Target Benefit Pension Plans are our future

By Robert Brown

A version of this commentary appeared in the Vancouver Sun, New Brunswick Telegraph Journal and the Guelph Mercury 

Man adding $ to piggybank_000005794823SmallMany papers carried an opinion article by Mark Milke of the Fraser Institute this week.  In this article, Milke notes that Canada now has a bifurcated pension world.  Public-sector workers have very good Defined Benefit Pension Plans while the majority of private sector workers have no pension at all, and those that do, tend to have Defined Contribution Plans where the worker carries all of the risks (e.g., investment risk, longevity risk).

But this bi-polar world will hopefully end in the foreseeable future.  Every worker can have a decent Defined Benefit Pension Plan and taxpayers do not have to be on the hook for ever-rising costs of public sector plans.  The compromise solution is a Target Benefit Pension Plan model.

Provinces have already started to move in the direction of Target Benefit Plans to control costs and save taxpayers money.

Just this past week, Alberta announced changes to its pubic sector pension model.  The main amendment is that annual cost-of-living increases will be paid only if the plans’ finances permit.  That is, this particular part of the benefit package will be dependent on the health of the pension fund at any moment.

New Brunswick has gone even further.  None of their pension benefits, going forward, will be fully guaranteed.  Rather the benefits that are being promised to the worker will initially be defined using a fairly conservative investment rate of return assumption.  Based on this assumption, workers will be told what Target Benefit they should expect to receive upon retirement.  If rates of return exceed the rate assumed, then benefits can actually be higher than at first indicated or targeted.  But, if investment returns are lower than anticipated (which should be a low probability event), benefits can actually be reduced.  Thus, the risk of low investment returns is passed from the employer (the taxpayer) to the worker through this “contingent” benefit structure.

Amended pension regulation in Quebec would allow similar plans to exist in that jurisdiction.

Ontario has made moves similar to those being enacted in Alberta.  For example, since 2009, the cost-of-living adjustment for the Ontario Teachers Pension Plan lies between 50 and 100% of the actual experienced cost of living increase.  If the plan funding is healthy (e.g., 100% or higher) then a 100% adjustment for inflation will be made.  But if the funding is not healthy (e.g., less than 100%), a smaller adjustment results.  In 2010, the cost of living adjustment for the Teachers Plan was 60% of the actual cost of living increase (at a time when the plan was 97% funded).

British Columbia has had similar provisions in their public sector pension plans for over a decade.  In BC, cost of living increases are paid for out of an Inflation Adjustment Account.  This account is funded by Defined Contributions from workers and the province (i.e.., taxpayers).  If the fund can afford it, full cost-of-living adjustments are made, but if the fund is not able to pay a full adjustment, smaller adjustments are made.  Because of this shift in the financing of the cost-of-living adjustment, the Plan liabilities for the Public Service Pension Plan in BC are only $18.0 billion rather than the $24.6 billon of liability that would exist if the cost-of-living adjustment were fully guaranteed.

We are now living in a unnecessarily bifurcated pension world.  Public servants have very good Defined Benefit plans.  The vast majority of private sector workers have no pensions at all, and those who do, are normally in Defined Contribution plans where there are no benefit guarantees whatsoever.  There is no need for this bifurcation and the pension envy that results.

Every worker in Canada could have a very good Defined Benefit plan without the employer facing unlimited funding risk.  The way to achieve this is through Target Benefit Pension Plans such as the Shared Risk Plans of New Brunswick.

The Provinces are already acting.  It is time for the private sector to join the movement by offering their workers very good, but truly affordable, Target Benefit Pension Plans — the pension plans of the future.

Robert L. Brown is an expert advisor with EvidenceNetwork.ca and a Fellow with the Canadian Institute of Actuaries. He was Professor of Actuarial Science at the University of Waterloo for 39 years and a past president of the Canadian Institute of Actuaries.

September 2013

This Commentary is from Commentaries, Aging Population & Its Potential Impact.

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