Target benefit plans (TBPs) have been making significant inroads in the public sector of late, more so than most of us realize. Not only are they found in New Brunswick and Prince Edward Island, where governments have adopted a variation of TBPs for their own public sector employees, they’re also making an appearance in Quebec where the government capped the amount it’s willing to contribute to pension plans in the municipal sector, effectively turning these DB plans into TBPs.
The federal government is keen on allowing federally regulated companies and crown corporations to establish TBPs and is in the process of finalizing the rules. Alberta just released comprehensive rules permitting TBPs in single-employer situations. Finally, the Regina police force adopted a TBP in July 1.
These Canada-wide data points represent rather impressive progress, given that legislation to formally establish single-employer TBPs has yet to be passed in most jurisdictions. If interest rates stay low for a prolonged period, which seems increasingly likely, no doubt more public sector plans will be forced by financial constraints to jump onto the TBP bandwagon.
This isn’t to say that TBPs won’t face hurdles. Public sector unions and retiree associations are fierce opponents of TBPs, and they will continue to test the will of governments that would usher them in. On the other hand, it takes only a couple of conversions in significant jurisdictions–say in Alberta and the federal government–to turn the tide nationally.
Ultimately, the biggest obstacle to the long-term success of TBPs may not be resistance from labour groups. It may not even be the inherent volatility of TBP benefits. Instead, it may be whether we are prepared to acknowledge and accept the inherent volatility of benefits.
So far, the tendency has been to make TBP pensions nearly as safe as DB pensions. We saw this in New Brunswick, which set the bar high by requiring at least a 97.5% probability that basic pensions would never be reduced. The recent consultation paper by the federal government suggests a still high 90% probability of the same.
The desire to provide a high degree of benefit security is laudable but comes at considerable cost, and not just financially. High benefit security means holding a significant amount of the assets as a buffer rather than turning it all immediately into benefits. When investments are doing well, TBP participants will receive less income than their money could buy.
This is probably not what participants will want, and for proof of that, consider DC plans. It would be easy to make DC payouts much more stable simply by holding back a portion of investment gains in good times. Few DC participants would agree to that, especially if it means that some of the holdback is eventually used to improve someone else’s pension instead. A modest holdback for the sake of benefit stability is a good thing, but it’s easy to overdo it.
The other major concern with trying to provide a high degree of security is that it obscures the “pension deal.” In DC plans, the pension deal is clear: the participant and the employer contribute a fixed percentage of pay and provide the participant with options to invest these contributions. At retirement, it buys what it buys.
Pension purists will decry the unpredictability of the retirement income that DC plans generate, but the pension deal is clear, and, as a result, there is surprisingly little grumbling from long-term DC participants themselves. If you see retirees marching on Queen’s Park or Parliament Hill, they almost certainly have DB pensions.
If TBPs are going to work, all stakeholders have to accept that TBP pension benefits can rise or fall, perhaps not as quickly or as often as in DC plans, but the possibility is more than slight and a (modest) downward adjustment in pensions should not be regarded as a disaster if and when it does occur. In return, TBP participants can look forward to a little more stability than they can expect from a DC plan. They don’t have to worry about investment options, and individual longevity risk is all but eliminated. This is the deal.
TBPs could yet prove to be the predominant plan design of the future. If we try to turn them into quasi-DB plans, however, we are inviting trouble in the long run.