest liability U of T has?  Pensions.  The “Deferred capital contributions” are just a fancy way of accounting for revenue and all of that amount has already been received as cash but U of T can’t call it revenue yet, so let’s remove the $1,076.4 from the bottom of the column.  That leaves $3,254.7 million of actual liabilities.  Now take the “Accrued pension liability” plus the “Employee future benefit obligation …” for a total of ($1,122.9 + $734.7) $1,857.6 million.  That is  57% of U of T’s real liabilities.  Nearly $2 billion is owed with no savings for that portion.


Perhaps you say to yourself, “big deal.  U of T is a massive enterprise with billions of dollars of revenue.”  And you’d be partly correct. U of T does have billions of dollars of revenue but in fact they have very little flexibility on raising additional dollars of revenue.  As large as U of T is (~50,000 students), the unfunded pension liabilities are almost double the total amount of tuition dollars raised every year.

This situation is not sustainable.  As more employees retire and live longer, the pension assets will quickly be used to support them.  Current employees who contribute to the plan are not really saving anything for themselves; they’re funding the older, retired faculty as they golf and play with their grandkids.  Another way of looking at this is that for every dollar of tuition that a U of T student pays, a portion of that is going to fund a retired U of T employee – an individual that is not contributing to the student’s current experience.

What is U of T’s plan to get out of this mess?  Beyond a terrible reversal in the expected lifespan of its retirees and employees, U of T must be hoping for a dramatic positive performance in the stock market.  If they could double their pension asset within a reasonable window, say 10 years, they would mostly be out of this mess.  Of course that would require an average rate or return of about 10%, far in excess of traditional pension plan returns.  Other than that miracle cure, all they can do is continue to save excess cash where they can and add it to the pension assets.  That’s tough to do when you have to provide services to 50,000 current students, support Nobel prize-winning researchers, and maintain 100 year old buildings.

Three last points: (1) U of T is not the only enterprise in this mess.  I could quickly identify about 25-50 other large, well known Canadian businesses that have similar pension problems.  (2) Accounting standards around pension plans (for instance, IAS 19) are finally providing relevant information to financial statement users – I encourage you to ask your financial accounting instructor for their opinion on the standards and on pension plans in general.  (3) Why does this matter to you?  You are likely YEARS away from retirement, pension plans are the farthest thing from your mind.  Similar to many other problems in the world however, the problems of one generation get passed to the next.  As a future employee, a future contributor to CPP, a future caregiver to your parents, as a student paying tuition, this pension problem is yours.  Sorry.  I encourage you read some more, here’s a recent Globe and Mail commentary that you may find interesting.

I’d be interested in your thoughts on pension plans.  How do you think U of T should get out of this mess?  Is it fair to pass the buck to the next (your) generation?  What are your plans for funding your retirement? Comment below.

Note: this blog was originally posted on my site hosted by Pearson Education(

Pensions? Let’s just wing it.

During this holiday time many of you may be flying around the country visiting family and friends.  There’s a good chance you are flying on Air Canada so I thought this post may interest you.  We’ve talked about pensions before, mainly related to universities.  A quick reminder: defined benefit pension plans (like most of Air Canada’s) involve a massive liability since the company agrees to pay each retiree a set amount per month and a large pot of money handled by a third party trustee.  The pot of money is intended to fund that massive liability.  The company is supposed to put substantial amounts of money into that pot of money held by the trustee each year so that the pot of money is equally massive as the liability.  When I say “massive” how big are we talking?  Well in Air Canada’s case the liability was $14.4 Billion at the end of 2011 (see Note 10 of the 2011 financial statements).  To put that in perspective, the province of BC’s debt is about $34 Billion.


Air Canada’s liability isn’t really that big because they have been putting money away for years to help pay those pensions, and its the net liability (liability-assets) that’s key. In a perfect world, the pot of money would be equal to the liability.  Then retirees could relax, knowing that no matter what happens to the company, they will be receiving their pension payments.  Like virtually every other defined benefit plan out there right now, Air Canada’s is “under funded” meaning that the pot of money (or “plan assets”) is less than the pension liability (or “pension obligation”).  There are two main reasons that so many (~93%) defined benefit plans are underfunded right now: (1) the financial market melt down of 2008 that decimated plan assets and (2) the incredibly low interest rates for the past 5 years.  Wait … what do interest rates have to do with this?

The pension obligation is an interesting liability that demonstrates quickly so many measurement problems in accounting.  Imagine the defined benefit plan for just one current employee.  Let’s assume that the employee and employer agree on a pension of $1,000 per month once the employee retires (after 67) until the employee dies.  First we need to estimate how long the future retiree will live for, then we need to calculate a present value of the annuity that we will be paying them from the time they retire until they die.  Then we need to take the present value of that annuity back to today to calculate today’s value of that liability.  Obviously those two present value calculations involve some discount rate.  The higher the discount rate, the smaller the present value.  As interest rates have fallen, appropriate discount rates for pension calculations have also fallen.  So the pension obligations have risen.  So its the perfect storm for pensions – the plan assets have taken a loss due to the market fall and the pension obligations have risen due to falling interest rates.  The end result?  93% of defined pension plans are currently underfunded.

Now, back to Air Canada.  How bad is Air Canada’s situation?  Well at the end of 2011, they had an unfunded pension balance of $4.5 Billion!  I know that we lose sight of the scale of numbers these days, but remember that Air Canada has about $11 Billion of revenue each year combined with about $11 Billion of operating expenses.  Their net income is rarely positive.  If I was a current or future retiree of Air Canada I’d be wondering where my pension payments were going to be coming from.  Is Air Canada worried about this situation?  Absolutely.  So is the Canadian government.  Under federal rules, Air Canada is supposed to be making extra payments to be closing that gap.  They recently asked the federal government for an extension that reduces their catch-up payments.  Air Canada was lucky to get a bit of a pension contribution holiday a few years ago, it is an interesting political situation to see what the government does this time.  On one hand the government wants to protect current and future retirees which means that Air Canada has to pony up the cash.  On the other hand the government can also read financial statements so they know far too well that Air Canada really doesn’t have the capacity to pay the necessary money.  Forcing Air Canada to make the necessary payments doesn’t make a ton of sense since that would basically mean bankruptcy.  Then you’ve got the competition issues – is a break for Air Canada fair to the other national airline, Westjet?

As you take flight this holiday season give this some thought.  There is no easy answer but jot your thoughts down as a comment and I’ll be happy to pass them along to Jim Flaherty, the finance minister who will have to deal with this.  Best of the holidays to you and have a fantastic 2013!

Note: this blog was originally posted on my site hosted by Pearson Education(