While defined contribution pension plans evolve and defined benefit plans decline, the McGill University pension plan is a true blend of both types — at least for some employees.
When Sebastien Betermier, an associate professor of finance at the university’s Desautels Faculty of Management, joined the plan after 2009, a DC arrangement was available for all new plan members. “For employees who joined the year before me, what you have is a DC, but with a floor,” he says.
Essentially, the original version functions as a DC plan, but with a minimum guarantee. It makes a DB calculation for each member based on their final salary and age of retirement. If the amount is higher than what a member would have earned if they put 100 per cent of contributions into the default investment option, the plan makes up the difference.
McGill’s hybrid plan is just one example of how these arrangements elude strict definitions. But, even though no two are exactly alike, new tools and legislation are facilitating the arrival of more hybrid plans on Canada’s pension landscape.
The hybrid umbrella
A plan like McGill’s, with a minimum benefit regardless of market performance and a DC layer so members can invest individually, has a flexibility that appeals to members, says Kevin Rozek, vice-president and consulting actuary at the Segal Group Inc.
That flexibility can go even further, he adds, referring to plans with a smaller defined benefit and a component that offers members a wider range of choices. Plan sponsors can provide a credit, with or without a matching feature, which members can put towards a DC plan, another savings vehicle like a tax-free savings account or a registered retirement savings plan, or use to boost their health-care benefits.
“In those types of plans, it really allows the member to have some sort of choice on where their current assets go, because everybody has a different financial situation as they’re working,” says Rozek. “But yet, it still provides some sort of basic DB benefit so there is some retirement savings at the end of the day.”
However, plan sponsors should avoid creating too much of a jumbled melange of plan features, he cautions, noting it could disengage employees. “I have heard of some plans that were just way too complex for the employees to understand and they had to basically . . . go back to where they started.”
Indeed, when using a hybrid arrangement, a solid, clear communications strategy is integral, says Jillian Kennedy, partner and head of DC and financial wellness in Canada at Mercer. “Plans are struggling with . . . engaging employees, because these are such complicated structures that it’s very difficult to simply tell an employee what they have to do and what they don’t have to do.”
Employees in DB plans may feel they don’t have to engage because everything is taken care of by their plan sponsor, she says, noting that attitude can be dangerous if plan members become too lethargic when it comes to preparing for retirement.
Some DB plan sponsors are choosing to tackle that lethargy by adding an additional voluntary savings or investment benefit where the plan member does have to make a choice, adds Kennedy.
Stay on target
Another option under the hybrid banner is a target-benefit plan. Similar to a DC plan, it can have either fixed or variable contributions. But in other respects, it functions like a DB plan, in that it calculates an ongoing benefit based on a formula and pools longevity and risk among all plan members. The benefits are adjustable according to the plan’s investment performance. Target-benefit plans are attractive for both plan sponsors and members, says Ed Lee, vice-president of retirement solutions at Morneau Shepell Ltd. While the flexibility of the plan is a major advantage for employers, it’s also better than a DC plan for members in two ways: it provides greater risk protection and pooling and it handles the problem of decumulation.
Once again, communication is key, stresses Lee. “A proper communications strategy is critical to the success of a targetbenefit plan. I think the biggest risk is members believing the benefits in the plan are guaranteed and not subject to change. Or similarly, on the contribution side, while I think most people believe it to be fixed contributions and variable benefits, it doesn’t necessarily have to be that way. There can be variable contributions within a little more limited range.”
Currently, federal pension legislation doesn’t allow for single-employer target-benefit plans. In 2016, Finance Minister Bill Morneau put forward Bill C-27, which would amend the Pensions Benefits Standards Act to allow Crown corporations and federally regulated employers to move to these plans. Faced with many detractors, the bill remains stalled at first-reading stage.
However, several jurisdictions, including British Columbia, Alberta and New Brunswick, allow for these types of arrangements. In Quebec, they’re permitted for specific pulp and paper sector employees. Saskatchewan allows for a variation on target benefits called limited liability plans. And other provinces are consulting on the plans, with some in the process of ironing out their policies.
“Some provinces have adapted legislation to embrace target benefits on the multi-employer, collectively bargained side, but even [on] that, not all provinces and territories have come up with that legislation,” says Rozek.
“As an actuary, I would say it would be very nice to see standardized legislation across the country. I know we’ve seen a few provinces — British Columbia and Alberta, in particular — who worked together several years ago to harmonize their pension legislation. And one of the things that came out of that was the target-benefit legislation, which is fairly effective in both provinces.”
However, even with that collaboration, the two provinces still ended up with different results. While B.C. allows a traditional DB plan to be converted to a target-benefit arrangement, accounting for workers’ past and future service, the Alberta model only takes future service into account.
For target benefits to really take off, federal and Ontario employees will have to get on board, says Rozek. “Those are the two largest jurisdictions that don’t offer it for anybody. And once we have it for the majority of Canadians, then they can go down the road of trying to harmonize the legislation.”
New kids on the block
While no single hybrid plan design stands out as truly popular, according to Lee, the common thread for many plan sponsors is moving away from plans that are strictly DB or DC.
“You’re seeing plans more focused on long-term sustainability and, as a result of that, making certain plan design changes where benefits are being changed from being 100 per cent guaranteed to being more discretionary. So, for example, moving from a plan or design that provides guaranteed post-retirement indexing to now only providing that indexing if the plan can afford to do so. There is a hybrid nature to that.”
As well, the advancement of new decumulation tools at the federal level also fall under the broad hybrid umbrella, says Betermier.
In its 2019 budget, the federal government announced new decumulation options for retirees called advanced life deferred annuities and variable payment life annuities. While the accompanying legislation to govern these types of arrangements doesn’t yet exist, he says they could go a long way to solving some of the problems with traditional DC plans.
Advanced life deferred annuities essentially provide a lifetime annuity, with the payments deferred until the member reaches a certain age. Members of many different types of registered plans, including DC arrangements, will be able to purchase these annuities. On the other hand, variable payment life annuities will allow annuity payments to plan members to shift alongside changes in the consumer price index, as well as the overall return performance of the underlying annuity investments.
Applying these types of tools to existing capital accumulation plans is very much in the spirit of a hybrid pension, says Betermier. It allows the added security that’s usually associated with a DB plan to latch onto the flexibility of DC plans when a person’s longevity calls for it.
Martha Porado is an associate editor at Benefits Canada.