We explore 10 key challenges for business leaders in 2014, with expert commentary on the issues.
When Jay Parker considers how the huge pension plan he manages will fare in 2014 and beyond, he has a target in mind.
“We have what is called a target benefit plan,” says Mr. Parker, who is executive director of the University of British Columbia’s staff pension plan.
Mr. Parker says that opting for this more flexible type of pension helps UBC meet challenges that most company plans will face in 2014: continued low interest rates and changing mortality patterns.
“There aren’t really a lot of plans in Canada that look like this right now. But it really is the talk of the [pensions] industry.”
Target benefit plans are relative newcomers compared with the standard forms of pension plans in Canada: defined benefit and defined contribution. To proponents like Mr. Parker, and many pension experts, this type of plan is well equipped to withstand the turbulence of a still-uncertain economy.
To understand why these plans are becoming popular, it’s important to know the difference between the plan types.
“The affordability of pension plans for the public and private sector is a big issue now,” Mr. Parker says. “There are so many problems, with low interest rates, solvency issues – issues that drive sponsors [employers] away.”
Target benefit plans fall somewhere in between defined benefit and defined contribution plans.
In a defined benefit plan, employees are promised a fixed amount when they retire; how much varies according to years of service and an individual’s earnings, but the amount the retired employee can expect is known in advance. The company manages the plan’s assets; the employees have no involvement in how the funds are invested.
In a defined contribution plan, the income you receive when you retire is not determined in advance. Under these plans, the employer makes fixed contributions into individual employees’ retirement accounts – it’s usually based on a percentage of your salary or it’s a set dollar amount. The money paid out upon retirement depends on the performance of the investments in the accounts.
Mr. Parker says that UBC has moved toward a target benefit plan because it offers some of the advantages of both defined benefit and defined contribution plans.
In a target plan, the employer and its employees make fixed contributions, similar to a defined contribution plan. The payouts that can be expected are set as a target, which depends on projections, made by actuarial experts, of what the plan will be able to afford.
While benefits are not set out categorically as in a defined benefit plan, there’s also less risk that the plan won’t be able to meet its obligations.
Target benefit plans are sometimes also called “shared risk” plans, as setting targets lowers the risk for both employers and employees, Mr. Parker says.
In most provinces and territories, defined benefit plans have to be reviewed every three years by regulators to make sure they have enough funds.
“A large percentage of pension plans in Canada are not 100 per cent solvent, which is not good,” Mr. Parker says.
This leads to problems on both sides. Employers with shortfalls are faced with either increasing their contributions or taking a hard line in labour relations, seeking to drastically revise or abandon their plan. Employees face the prospect of a pension plan that may not be there for them, even though they may have paid into it for years.
In a target plan, if the funds fall short, both sides know in advance how the benefits will be adjusted – according to a formula that both have agreed on beforehand.
“Really, there are only two ways to attack a funding problem: You can increase the funding or reduce benefits; it doesn’t get more complicated than that,” says Karen Hall, an actuary and vice-president, retirement, with Aon Hewitt who oversees UBC’s pension plans. “Target benefits simply pay what the plan can afford.”
Mr. Parker says that the flexibility of the target benefit plan helps UBC deal with the continuing environment of low interest rates and changing mortality patterns.
Low interest rates, while a friend to borrowers and mortgage holders, hurt pension plans because their funds are put into long-term investments. Since the 2008 recession, prime interest rates have been closer to zero than they have ever been, making the return on these long-term investments poor.
While there are strong hints that interest rates will rise in 2014 as the economy picks up, economists have predicted this trend several times in the past few years, and it hasn’t happened yet.
The other issue is rising life expectancy. With Canadians living longer than ever, there is increasing pressure on plans, which can end up supporting pension holders for decades. It’s also hard on the younger workers who have to keep contributing but can’t be sure how the economy might change in 10 or 20 years. A target benefit plan offers a blend of predictability and flexibility, Mr. Parker says.
It’s not perfect, he acknowledges. The laws and rules needed to govern target benefit plans are not completely in place yet in most of Canada. Also, pensions are regulated differently in each province and territory, making it hard to develop national target plans.
Nevertheless, Mr. Parker believes that UBC’s staff plan is well equipped to withstand the storms of 2014. “We have 10,000 members, with more than $1-billion in assets and our plan is about 40 years old,” he says.
“Our plan is far from gold plated, no bells and whistles.” But it’s better than the situation in the private sector, adds Mr. Parker, “where probably the majority of workers in Canada have no pension whatsoever.”
The experts weigh in
Here is what three experts have to say about target benefit pension plans and the University of British Columbia’s staff plan.
Assistant professor, Department of Statistics and Actuarial Science, Simon Fraser University, Burnaby, B.C.
I think target benefit plans are a potential solution for plan sponsors and plan participants, but it’s not a panacea for everybody. These types of plans need a long-term focus.
By this, I mean keeping the stability of the plan in mind over several generations. Pension trustees should be able to show the members that the plan has been managed as agreed upon by all parties ahead of time.
With the right approach from trustees, I think it can work. There are international examples of similar plans, and there are lessons that could be learned from those experiences.
Pensions and benefits director, Unifor (new union combining Canadian Auto Workers and Communications, Energy and Paperworkers unions), Toronto
While I don’t know too much about the UBC plan, I find it interesting.
I’m concerned that employers are going to use this period of low interest rates to get out of defined benefit plans. Employers are looking to get out now when they have large obligations, but when interest rates do go up, defined benefit plans will do well.
I think there is something to be said about cost sharing, but risk sharing is another matter. There’s something a bit uneven when you have employees who earn $30,000 or $40,000 a year sharing risk with big employers.
Chair of the board of the Association of Canadian Pension Management (ACPM) (representing pension service providers), Toronto
The ACPM is supportive of target benefit pension plans as another option. It’s kind of an elegant solution. For a lot of companies, the choice is between struggling with defined benefit or switching to defined contribution. It’s better to have a halfway point.
We try to recognize a balancing of interests. We don’t see any particular type of plan as the be-all and end-all.