Pension reform in New Brunswick can be traced to two highly publicized pension plan failures, which reduced incomes substantially below the level promised by the plans. These events tangibly demonstrated the risks inherent in the current pension delivery model being followed across Canada.
Many private, public and municipal pension plans in the country are facing funding challenges on both a solvency and a going-concern basis. This has led to higher future contributions and lower future benefits in many pension plans. Furthermore, under these conditions, the business-as-usual approach adopted by plan sponsors has been to pressure regulators and politicians to relax solvency and funding rules in the hope that future conditions will improve and ultimately make increased contributions unnecessary. The reality with this approach, however, is that less money in a plan makes the benefits less secure and less secure plans run counter to the objective of avoiding plan failures.
While DB plan members are told their benefits are “guaranteed,” this is a weak promise unless real action is taken to actually provide the guarantee. Very few plans are actually managed to provide a guarantee. Rather than applying a traditional solution based on funding relief (which essentially implies ignoring today’s risks and hoping for conditions to improve before the plan closes), the New Brunswick government made the decision to confront the real problems facing pension programs today: namely, financial sustainability, intergenerational equity and benefit transparency.
The government appointed an expert task force and engaged with their union representatives to discuss the real issues and come up with a comprehensive solution. The task force and the unions involved in this process conducted an exhaustive review involving numerous benefit costings and a variety of stochastic analyses and received a range of expert input on the pros and cons of the many options that were explored.
The resulting shared risk pension plan (SRPP) does not rely on fixed estimates of what future investment returns will be. Instead, its design enables it to respond to actual investment returns by allowing for variability in the benefit level, starting from a conservatively priced base benefit but aiming to provide a higher inflation-protected target. Contributions are constrained within a relatively narrow range from the initially agreed level and the benefit distributions then vary depending on the plan’s financial performance.
SRPP legislation allows inclusion of benefits for past service as part of the plan but imposes strict standards on contributions and risk management. As a result, there is a very high probability that base benefits will be secure.
In addition, meaningful cost-of-living increases would be expected in all but the very worst of economic scenarios. In these same economic scenarios, traditional DB plans would be under significant strain and require much more drastic action in order to continue providing benefits.
In effect, the SRPP is designed to be aligned with economic and demographic reality. This approach is substantially different than the traditional method of making weak promises, ignoring the risks of today and leaving the potential fallout to future generations.
One criticism of SRPPs is that the risk is not truly “shared” as the employer has limited risk due to the modest range of variability of contributions. It’s important to understand that the contribution rates established under the SRPP model include a permanent risk premium that serves to reduce the risk faced by plan members.
Furthermore, contributions are allowed to vary (within a modest range) so the employer does participate in the downside risk by making additional contributions. In addition, rules around surplus distribution are also pre-determined, thus ensuring member participation in positive plan experience and avoiding the debate of surplus ownership. In effect, an SRPP is a participating pension pool where contributions are made by members and their employer, and the benefit distributions are dependent on what the plan can afford, no more and no less.
The challenges associated with the traditional DB plans are well known and do not seem to be about to go away. DC plans have yet to show that they are effective in delivering sufficient and stable retirement benefits. Much has been learned over the past few decades.
Pension industry leaders would be well served to consider these issues and participate in the development of a new, more adaptable retirement savings vehicle focused on effective delivery of stable, reasonably predictable and secure retirement income to Canadians.
Conrad Ferguson, a partner in Morneau Shepell’s Atlantic Office, worked for the government-appointed expert task force on the SRPP design for New Brunswick. Mel Bartlett, the managing partner for Morneau Shepell’s Atlantic Office, worked with Prince Edward Island on its public sector pension plan changes. The views expressed are those of the authors and not necessarily those of Benefits Canada.