While it may be true that there’s nothing new under the sun in the pension world, target-benefit plans may prove the exception. In the traditional landscape of defined benefit versus defined contribution plans, target-benefit plans represent a new frontier in pension design for employers.
A target-benefit plan is an alternative plan design that combines features of defined benefit and defined contribution, providing employees with a targeted defined benefit but with fixed contributions from employers (and, where applicable, from plan members), and allowing for the flexibility to reduce or adjust benefits if the plan’s funded position falls below a certain level. They provide the cost certainty to employers often associated with a defined contribution plan, while permitting the pooling of longevity and investment risk found in defined benefit plans.
While the features of target-benefit plans have existed for some time in the unionized multi-employer pension plan context, recent legislative developments in Canada have expanded the concept to the single-employer model. Both Alberta and British Columbia have in recent years enacted legislation enabling the plans in those provinces (although British Columbia’s legislation, unlike Alberta’s, confines the target-benefit design to multi-employer plans), and proposed legislation in Ontario and Nova Scotia would limit the approach to collectively bargained plans. In contrast, the shared-risk plan model implemented in New Brunswick applies to both single-employer and multi-employer plans, union and non-union environments and the public and private sectors.
In October, the federal government introduced proposed amendments to the Pension Benefits Standards Act that provides a framework for the establishment, administration and supervision of target-benefit plans for federally regulated employers. The draft legislation allows for the establishment of a new single-employer or multi-employer target benefit plan but it wouldn’t permit conversion of an existing plan to the new approach. However, members — or their collective bargaining agents — and former members and other plan beneficiaries could agree to surrender benefits under an existing plan in exchange for benefits under a target-benefit arrangement.
Although the federal government has yet to publish much of the detail surrounding the implementation of these plans, the draft federal legislation sets out many of the key features of the proposed target-benefit regime.
What are the main features of the proposed federal regime for target-benefit plans?
First, the target benefit plan must be under the administration of a board of trustees or similar body constituted in accordance with the plan’s governance policy in order to manage its affairs. Although the draft amendments provide that individuals on the board of trustees should be chosen in accordance with the requirements of the (yet-to-be-released) regulations, they do require that at least one person be chosen jointly by the plan members and eligible employees. Also, if the total of former members and survivors equals or exceeds a certain threshold, they must jointly choose at least one individual.
Second, the regulations require a written governance policy for a target-benefit plan.
Third, a target-benefit plan must include a funding policy approved by the administrator that sets out such required items as: the target pension benefit formula; the manner for currently determining pension benefits under the plan, if it’s different from the target benefit formula; employer contributions — and, if any, member contributions — to the plan; the objectives of the plan with respect to pension benefit stability; a deficit recovery plan; surplus utilization; and any other prescribed content. In addition, the regulations require actuarial modelling before establishing the plan and at prescribed intervals. Moreover, a target-benefit plan will require actuarial valuation reports on at least an annual basis or more frequently if directed by the superintendent.
Fourth, a target benefit plan must be established as a new pension plan and a declaration must be filed with the superintendent, along with the application for registration specifying that the arrangement complies with the provisions of the act and the regulations that apply to target-benefit plans. However, as a compromise, the draft legislation provides that an employer may propose to any of its employees who are members of an existing pension plan or their collective bargaining agent and to any former members and other plan beneficiaries that they surrender all or part of their pension benefit under the existing arrangement in exchange for benefits under the target-benefit plan. This surrender requires informed consent in circumstances where a written explanation of the provisions of the target-benefit plan and other prescribed information is provided to members, former members and other plan beneficiaries; members’ spouses and common-law partners; and the collective bargaining agent, if any. In addition, the superintendent must pre-approve the explanation and other information.
As a further protection to members, the draft legislation provides that if benefits under an existing defined benefit plan are surrendered in exchange for benefits under a target-benefit plan and the plan is wound up within five years, the member or former member will be entitled to the greater of the value of the surrendered benefit under the original defined benefit plan and the benefit under the target-benefit plan.
Finally, the draft legislation also includes other provisions relating to the requirements for a target-benefit plan and the protection of members’ benefits, including items such as as the minimum interest rate to be credited on member contributions; pre-retirement survivor benefits; and disclosure to members. The draft legislation requires that members and former members (as well as members’ spouses and common-law partners) receive notice, before the amendment takes effect, of any amendment to the plan in relation to the amount of pension benefits or contributions under the plan.
Significantly, it also requires that the notice “be drafted in a manner that is understandable by a person who does not have technical or specialized knowledge of pensions.”
What are the likely implications of the federal target-benefit plan proposals?
Given that the federal proposals have already encountered criticism from organized labour, it’s unlikely the model will receive a warm reception in the unionized context. However, the target-benefit plan remains a viable option in the collective bargaining context where the alternative is to implement a defined contribution plan for new hires.
From an employer perspective, the target-benefit plan design — with its significant compliance costs, rigorous funding and governance requirements and the provision for employee/member/former member representation on the governing body — may discourage many employers from pursuing the new option. However, employers with large and volatile defined benefit liabilities may see it as an opportunity to change course on their future retirement obligations.
Since the federal proposals don’t permit the conversion of past accrued benefits under an existing plan, it will be more interesting to see whether employers will avail themselves of the option of seeking consent to surrender benefits under an existing defined benefit plan in exchange for benefits under a newly established target-benefit plan. Those that undertake that process will face significant negotiation and compliance costs, but the upside of shedding traditional defined benefit obligations may be worth the investment.
However, it’s doubtful that employers will be able to entirely eliminate the legal risk associated with the process, since even if they make all required statutory disclosure and obtain regulatory approval, the risk of common law claims by members for breach of fiduciary duty in connection with the change remains a real possibility.