It may come as a shock to some pension-plan members to learn that the benefits they have accrued in their defined-benefit pension plan could be cut if their employer is having difficulty funding the plan. Even those who have already retired could see their pensions cut.

It’s not a practice that is widespread and it can’t be done without jumping through a number of hoops and gaining the approval of pension authorities. But it’s a worrying prospect, and one that highlights the importance of making sure clients are vigilant about their pension entitlements. They should also continue their personal savings plans wherever possible.

Pension-plan funding was big news last year as plan sponsors scrambled to make up funding shortfalls in order to meet their future pension commitments. Some tackled the problem by closing their DB plans to new members and creating a two-tier system that sent new hires into defined-contribution plans, for which no particular pension is promised; existing employees were allowed to continue in DB plans, for which benefits in relation to earnings and years of service are guaranteed. Some employers abandoned their DB plans completely, switching existing employees to DC plans.

This latter scenario is still happening. But in most cases, employees coming out of a DB plan will eventually get the pensions they had accrued up to the point at which the switch was made. Reducing benefits that have already been accrued in a DB plan is something else.

Earlier this year, Nicholas Le Pan, superintendent of financial institutions at the Office of the Superintendent of Financial Institutions — the regulatory authority for pension plans under federal jurisdiction — told a meeting of the Empire Club in Toronto that OSFI “has seen a marked increase in the number of plans seeking to reduce benefits. In some cases, this may be better for plan members than the alternative of plan termination.”

But it’s not an easy road to pursue, he added. OSFI has been approving benefit reductions in cases in which it considers it’s “better for plan members than plan termination,” he says.

In some cases, across-the-board benefit cuts, including pensions already being paid to retirees, have been approved. There is the possibility the benefits will be reinstated later if the pension fund’s position improves, and there may be “priority provisions” for retirees to be “made whole” if the plan is terminated.

For the most part, pension-plan sponsors are hesitant to reduce accrued benefits, says Karen DeBortoli, director of the Canadian research and innovation centre at pension consultants Watson Wyatt Worldwide in Toronto. Sponsors would look at other cost-saving options first, she says, such as replacing guaranteed indexing with ad hoc adjustments to benefits. And most would try not to touch retirees. Reducing retirees’ pensions would be “the last resort of last resorts,” she notes.

Under federal pension laws, the possibility of reducing accrued benefits must be provided for in the pension plan’s documents and generally applies only to negotiated-cost DB plans, says Karen Badgerow-Crôteau, managing director of the private pension plans division of OSFI in Ottawa. NCDB plans are pension plans in which unions and management have agreed to the terms and conditions through collective bargaining, and in which contribution rates and other provisions — including provisions allowing reductions in accrued benefits to address solvency problems — have been negotiated and fixed, forming part of the collective agreement. They remain in place for the term of the agreement.

Such plans are more likely to be found in established industries, such as waterways, Badgerow-Crôteau says. Federal regulations cover only about 10% of the Canadian workforce, including employees of banks, airlines and communications. The rest fall under provincial pension rules.

Under Ontario’s legislation, for instance, single-employer DB pension plans are not allowed to reduce accrued benefits. But the restriction doesn’t apply to multi-employer pension plans — including NCDB plans — that arise out of a collective agreement or a trust agreement.

These plans have to be able demonstrate when they file their regular actuarial valuations — which is generally done every three years unless the plan is underfunded — that their pension-plan contributions will support the promised benefits. If they can’t do this, they have to propose a way to address the problem — by increasing contributions, reducing benefits or a combination of both. And benefit reductions may include accrued benefits as well as benefits already being paid to retirees.

@page_break@Ontario regulates about 6,000 pension plans, about half of which are DB plans. But there are only about 124 multi-employer pension plans under Ontario’s jurisdiction, and about 70 of them are DB plans.

Of the 1,200 plans under OSFI’s jurisdiction, about 40 are NCDB plans. And even though there has been an increasing number of requests from plan sponsors to reduce accrued benefits, Badgerow-Crôteau says, the number of plans in this situation ranges between five and 10 at any given point in time, compared with perhaps one, at the most, a few years ago.

Under federal laws, a reduction in accrued benefits requires an amendment to the plan and must be approved by the superintendent, she says. But seeking an amendment to reduce accrued benefits, she adds, is “very much a last resort.”

Badgerow-Crôteau emphasizes that it’s up to the pension plan’s administrator to make the initial call on whether it would be better for plan members to have their benefits cut than to lose their pensions entirely. In April, OSFI issued guidelines for administrators to follow.

In Ontario, in a situation in which contributions in a multi-employer pension plan are not enough to support benefits, Ontario laws require the pension plan’s actuary to submit a range of options to the pension plan’s administrator, who decides which to adopt. The Financial Services Commission of Ontario, which regulates pension plans in the province, has not issued guidelines on this.

However, federal guidelines expect plan administrators to consider other options before adopting a reducing amendment -— for instance, increasing contribution levels or reducing future benefit accruals. As well, the pension plan’s text and any supporting documents must allow for a reducing amendment. Some plans prohibit such reductions, says Badgerow-Crôteau.

Without a right of amendment in the pension plan’s documents, plan sponsors would not want to reduce accrued benefits, says DeBortoli: “The probability of legal action in such cases would be 100%.” And it would be “exceedingly difficult” to touch benefits in pay.

Under OSFI’s guidelines for be-n-efit reductions, the pension plan’s administrator has to inform all those affected individually — including existing and former members and retirees — of the impact of the reducing amendment and of their right to make representations to the superintendent about it, whether or not there is a bargaining agent. Those affected then have 30 days to make written submissions.

Because the interests of affected groups — for example, retirees vs active members — often differ in a benefit-reduction situation, the administrator has to make sure “an appropriate process is in place for ensuring representation of all affected groups.”

Whether requests to OSFI for benefit reductions increase may depend on the direction in which interest rates head, says Badgerow-Crôteau. She emphasizes that it’s crucial for individuals to understand the structure of their plans and keep themselves informed.

OSFI’s Web site (www.osfi-bsif.-gc.ca) is designed to help plan members get information, says Rod Giles, OSFI’s manager of communications and public affairs.

Adds Badgerow-Crôteau: “OSFI’s role is to make sure pension plans are funded properly and provide benefits to members.” IE