Air Canada's Great Pension Divide?

One of the key issues that had Air Canada management and union negotiators talking right up to the Monday midnight strike deadline was pensions. The Canadian Auto Workers union — which represents the airline's 3,800 sales and service agents — says the pension changes proposed by Air Canada would make new hires "second-class workers."

What is Air Canada proposing?

The airline wants the CAW to agree to a number of changes to the pension program that its customer service employees pay into. The union says Air Canada's demands for pension concessions are not negotiable.

There appear to be two major stumbling blocks:

• The airline's demand for pension cuts that could see new retirees having their pensions being chopped by an average of 40 per cent, according to the CAW. (The airline says the cuts aren't that big.)
• The airline's demand that all new hires into the bargaining unit be routed into a new, defined contribution pension plan, rather than joining the current employees' defined benefit plan.

What's the difference between these two types of pension plans?

The latest figures show that only about six million Canadians — roughly 40 per cent of employees — were members of a registered pension plan at the start of 2010. About half were in the public sector and half in the private sector.

For those with pensions, the two main kinds are defined benefit plans (75 per cent of those with a pension plan) and defined contribution plans (16 per cent of all pension plan membership). The rest are in some kind of hybrid plan.

For employees, a defined benefit plan is the gold standard in the pension world. Air Canada's current pension plan for its customer service reps is this kind of plan.

Here are the key points of defined benefit plans:

• DB plans guarantee a pre-set lifetime pension after a certain number of years of service. The better plans include partial or full indexing for inflation.
• Both the employee and the employer contribute to this type of plan.
• It's the employer's responsibility to make sure the plan is properly funded to pay the promised benefits.
• It is the employer that must make up any plan shortfall.

Defined contribution plans, on the other hand, sport some key differences:

• The level of payout is not guaranteed. These plans are often not indexed for inflation.
• You and/or your employer contribute a set amount of money each year.
• Your retirement income is based on how the pension plan's investments perform.
• Since there is no specific pension payout guarantee, the employer is not on the hook for future pension plan shortfalls.
• Pension risk with this type of plan is transferred from the employer to the employee.

Aren't defined contribution plans becoming more common?

Yes, especially in the private sector. Statistics Canada says the number of private-sector employees covered by defined-contribution schemes rose by almost 400,000 people between 1991 and 2006. At the same time, the number of private sector workers covered by defined-benefit plans fell by 270,000.

Defined benefit plans are still the most common plans, with 75 per cent of those with a registered pension plan having a DB plan. But 10 years ago, that figure was 85 per cent.

Private companies are increasingly switching over their pension plans to the less-costly defined contribution arrangements in order to reduce the potential cost of their pensions, Statistics Canada said.

"Although [defined contribution] plans have some undeniable advantages for employees, their increased prevalence suggests a transfer of risk from employers to workers since 1991," the agency said.

Why is the airline asking for pension concessions?

Since Air Canada is responsible for making up shortfalls in its pension plan, it says it has no choice but to insist on concessions. The airline says it had a pension deficit of $2.1 billion at the start of 2011.

"This deficit is not sustainable and has not been sustainable for most of the decade, as it puts at risk both the viability of the company and the pensions of all employees," says Air Canada spokesman Peter Fitzpatrick.

Federal pension legislation requires Air Canada to make hefty payments in coming years to address that deficiency. By the airline's estimate, it will have to make $550 million in past and current pension contributions in 2014 alone.

Air Canada spokeswoman Isabelle Arthur says the airline has 26,000 active employees in its pension plan, which has to provide pensions for 29,000 retired workers, "so we have to find a solution that ensures that Air Canada remains a viable company."

Why is the union fighting so hard on this issue?

The CAW says making new hires join a new, defined contribution pension plan weakens the existing defined benefit plan because all new contributions would be diverted into the new plan.

Defined contribution plans, which offer no guarantees of final pension payouts, also create (in the CAW's words) a two-tier system "which would make second-class workers of future generations."

The CAW, along with two other unions representing Air Canada workers, jointly pledged last month to fight any further attempts by the airline to reduce or eliminate their defined benefit plans.

The union also notes that the airline's top managers continue to make millions of dollars annually and enjoy generous guaranteed pensions.

To be fair, I don't know the details of the dispute, but Air Canada is doing what most private companies with defined-benefit (DB) plans are doing, cutting benefits and shifting new entrants into defined-contribution (DC) plans. Basically, new employees get screwed and older ones get squeezed.

What I do know about Air Canada's pension plan is that it was poorly managed for years. The new team running Air Canada's pension is much better, much more sophisticated and they strive to match assets and liabilities using both public and private investments. But the pension deficit they inherited is enormous, leaving them an impossible task of closing an ever widening gap. That's why the company is fighting the unions hard on pensions. But as the deadline approaches for a strike at Air Canada, union leaders are paying close attention to a fight over pension, and by the looks of things, this fight is just getting started.

***Feedback***

Bernard Dussault, the former Chief Actuary of Canada, was kind enough to share his thoughts on Air Canada's pension dispute:

It is not the first time that I hear the representative of a defined benefit plan sponsor saying, like Air Canada spokeswoman Isabelle Arthur (“the airline has 26,000 active employees in its pension plan, which has to provide pensions for 29,000 retired workers, so we have to find a solution that ensures that Air Canada remains a viable company"), that the high ratio of pensioners to active members of the pension plan causes financial hardship to the sponsoring company. This is a myth. When a private plan is fully funded, this ratio has no impact whatsoever on the financial status of the sponsor because all money required to pay all future benefits to existing pensioners is already “in the bank” (i.e. the pension fund). Air Canada's pensions-related financial hardship is mainly (if not exclusively) caused by all contribution holidays taken so far by the sponsor.

For a different perspective, read Jonathan Forethought Risk blog comment on Air Canada. Jonathan states that he believes that the divide was caused by a mismatch of risk, not contribution holidays. In fact, he demonstrates that Air Canada has been making regular contributions to its fund. I think mismanagement by the previous pension fund officers and contribution holidays are to blame.