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© Copyright 2000 Rogers Media. The following article first appeared in the May 2000 edition of
BENEFITS CANADA magazine.
Building the Perfect Plan
DB plans are still dominant in Canada. But there has been extraordinary growth in hybrid plans
since 1995.
By Wafaa Babcock and Clare Pitcher
A new survey of Canadian corporate retirement plans for salaried employees confirms that defined benefit
(DB) plans still dominate the national pension landscape. The Pension Survey Report conducted by
Buck Consultants Limited (which incorporates research from more than 209 plan sponsors and 460 plans)
reveals that not only has the trend of converting DB plans to defined contribution (DC) plans tapered off,
but DB plans are often being maintained in conjunction with a DC-type plan.
Increasingly, sponsors are designing their own plans as opposed to simply adopting the straight DB or DC
approach. In fact, almost half of the DC pension/savings plans surveyed were designed to be implemented in
conjunction with a DB plan. Indeed, the survey reports that the proportion of plans combining elements of
both these plans has increased by 25% since 1995, when the last Pension Survey Report was conducted.
These hybrid plans are cropping up in many shapes and sizes. For example, a non-contributory DB plan (with
a benefit accrual rate of about 1%), may also incorporate an employee-paid DC component, which, in turn,
may be at least partially matched by the sponsor.
The emergence of hybrid plans is not a surprising trend. Despite public perception, DB plans never went out
of style, and they will continue to remain popular, particularly for larger firms. The addition of the DC
component is the result of a number of factors which have developed over the past few years, including
changes in the regulatory environment, some of which have made DC plans relatively more attractive,
particularly for plans with employee contributions. As well, sponsors are feeling pressure from employees
to hand over more control of pension and investment decisions.
Overall, today's employees are better informed about personal financial matters than ever before, and they
want more choices and ownership of their retirement benefits.
There is also a trend towards a workplace culture that encourages the sharing of risk between employer and
employee. With DB plans, the employer takes the primary risk, while with DC plans, it is the employee that
assumes the risk. Plans that include a blend of DB and DC elements, however, provide a more balanced
sharing of risks.
KEY FINDINGS
There are a number of other key findings contained in the report that shed light on the nature of corporate
pension plans.
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Final average vs. career average earnings. The proportion of final average DB plans has
increased, both in terms of number of plans and members, at the expense of career average plans. Survey
results show 86% of plans with 93% of members are final average plans.
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Early retirement benefits. With respect to subsidized early retirement benefits, 77% of plans
covering 90% of members have some form of unreduced early retirement benefits, usually based on a
combination of age and service requirements. Eighty-five per cent of plans, with 95% of members, have
subsidized early retirement benefits--approximately the same levels as in 1995.
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Inflation protection. Three-quarters of DB plans covering 96% of plan members provide periodic
cost-of-living increases to their retirees. This number is up from 91% reported in the 1995 survey.
Most plans continue to provide increases on an ad-hoc basis, as a proportion of the increase in the
consumer price index. Clearly, the majority of sponsors have taken on the responsibility to help
protect pension benefits from inflation, without being forced to by the government.
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Flexible pensions. Over the past few years, some sponsors have added a flexible component to
their DB plans. Under this type of arrangement, employees can make additional tax-deductible
contributions to obtain various types of ancillary benefits, which supplement the basic pension accrual
provided by the plan at retirement. This can be a tax-effective strategy as these contribution benefits
do not typically form part of the pension adjustment, maximizing the remaining amount available for
employees' registered retirement savings plan (RRSP) contributions.
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Only 11% of plans with 17% of members, indicate that their pension plan containes any flexible pension
component. And of those plans that don't have a flexible benefit component, only 21% are considering
one in the future. These low numbers are likely due to the complexities and uncertainties associated
with flexible arrangements.
PLAN SATISFACTION
Regardless of how they design their plans, the majority of sponsors (83%) say providing employees with
information on their plan--be it in the form of better communication, education, advice, access to online
information or modeling software--is an important component of improving the relationship between plan
sponsors and members. The remaining firms (17%) surveyed say employees are looking for more flexibility in
their pension plans, whether this be group RRSPs or alternative retirement arrangements.
DC plan sponsors say improved communication, information and education of plan members would add value to
the relationship between the firm and its employees. In fact, a resounding 86% of this group is looking for
better communication. In total, 33% of DC plan sponsors want to see more employee education regarding their
plans--both specific information and retirement planning information in general.
As DC plans involve investment decisions made by employees, sponsors are also interested in computer
software that allows plan members to model different investment scenarios. Almost 20% are looking for ways
to provide employees with easy access to their personal investment information as well as general
information through the Internet, intranets or toll-free interactive voice response technology.
As might be expected, a greater proportion of sponsors with DC plans want to give their employees
personalized financial planning information.
Not surprisingly, employee satisfaction with retirement programs is largely determined by demographics.
Older employees, for example, tend to be content with their DB plans, while younger employees prefer DC
plans. Interestingly, the most satisfied employees are from organizations that have developed hybrid plans,
or at least a hybrid plan that is available to older workers. On the other hand, sponsors that move from a
DB plan to a DC plan tend to experience dissatisfaction among older workers. Additionally, in those
organizations where only the company makes contributions to the plan, employees tend to be disinterested or
complacent about their retirement program.
Meanwhile, many employees with DB plans do not like the reduced RRSP contribution room that comes along
with these plans, although the availability of pension adjustment reversals for terminating employees is
considered to be some consolation.
Firm size also plays a role in plan selection. Smaller companies lean towards DC plans. There are a number
of reasons for this fact. They include the simplicity and lower proportionate cost of administration and
operation compared to a DB plan, as well as the possibly less paternalistic nature of smaller employers,
the desire for a fixed contribution rate and the issue of regulatory compliance.
DC AND SAVINGS PLANS
Sixty per cent of DC/savings arrangements covering 39% of members are DC pension plans, while 40% of plans
covering 61% of members are some type of savings plan such as group RRSPs, which involves some level of
employer funding. Forty per cent of plans covering 71% of members are in addition to, or in combination
with, a DB plan. Once again, firm size comes into play. Larger employers typically contribute lower rates
to these plans, presumably because they are often in combination with an employer-paid DB plan.
The survey illustrates that these plans typically offer about five investment options, ranging from
guaranteed investment certificates and money market funds to market-based mutual or pooled funds. Seventy
per cent of the plans surveyed have 10 or fewer options. However, larger plans do not necessarily provide
more investment options, as the number of options was scattered across all sizes of plans. In addition,
more than 80% of plans, covering 88% of members, allow members to select investment options for their own
contributions. The smaller plans tend to give members the right to select the investment option for
employer contributions, while larger plans are less likely to do so.
EXCESS AND EXECUTIVE PLANS
Excess pensions (i.e. amounts over and above tax limits) continue to be offered to middle management due to
Revenue Canada's (now the Canada Customs and Revenue Agency) brake on the indexing of maximum pension
limits--an issue which was not addressed in the most recent federal budget. Forty-four per cent of plans
with 52% of the membership provide excess benefits. Sixty-eight per cent of excess plans covering 77% of
members extend these arrangements to all members--up from 54% of plans with 55% of members in the 1995
survey.
While the prevalence of funding these benefits may have increased somewhat, the majority of plans
(two-thirds) and members (80%) are in unfunded arrangements. Consequently, the security of these benefits
continues to be a concern in that they rely solely on the financial strength and integrity of the company.
In addition, a high proportion of these types of benefits remain unfunded because of the lack of
tax-effectiveness of funding a non-registered plan through a retirement compensation arrangement.
Pressure is mounting to provide some type of security to the growing number of members covered by these
unregistered and unfunded plans. Plan sponsors need to address how security will be provided to members,
whether it be through funding, a letter of credit or some other means.
In many cases, companies provide their executives with retirement benefits in plans separate from those
offered to other employees. In some instances, executives participate in the base plan and then receive
additional or enhanced benefits. Seventy-eight per cent of plans with special executive benefits only
provide these benefits to first-level executives (vice-president) or higher. Executive benefits apply to 5%
or less of the employee group for 86% of plans with such benefits. The majority (84%) of executive plans
are DB.
Overall, DB plans continue to remain popular. Organizations considering a complete conversion from DB to a
DC plan--often the direct result of a merger or an acquisition--may want to rethink that decision or, if
they haven't already, consider the option of designing a DB/DC plan. For many sponsors this can provide the
best of both worlds. Ultimately, however, plans are most appropriate when the design is driven not by
trends, but by the organization's own circumstances, needs, culture and specific objectives.
Wafaa Babcock and Clare Pitcher are principals and senior consulting actuaries with Buck Consultants
Limited in Toronto. Wafaa Babcock is the Pension Survey Reportcoordinator.
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