Without question, workplace pension plans, particularly the traditional DB plan, serve many important purposes in modern society. Employer planning and retention considerations, employee retirement security concerns and government socio-economic concerns all support the maintenance of a widespread robust workplace pension plan regime.

However, many employers have terminated their DB plans in recent years, largely due to funding and risk concerns. Many employers have replaced their DB arrangements with DC plans. However, there is a prevalent concern that DC plans may not provide sufficient retirement income to employees. This raises the following question: Are there alternatives?

The trend toward compromise
Shortcomings with the traditional pension models have come to forefront as the workplace pension plan has matured. In response, plan sponsors and the pension industry have been busy creating plan designs/features that offer a middle ground. Under each of the designs discussed below, there is a balancing between the pure DB and pure DC models. These plan designs/features, to varying degrees, provide a middle ground between fixed employer funding obligations (money in) and fixed benefits provided to employees (money out).

Flexible benefits — Flexible benefit components of DB pension plans have existed for many years. They are traditional DB plans that provide a basic benefit (e.g., a pension based on 1% of final average earnings formula) where employees are then given the option to make voluntary contributions—on a tax preferential basis—to provide ancillary benefits chosen by the employee, such as early retirement subsidies or enhanced survivor benefits. The employer is required to fund the basic benefit in accordance with the statutory funding rules. As such, the employer funding requirements continue to be variable, albeit likely more manageable over the long term because it’s not responsible for funding expensive subsidies. The value of the basic DB benefit is fixed, which is advantageous for employees, but the value of the often-costly ancillary benefits is borne entirely by the employee if he or she elects to fund those benefits.

Jointly sponsored pension plans (JSPPs) — Under a JSPP, employees are jointly responsible with the employer(s) for funding the fixed benefit, in respect of both ongoing accruals and past deficits. The level of benefits and employees’ contributions must be directly related to employees’ earnings. JSPPs are not permitted to reduce accrued benefits while the JSPP is ongoing but, if the JSPP winds up and has a deficit, employees’ accrued benefits may be reduced. If contributions are not sufficient to eliminate an unfunded liability or deficit, the benefits provided under the JSPP must be reduced or contributions must be increased. Under JSPPs, both the level of contributions and the level of benefits are variable on a prospective basis.

In recognition of the shared funding risks associated with JSPPs, employees or their representatives jointly sponsor the plan with the employer(s). Both are responsible for making plan design decisions, such as increasing or decreasing contribution levels or making changes to benefit levels. Employees and employer(s) are also required to jointly appoint the administrator, which may or may not be a jointly governed entity (e.g., board of trustees). Therefore, both the funding risks and governance of the JSPP are shared.

Currently, JSPP legislation is unique to Ontario. The majority of large public sector and broader public sector pension plans in Ontario are JSPPs (e.g., Ontario Teachers’ Pension Plan, Ontario Municipal Employees’ Retirement System). However, JSPPs are slated to be introduced in Alberta, British Columbia and Nova Scotia, and the use of JSPPs will undoubtedly be explored more broadly in the private sector in the future as a means to provide fixed benefits while sharing funding risks with employees.

Target benefit plans (TBPs) — The most recent and most talked about middle-ground design is the TBP. Under TBPs, the employers’ contributions to the plan are fixed (e.g., as an amount per hour worked), and the plan provides a target (rather than defined) benefit. In other words, the money going into the plan is fixed and the benefits paid out are variable if the pension assets are not sufficient to provide the benefits. TBPs set out the mechanism by which the benefit may be modified if the benefit is not affordable. Depending on the experience of the TBP and subject to any prescribed conditions, accrued benefits may be reduced while the plan is ongoing, including pensions that may be in pay to retirees.

The poster child of TBPs are shared-risk plans, which were introduced in New Brunswick in 2012. These TBPs provide a base benefit that is conservatively funded. Additional benefits (e.g., benefit upgrades and future indexing) are conditional upon there being sufficient assets in the pension fund to provide such benefits. The employers’ obligation to contribute is limited to the agreed-upon fixed amount and no payments are required to fund going concern unfunded liabilities or solvency deficiencies.

A better built DC plan
The plan designs discussed above all have a benefit formula and, as such, resemble the traditional DB plan. On the other end of the spectrum employers and the industry have also been working on building a better DC plan. Generally speaking, the actions being taken, as discussed below, are aimed at accessing lower-cost, higher-yielding investments in order to get more money into the hands of retirees.

Lower-cost DC investment options — Under most DC plans, members direct the investment of their individual accounts within a range of options selected by the employer. Historically, investment fees paid under the DC plans are less than retail but far greater than investment fees incurred by large DB plans. Employers have been exploring avenues to restructure DC plan investments in order to access lower-cost DC investments. The goal is to increase the absolute investment returns, which has a direct impact on members’ DC account balances at retirement.

Employer investment of DC accounts — Some employers have, or are contemplating, assuming responsibility for the investment of DC plan assets, rather than requiring individual members to direct the investment of their individual accounts, as a means to achieve better investment returns. The concept is that by investing the assets of the entire DC fund (similar to a DB fund) the employer will be able to achieve better investment returns for all plan members.

Implementation of variable benefits — Pension benefits standards legislation in many provinces has been amended to permit the payment of pensions directly from a DC plan. This avoids the need to transfer members’ accounts out of the registered plan for the purchase of costly annuities or to a retail locked-in vehicle.

Where do we go from here?
The need to provide meaningful retirement income for middle-class Canadians is a pressing issue. Federal and provincial governments are exploring an array of alternatives. We expect the traditional DB and DC workplace models will continue to move towards the models outlined above—or variations of these models—in order to address the needs of both employers and employees. These changes are an important step to the creation of a more sustainable pension regime for Canadian employees.

As a cautionary closing comment, employers that are considering making changes to their pension plans are best advised to carefully consider employment, labour and pension law issues early in the planning stage to determine whether there are impediments on their ability to implement changes.

Terra Klinck is a partner and Natasha Monkman is an associate in Hicks Morley’s pension, benefits and executive compensation practice group. The views expressed are those of the authors and not necessarily those of Benefits Canada.

Copyright © 2021 Transcontinental Media G.P. Originally published on benefitscanada.com

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Charles Spina:

TBPs that do not at least protect pensions in pay are, in essence, capital accumulation plans that are saddled with DB cost, regulatory and governance overheads.

Wednesday, August 06 at 1:08 pm | Reply

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