As membership in traditional defined benefit pension plans continues to decline, it’s becoming more common to see “contingent” plans — including target-benefit, shared-risk, multi-employer and jointly sponsored — which require members to take on at least some of the risk that benefits may or may not meet expectations.
At the same time, the term “sustainability” is front and centre in pension discussions, but what does it mean in the new context for pensions? How can it be achieved? What are the implications for regulatory policy?
A new report by the C.D. Howe Institute explored these questions through interviews with 30 experts, drawing conclusions about how regulatory policy can best adapt to these changes. “We tend to be very narrowly focused when we look at legislative change,” says Barry Gros, a retired actuary, chair of the pension board for the University of British Columbia Staff Pension Plan and co-author of the report. “Once you start going across all these different types of contingent plans, you start to see some themes that you might not notice if you just focus on one type of plan. I think that was the power of the study.”
The experts interviewed for the report agreed the term “sustainability” is a relatively recent development, arising as part of the shift towards a risk management paradigm for pensions. As well, the experts reported using the term “sustainability” without having an official definition. However, when they were probed for their own definitions and interpretations, responses varied, though they usually contained elements such as: long horizon, affordability and a commitment to members’ financial wellness in terms of providing a meaningful benefit.
“We thought everything with respect of sustainability would revolve around financial measures,” says Gros. “We were looking for the Holy Grail of the right valuation technique or model that could get you to sustainability, and that’s not what we found at all.”
Different plans use different models, he says, noting the most common model integrates benefit funding, investment policies and the benefit itself. “But for different models, there was different emphasis. Some people really emphasized having a meaningful benefit; for all intents and purposes, what’s the point of sustaining something that people can’t live on? So integral to their definition of sustainability was this concept of a meaningful benefit.”
As well, the report found that many experts view sustainability as a balancing act between the needs of the present and the needs of the future. Indeed, it noted a strong intergenerational equity component is tied up in the definition of sustainability, which is emerging more in discussions of contingent pension plans, and it expects intergenerational equity could become one of the defining pension issues over the next decade.
“Back in the day when contributions were low and they were affordable and it wasn’t really affecting people’s take-home pay, it wasn’t a big issue,” says Gros. “But if you look at a lot of these contingent plans now — especially in the JSPP sector — the contributions are about at the maximum; they can’t go any higher without the plan member, especially new members who can’t afford housing, being asked to put 12 per cent into their pension plan. This whole issue of fairness of contributions for what you can expect to receive and transfer of wealth between generations in order to stabilize the benefits — I think that could become a really big issue.”
The report’s respondents were also asked about the requirements for a plan to be, or to become, sustainable. In addition to financial measures, they identified a range of other factors, including the design and nature of the plan, governance and communication with stakeholders.
“It’s kind of chicken and the egg, a little bit,” says Gros. “Everyone will agree that financial measures are critical, but you get the right financial measures based on the type of design you have.”
Using a typical target-benefit plan as an example, there are a lot of levers, adds Gross, referring to pre-retirement indexing, post-retirement indexing and early retirement subsidies. “All of those are levers so if there’s an adverse experience, either on the liability or asset side, they can adjust the plan and maintain its sustainability by reducing those levers when the plan is being stressed and then improving the plan when it’s getting better.”
But a typical multi-employer plan doesn’t have any lever. “Basically, benefits are the only lever, and that really puts them under stress,” says Gros. “So plan design is really important, but it’s directly linked to the financial element.”
Communication and governance are equally important. “Having the right people involved and a good structure in place for governance is really critical because you’ve got to make the right decisions, you’ve got to be looking at things from the long term . . . you need to have a long-term view and do long-term analysis to really understand the direction your plan is going in.”
The report concluded that contingent pension plans will likely play an increasingly important role in delivering retirement benefits in the future. These plans offer a different promise and a different contract with plan members, so that has to be reflected in how they’re managed, communicated and regulated.
It suggested that the parties involved in setting pension policy and standards should spend more time understanding in-depth the existing practices of well-managed plans and seriously consider the report’s recommendation that prescriptive standards focus on aspects such as governance and member communication, leaving financing-related standards to be principles-based.