Partner at McCarthy Tetrault explains why employer refunds are 'the gold standard' for addressing DB surplus
Despite some defined benefit plans witnessing a surprise surplus in their plans, Deron Waldock is quick to note that window isn’t going to stay open for long.
“Employers should be looking at their books right now, looking at the financials for the pension plans, and if they have a surplus, make some decisions,” said Waldock, partner, national pensions, benefits and executive compensation group at McCarthy Tétrault. “Are there better things you could do with that money than let it sit in the pension plan?”
Yet employers can’t easily access these excess funds because once that money is in the plan, “it’s not like it’s general revenue or something they can touch. Once it’s in there, it’s gone,” added Waldock, who also spoke at a recent Canadian Pension and Benefits Institute (CPBI) webinar.
When it comes to dealing with trapped surpluses, Waldock outlined a few strategies. For one, he believes employer refunds to be “the gold standard” – that is, if companies can navigate the legal hurdles.
He underscored the point that securing a refund isn’t easy. Employers must either prove clear entitlement, an expensive and uncertain legal process, or negotiate a surplus-sharing agreement with employees. He often advises the latter.
“It’s almost like buying insurance. You’re buying peace of mind by giving and sharing a little bit but that allows you relatively easy access to the remainder,” he said.
He pointed to a recent case where a company had $10 million in surplus. By agreeing to a 50-50 split with employees, they could immediately recover $5 million without protracted legal battles.
“That’s a relatively easy way of accessing $5 million, which could come in handy these days,” Waldock noted.
Additionally, if the company has a strong legal position, it might negotiate an 80-20 or 60-40 split instead.
Once a surplus-sharing agreement is reached, however, it overrides any conflicting historical language in the pension plan. The employer can then use the recovered funds however it chooses, whether for expansion, R&D, or dealing with economic uncertainty.
While employer refunds are the gold standard, most plans turn to more straightforward solutions, like contribution holidays, where employers can use surplus funds to cover current service costs instead of injecting fresh money.
“It’s painless, straightforward, and efficient,” he said, as they don’t require regulatory approval or employee consent, making them a low-risk option.
Despite one of the most common approaches to dealing with surplus has been increasing benefits, Waldock emphasized that strategy has fallen out of favour because benefit increases create long-term liabilities.
“Historically, the easiest thing was, ‘I’ve got extra money, okay, we’ll improve your benefits… but once you improve benefits, that now becomes the baseline and you have to pay that cost forever,” explained Waldock.
Another underutilized strategy is merging multiple pension plans within a company. Many large employers operate separate plans for different locations, sometimes with surpluses in some and deficits in others. But Waldock noted combining them can create a more stable funding picture.
Even with the current surplus environment, Waldock warns that employers shouldn’t assume these excess funds will last. Economic conditions are shifting, and upcoming longevity table updates could increase pension liabilities.
“We’re about due for a new longevity table, and when that comes out, it’s going to cost more to fund pensions,” he noted.
For companies considering surplus strategies, waiting could be a costly mistake.
“Nobody should just be allowing chance and circumstance to take care of that,” Waldock said. “If I have a winning lottery ticket, I’m going to do something about it.”
Historically, since the early 2000s after the financial crisis, solvency was a huge issue because pension plans were in deficits, explained Waldock. That led to legislative changes aimed at stabilizing underfunded plans, with the pandemic creating “the perfect storm.”
“We had 20 years of putting in special payments to amortize deficits, the plans had a lot of money that were in them while the deficits had been attacked and had shrunk as a consequence of that,” explained Waldock. “You had good stock markets, you had interest rates going up, and you had all this extra cash that had been injected into the plans. Suddenly they started to get into surplus.”
Rising interest rates, strong market performance, and two decades of special payments to amortize shortfalls are the main factors that have led to the increase in pension surplus. But as Waldock explained, for every 1 per cent that interest rates go up, the liabilities of the plan effectively go down by about 7 per cent.
“That’s just the way the math works out,” said Waldock.
Surplus ownership
The question of surplus ownership has been fiercely debated for decades, Waldock noted, pointing to legal battles dating back to the 1980s, including the Dominion Stores case, where Conrad Black attempted to strip surplus funds from the company’s pension plan.
While employees fought back, arguing the surplus belonged to them because pensions are deferred compensation, employers, on the other hand, argued that they are only obligated to provide the promised benefit, and any extra funding should belong to them.
The debate ultimately reached the Supreme Court in 1994 with Schmidt v. Air Products Canada Ltd., which established a key rule: ownership depends on the plan’s historical language. But even then, that’s where things get complicated as Waldock emphasized the language, especially in older plans, was not drafted with that legal test in mind.
And with plans dating back to the 1940s and 50s, sponsors often find themselves sifting through decades of ambiguous documents.
This ambiguity has led most jurisdictions to adopt surplus-sharing agreements, allowing both parties to negotiate a fair split rather than engaging in costly legal battles. He highlighted that in order for the agreement to effectively work and override what the plan’s historical terms may actually say, plans need to be in a jurisdiction that permits surplus sharing arrangements and must also meet the legislative requirements, like notices and approval thresholds.
Waldock believes this approach provides the most practical resolution, ensuring all parties feel they have secured a fair outcome without prolonged litigation.
“The surplus sharing regimes that are in Ontario and other provinces allow to deal with surplus that’s generally a win. Everybody’s reasonably happy, which usually means it's a good deal,” he said.
