There has been a lot of talk about various pension plan deficits and what can be done about them. One of the most talked about changes: the transfer from a Defined Benefit Pension Plan (DB) to a Target Benefit Pension Plan (TBPP) is occurring in the US and is starting to encroach into Canada. So you might ask yourself why should I care? Here’s why you should.
In a DB plan, the plan sponsor (your employer) is entirely responsible for the plan finances. There is a defined formula that tells the pensioner what they will be receiving when they retire. In most of our cases, we receive 2%/year of service minus a Canada Pension integration factor times some final average salary. The pension is increased yearly by some cost of living factor. This amount does not depend on the financial situation of the pension plan. The company is required to make up any shortfall. This means that most of the risk associated with plan funding is in the company’s hands. Target Benefit Pension Plans are a different beast.
TBPP works on a different premise. Key and fundamental is if there is not enough money in the plan, then some of the promised benefit can be reduced. This represents a considerable shift in the risk of plan underfunding from the company onto the employees and pensioners. All Target plans work in this way but how much risk is shifted to the employee/pensioner depends on the details of the individual plan.
Details of Target Benefit Pension Plans are still up for discussion. There are no hard and fast rules. There is a separation between base and ancillary benefits. Base benefits would be the most protected but ancillary benefits would be reduced first. Base benefits would include your base monthly pension. Ancillary benefits could include such things as indexation, death, disability and bridge benefits. Even the definition of what is base and what is ancillary is not yet completely decided. Under the target benefit scheme even the base benefits could be reduced as a last resort to keep the plan going.
The most important part of TBPP is the definition of the financial position of the plan and the definition of the company’s liability. Defining when a plan is underfunded is key to deciding when to cut benefits. There was some talk of using very different techniques from the past that would certainly increase the risk for employees and pensioners if the company failed. Others are advocating such ultra-conservative funding rules that the plans would be always appear underfunded and therefore need to reduce benefits unnecessarily. Of next importance is how much the employer (and employees) should be contributing. The most egregious plans have a cap on the amount the company has to contribute (say 12% of wages) in any year to the plan. Other schemes talk about using risk assessment models to define what should be put in. All of these schemes are set up to reduce the uncertainty and risk for the employer.
The last detail I would like to discuss is the way in which a conversion from DB would be done to TBPP. The Society’s Pensioners Chapter along with other pensioner groups have been trying to get the governments to allow plans to be converted only under an individual informed consent regime. This would mean that each member of the plan would have the right to refuse to go to the new plan. For pensioners, if they chose not to go with the new plan, they would stay with the plan that they had when they left the company. For employees it may mean that they would have a pension split between two plans, a DB plan for past service and a TBPP going forward, if they chose not to convert. Many other schemes for conversion included negative options plans such as if 1/3 of the employees and pensioners do not disagree in writing the plan can be converted. The change to a target plan is such an important decision we do not believe that anyone has a right to make it for us.