Air Canada and the union representing its flight attendants recently agreed to a new hybrid pension plan for new hires. It consists of a slimmed down DB tier, supplemented by a new DC tier. Some observers think this announcement signals a change in direction for pension plans, but that is unlikely to be the case. In fact, RBC Royal Bank’s recent decision regarding its own pension plan is more representative of the market direction than is Air Canada’s.
This author has long argued that pension plan sponsors should consider the entire risk-sharing spectrum when considering plan design. Currently, plan sponsors tend to gravitate to just the two endpoints of that spectrum: DB plans, where the employer takes virtually all of the risk, and DC, where the risk resides with the participants. Neither solution has proven to be satisfactory; it makes more sense to share risk.
With this reasoning, one would be tempted to conclude that Air Canada’s new hybrid plan is the way to go. However, this is almost certainly not the case. Air Canada’s two-tier solution is problematic in a couple of ways. First, it is hard for members to understand their entitlement and equally hard for employers to communicate it. The DB portion pays a monthly pension benefit for life whereas the DC provides a lump sum. Mashing the two pieces together takes a lot of actuarial sleight of hand and some fuzzy assumptions. The other drawback is that a two-tier arrangement is more costly and more complicated to administer. The cost of record-keeping is independent of the size of the entitlement, whether it is DB or DC. So a slimmed down DB plan for Air Canada’s flight attendants will cost about the same to administer as the full-scale DB plan that current Air Canada employees enjoy. The cost of administering a two-tier plan is nearly twice as much as administering only a standalone DB or DC plan. To add to the complexity, employers who have a two-tier arrangement often resort to using separate service providers for the DB and DC pieces.
Better hybrid plans may be on the way, but will they be too late to make an impact? A true hybrid usually involves just one plan that encompasses both DB and DC features rather than a two-tier plan. One example is a target benefit plan where the pension formula is expressed in DB terms but the amount ultimately payable may vary depending on investment performance, much like a DC plan. This design is better than a pure DB plan for most employers. At the same time, it is better than a pure DC plan for most employees.
Target benefit plans already exist in the form of multi-employer pension plans. Several years ago, they were highly recommended by all of the expert panels on pension reform for single-employer situations, but the provinces have yet to produce enabling legislation. In the meantime, life must go on, which means that Air Canada and its union were forced to adopt a sub-optimal plan design that is unlikely to serve as a template for others. It also means that many private sector employers will continue to do what RBC has done, which is to close off their DB plan to new hires and migrate to DC.
This all suggests that the plan sponsors don’t expect hybrid plans to be game-changers. If they thought legislation was imminent, and that it would be meaningful, sponsors would wait before making any major design changes. Air Canada and RBC are but two examples among many indicating that few employers are waiting.
This begs the question of what the ultimate fate of target benefit plans will be, if and when governments permit them in single employer situations. Employers who have already switched to DC are unlikely to move to them. DB plan sponsors who can easily move to DC—say in non-union situations—are also unlikely to implement target benefit plans if they can offload all of the risk without too much employee resistance. This leaves only collectively bargained situations and a few other DB plans where the employer buys into the DB philosophy but must reduce risk because of shareholder concerns. To those of us who believe in making use of the entire risk-sharing spectrum, this seems like a lost opportunity.