The relatively new New Brunswick shared-risk plan (SRP) model has received a lot of attention and positive publicity over the past year, not only in the province and the rest of Canada but also around the world. However, there are a number of significant shortcomings that have, to date, not been particularly well identified, understood or communicated.
The SRP story is one of broken promises, a flawed model and misleading communication.
At the core of the issue is the Government of New Brunswick. It abrogated its statutory obligation regarding pension benefits to its current and former employees by legally allowing itself to override its own pension promises. It did this by changing the law retrospectively (i.e., in respect of service and benefits already earned) rather than just prospectively. In other words, it changed a “guarantee-to-pay” to a “hope-to-pay,” an alarming change for both current and future retirees who are depending on their pension for financial security in retirement. Can you imagine the impact on our society if private citizens could simply decide not to honour their contractual obligations?
In defence of its action, the government will say it received the consent of the unions and retirees to this new plan. The reality is, the “consent” was far from unanimous and, more importantly, the consent received was based on incomplete disclosures and misleading information. Furthermore, it’s clear from public statements that even the politicians, who were responsible for championing the new legislation, didn’t fully understand what was being forced on plan members, stating the base benefits were guaranteed when in fact they are not.
Not only did the government do this to its own employees, but it also enabled other employers in the province to likewise adversely affect their employees.
Leaving aside this unprecedented action, there are significant fundamental flaws in the SRP itself—what was communicated (or not) and how it was implemented—to make it a potentially dangerous model for use in the Canadian pension industry.
To better understand the operation of the N.B. SRP model, PBI Actuarial Consultants recently identified a number of significant and fundamental concerns. It performed an in-depth review and analysis of the risk management goals and measures of success pertaining to the conversion, effective Jan. 1, 2014, of the pension plan under the N.B. Public Service Superannuation Act (PSSA) to the N.B. Public Service Shared Risk Plan (PSSRP). Specifically, PBI evaluated the appropriateness of the actuarial model and underlying assumptions and input parameters used to determine and communicate the likelihood of the new PSSRP’s success. Here is a summary of the findings.
Stochastic projection modelling has significant limitations
Stochastic projection modelling (SPM)—central to the operation of the N.B. SRP model—is a sophisticated actuarial technique for looking into the future and evaluating different probabilistic outcomes. However, the results of the model are dependent on the inputs (i.e., the underlying actuarial and economic assumptions about the future). Currently, there are no standards governing SPM, in particular the inputs. (Note: the Canadian Institute of Actuaries is in the process of developing standards.)
Without the appropriate disclosure of the range of variability and uncertainty and other shortcomings, SPM and the associated risk management goals and measures of success are not appropriate as either a regulatory criterion or, more importantly, for the communication of likely benefit levels to plan members.
Based on the plan’s selected set of assumptions, the PSSRP passes the regulatory tests of success for both the base benefits (primary goal: 97.5% likelihood of success) and the ancillary benefits (secondary goal: 75% measure of success).
However, based on an alternative set of equally valid assumptions, the PSSRP achieves only 72.5% success for the primary goal and 47% for the secondary goal. In other words, the plan fails both tests of success. Therefore, there’s a huge range of uncertainty and subjectivity involved that doesn’t appear to have been disclosed or adequately explained to members and unions when the government sought their consent to the new arrangement.
Furthermore, the projected level of failure (27.5% versus 2.5%, representing more than 10 times the risk of base benefit cuts, and 53% versus 25%, representing more than double the expected further ancillary benefit reductions) is significant based on this alternative set of reasonable assumptions. The question is, then, would members and unions have supported the new plan had they known this information when the N.B. government introduced and converted the plan?
Regardless, communicating a 97.5% probability of success of anything—as with the primary goal—without the appropriate disclosures conveys virtual certainty. This is not the reality and is very misleading.
Regulations open to interpretations
The regulation in respect of the secondary goal for key ancillary benefits (pre-retirement earnings escalation and post-retirement indexing) is open to interpretation, leading to a substantial difference in the measure of success and related benefits. Even staff at the Office of the Superintendent of Pensions had different interpretations of its meaning.
At this point, it’s unclear as to what benefits are actually going to be paid and how that compares to what was communicated to members and unions.
This additional layer of confusion points to a further problem with the model: its complexity and cost and how members may be affected.
Reduction in benefits
Even if everything goes as planned, there will be a significant reduction in benefits for a number of reasons.
First, for final averaging purposes, pre-retirement earnings are increased at the rate of inflation—the consumer price index (CPI)—rather than at actual salary increase rates. Over a typical person’s working lifetime, actual salary increase rates will exceed the CPI by an average of at least 0.5% to 1.0% a year, which represents the equivalent average overall reduction in benefits of at least 15% to 25% or more.
Second, there was an increase in the earliest unreduced retirement age (from 60 to 65) and associated reduction in early retirement subsidies. Depending on actual retirement age, the reduction in the value of the benefits received could be as much as another 30%, which, when combined with the reduced earnings escalation rate, could easily result in an effective benefit reduction of about 50%.
Finally, the objective for the new plan’s ancillary benefits is only 75% of the already-reduced target benefits. This represents a reduction layered on a reduction, with the outlook for the future being a significant decrease in post-conversion target benefits relative to pre-conversion guaranteed benefits.
Shifted, not shared
The SRP is not shared in the sense of equal sharing of risk between employer and employees. Its very name is inappropriate and misleading.
Members bear far more of the risk in an SRP than the employer, ultimately 100% of the risk. The sharing is actually among the members, with the employer or government having effectively shifted the risk to members. The only type of plan that can be correctly classified as shared risk is a jointly sponsored pension plan (i.e., risks, rewards, gains and losses are shared 50/50 between employer and members). The N.B. SRP is not such a plan; it’s really a target benefit plan.
In the name of sustainability
Often this sort of change (to SRP) is done conveniently, but unnecessarily, in the name of pension plan sustainability. In reality, it’s done for two main reasons: to drive down benefits (and costs) and to transfer the risk from the employer to the employees.
Prior to conversion to SRP, this plan was close to 90% funded on a going-concern basis just prior to this unprecedented overhaul, clearly not in such bad shape as to make it unsustainable without radical changes. Some structural and plan design changes—including some combination of benefit reductions (or conditionality) and contribution increases going forward—could have sufficed and not necessitated the plan being turned completely upside down.
In light of PBI’s findings, the N.B. PSSRP (and the entire N.B. SRP model spreading throughout the province) needs to be revisited. And the new government, as per its pre-election campaign commitment, needs to be open to change and willing to work together transparently with the unions and retirees’ coalition to find a solution that meets everyone’s goals.
H. Clare Pitcher is a senior consulting actuary with PBI Actuarial Consultants Ltd. The views expressed are those of the author and not necessarily those of Benefits Canada.