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Air Canada and the union representing its flight attendants recently agreed to a new hybrid pension plan for new hires. It consists of a slimmed down DB tier, supplemented by a new DC tier. Some observers think this announcement signals a change in direction for pension plans, but that is unlikely to be the case. In fact, RBC Royal Bank’s recent decision regarding its own pension plan is more representative of the market direction than is Air Canada’s.

This author has long argued that pension plan sponsors should consider the entire risk-sharing spectrum when considering plan design. Currently, plan sponsors tend to gravitate to just the two endpoints of that spectrum: DB plans, where the employer takes virtually all of the risk, and DC, where the risk resides with the participants. Neither solution has proven to be satisfactory; it makes more sense to share risk.

With this reasoning, one would be tempted to conclude that Air Canada’s new hybrid plan is the way to go. However, this is almost certainly not the case. Air Canada’s two-tier solution is problematic in a couple of ways. First, it is hard for members to understand their entitlement and equally hard for employers to communicate it. The DB portion pays a monthly pension benefit for life whereas the DC provides a lump sum. Mashing the two pieces together takes a lot of actuarial sleight of hand and some fuzzy assumptions. The other drawback is that a two-tier arrangement is more costly and more complicated to administer. The cost of record-keeping is independent of the size of the entitlement, whether it is DB or DC. So a slimmed down DB plan for Air Canada’s flight attendants will cost about the same to administer as the full-scale DB plan that current Air Canada employees enjoy.  The cost of administering a two-tier plan is nearly twice as much as administering only a standalone DB or DC plan. To add to the complexity, employers who have a two-tier arrangement often resort to using separate service providers for the DB and DC pieces.

Better hybrid plans may be on the way, but will they be too late to make an impact? A true hybrid usually involves just one plan that encompasses both DB and DC features rather than a two-tier plan. One example is a target benefit plan where the pension formula is expressed in DB terms but the amount ultimately payable may vary depending on investment performance, much like a DC plan. This design is better than a pure DB plan for most employers. At the same time, it is better than a pure DC plan for most employees.

Target benefit plans already exist in the form of multi-employer pension plans. Several years ago, they were highly recommended by all of the expert panels on pension reform for single-employer situations, but the provinces have yet to produce enabling legislation. In the meantime, life must go on, which means that Air Canada and its union were forced to adopt a sub-optimal plan design that is unlikely to serve as a template for others. It also means that many private sector employers will continue to do what RBC has done, which is to close off their DB plan to new hires and migrate to DC.

This all suggests that the plan sponsors don’t expect hybrid plans to be game-changers. If they thought legislation was imminent, and that it would be meaningful, sponsors would wait before making any major design changes. Air Canada and RBC are but two examples among many indicating that few employers are waiting.

This begs the question of what the ultimate fate of target benefit plans will be, if and when governments permit them in single employer situations. Employers who have already switched to DC are unlikely to move to them. DB plan sponsors who can easily move to DC—say in non-union situations—are also unlikely to implement target benefit plans if they can offload all of the risk without too much employee resistance. This leaves only collectively bargained situations and a few other DB plans where the employer buys into the DB philosophy but must reduce risk because of shareholder concerns. To those of us who believe in making use of the entire risk-sharing spectrum, this seems like a lost opportunity.

Fred Vettese is chief actuary of Morneau Shepell. These are the views of the author and not necessarily that of Benefits Canada.
© Copyright 2014 Rogers Publishing Ltd. Originally published on benefitscanada.com

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See all comments Recent Comments

Bob:

Sorry Fred but you are generally wrong in this approach. The cost of admin need not be higher and the cost of the target is about the same, so costs be damned.

Explaining a target plan when times are not good or even when times are good is not easier, in fact the DB/DC hybrid can be much easier to follow.

You speak of income replacement and employee engagement and understanding. So here is a plan design and not knwoing the exact design, let us assume that the individual will get 30% from the governement plans and 25% from the DB portion after a career, they are at 55% with a DC portion they have to build up to a greater lifetime income or to provide ancilliary benefits because of early retirement, bridge, other survivor benefits.

Far better options that are allowed in any target benefit fund. We are not a one size fits all world and allowing people choice in both saving, encouraging savings and in being able ot meet unique demands is better.

If target design was the best why not have the goverment just force all into a government scheme.

Many DB sponsors in various jurisdictions who have moved to either full DC or to target date programs regret or will regret the decision. But in a world which acts like lemmings, all want to jump because of lack of innovation and everyone else is doing it.

Again not seen the Air Canada design yet but I have a few models where it works well.

But maybe that is a problem when our consulting community has difficulty seeing the possibilities outside the DB/DC and the wonder of target date plans that may be no better and mat be wrse than the existing.

Friday, September 30 at 8:22 am | Reply

David Vincent:

I agree with Fred and would add one more somewhat less known benefit of the target benefit plan over conventional DC plans (assuming target benefit plans become common, which has not happened). The pooling of investment management may address some of the key problems of many DC plans, lack of investment knowledge of the participants and higher investment management fees.

Friday, September 30 at 1:16 pm | Reply

Bob:

Lack of investment knowledge and fees can be addressed in DC plans, one does not have to subject the employees to choice. or high costs. Whayt happens if i tok the moeny to pay the actuaries and used it to subsidize the investment fees.

The other part of the equation may be flexibility. In the DB base pension along with the Government programs, I ahve a good start wiht a lifetime pension. With the DC side i have great(er) flexibility in how I use the savings to provide for my present or future needs. Such flexibility does not exist within the DB/target benefit world.

Friday, October 21 at 2:44 pm | Reply

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