This is our first post (in a four-part series) where we address common myths associated with target benefit plans and defined benefit pension plans. For more on target benefit plans see our prior posts (Part I, Part II and Part III).
Before we get started on the myths, it is important to understand what target benefit plans (TBPs) are and how they differ from, but also share the attributes of defined benefit (DB) and defined contribution (DC) plans.
DB plans provide a pension payable for life at retirement and the employer is responsible for funding the benefit, subject to any fixed required employee contributions. Where there are funding deficits in the plan, the employer is required to make additional payments to address the deficiency.
DC plans are similar to group RRSPs and provide a capital accumulation savings-type vehicle. Employer contributions (along with any employee contributions) are fixed, but the ultimate benefit for the employee is uncertain, being subject to contributions and investment performance. Because longevity risk is not pooled and each individual has to rely on his or her own savings account, there is a risk of a member outliving his or her retirement savings.
Like DC plans, contributions to a TBP are fixed (or variable within a narrow range). Like DB plans, target benefit plans provide a DB-type pension at retirement and pool both longevity and investment risks. However, under a TBP, benefits may be adjusted, up or down, in response to the plan’s funded position from time to time. The goal of TBPs is to deliver the targeted benefit, but at the same time ensure sustainability and maintain intergenerational fairness. If there are insufficient funds in the plan to deliver the targeted benefit, the benefits may be decreased. Allowing benefit adjustment is another lever in addition to payment of additional contributions where there are funding concerns.
Myth #1: Target Benefits are a New “Untested” Concept
TBPs have recently been implemented in New Brunswick and Alberta, and the federal government has indicated that it also intends to introduce legislation to permit these plans for federally-regulated employers. In doing so, these governments are providing a new pension design option for sponsors of single employer pension plans. It is important to remember, however, that target benefits have existed in other forms for many years.
Target benefits – while not generally permissible for single employer pension plans – have existed for many years in the multi-employer environment (i.e., plans in which two or more unrelated employers participate). Multi-employer pension plans providing target benefits, which are often sponsored by unions, have been permissible and existed in most Canadian jurisdictions for some time. These multi-employer plans are typically administered by a board of trustees, at least half of whom are representatives of the members.
What is new for target benefits is prescribed risk management to help with benefit security. In New Brunswick, there are prescribed risk management goals that have to be attained and risk management procedures that must be followed. In Alberta, there are requirements for a provision for adverse deviation as well as stress testing. Some form of risk management for target benefit plans is desirable.
In addition to multi-employer pension plans, in Ontario, there are several large public jointly sponsored pension plans (JSPPs) where costs are shared 50/50 between plan members and plan sponsors – thereby, a category of target benefit plans that existed prior to the recent changes to introduce target benefit plans in certain jurisdictions. Some of these JSPPs are hailed as being some of the best run pension plans in Canada.
Thus, while the introduction of target benefit plans as an option for single employers is a welcome change, these types of plans have been operating in the multi-employer context for some time.