Before getting started on the myths, it’s important to understand what target benefit plans (TBPs) are and how they differ from (but also share) the attributes of DB and DC plans.
Like DC plans, contributions to a TBP are fixed (or variable within a narrow range). Like DB plans, TBPs provide a DB-type pension at retirement and pool both longevity and investment risks. However, under a TBP, benefits may be adjusted, up or down, in response to the plan’s funded position from time to time.
The goal of TBPs is to deliver the targeted benefit but at the same time ensure sustainability and maintain intergenerational fairness. If there are insufficient funds in the plan to deliver the targeted benefit, the benefits may be decreased. Allowing benefit adjustment is another lever in addition to payment of additional contributions where there are funding concerns.
Myth #1: Target benefits are a new “untested” concept
TBPs have recently been implemented in New Brunswick and Alberta, and the federal government has indicated that it also intends to introduce legislation to permit these plans for federally regulated employers. In doing so, these governments are providing a new pension design option for sponsors of single-employer pension plans. Remember, however, that target benefits have existed in other forms for many years.
Target benefits—while not generally permissible for single-employer plans—have existed for many years in the multi-employer environment (i.e., plans in which two or more unrelated employers participate). Multi-employer pension plans providing target benefits, which are often sponsored by unions, have been permissible and existed in most Canadian jurisdictions for some time. These multi-employer plans are typically administered by a board of trustees, at least half of whom are representatives of the members.
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What’s new for target benefits is prescribed risk management requirements to help with benefit security. In New Brunswick, prescribed risk management goals must be attained and risk management procedures must be followed. In Alberta, there are requirements for a provision for adverse deviation as well as stress testing. Some form of risk management for TBPs is desirable.
In addition to multi-employer plans, in Ontario, there are several large public jointly sponsored pension plans (JSPPs) where costs are shared fifty-fifty between plan members and plan sponsors—thereby, arguably a category of TBPs that existed prior to the recent changes to introduce TBPs in certain jurisdictions. Some of these JSPPs are hailed as being some of the best-run pension plans in Canada.
Thus, while the introduction of TBPs as an option for single employers is a welcome change, these types of plans have been operating in the multi-employer context for some time.
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Myth #2: Limiting employers’ pension design options means continued DB plans
There’s been a suggestion that if you do not offer employers the option of implementing a TBP, they will simply choose to continue their existing traditional DB plans.
One of the key flaws with this suggestion is that it appears to overlook the fact that the private pension system is a voluntary one. Subject to notice requirements and/or applicable collective agreements, employers can generally prospectively change or eliminate benefits provided to employees, including pensions as long as accrued benefits are preserved.
Employers have been exiting traditional DB plans in droves over the last few decades. This shift has been as a result of numerous factors, including employers’ desire for cost predictability, concerns over funding volatility and long-term affordability given escalating longevity risks.
For single employers, most pension standards legislation provides only one other pension design option for an employer wishing to change from DB: DC pension plans. Oftentimes, negotiations will result in the preservation of DB plans for those employees who have them, with new employees being placed in a DC plan. Sometimes employers will exit the registered pension plan regime altogether in favour of group RRSPs for new hires.
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Shouldn’t there be an alternative to DC plans where an employer decides to exit the traditional DB model in favour of a less volatile pension arrangement? In the right circumstances, isn’t a targeted DB pension for the entire workforce better than a “guaranteed” DB pension for some and a DC plan for future service and new hires?
Permitting TBPs as a design option means there is another viable option for employers with non-union workforces to consider and for employers and unions to negotiate in respect of unionized employees. In the context of unionized workforces, employers would still have to negotiate the establishment and terms of any TBP with employee bargaining agents.
Pension legislation that permits plan design options other than the traditional choices should be encouraged as a progressive alternative that could, in many circumstances, be preferable to exiting DB for future service and/or future hires, creating an ongoing DB legacy issue for the sponsor and intergenerational benefit differences among members.
In our next post, we will explore two more myths.
Jana Steele and Ian McSweeney are both partners in Osler, Hoskin & Harcourt LLP’s pensions and benefits group. This article originally appeared on Osler’s Pension & Benefits Law Blog. The views expressed are those of the authors and not necessarily those of Benefits Canada.