Canadian HR Reporter

January 27, 2014 FEATURES FEATUR 27 CANADIAN HR REPORTER PENSIONS 'Sweet spot' between DB, DC pensions Shared risk between plan sponsor, members may make target benefit a wise alternative By Liz Bernier P ension plan sustainability has been a growing concern for years, but there hasn't been much of a consensus on a solution. Calls for Canada Pension Plan (CPP) enhancements have gone unanswered by the federal government and those employers that do offer pension plans are migrating en masse from defined benefit (DB) plans to defined contribution (DC). So what's to be done? One potential option may be target benefit (TB) plans, which many experts say are a "middle ground" between DB and DC. How do they work? There are different types of target benefit plans, but the general premise is the risk is shared between the plan sponsor and plan members, instead of falling solely on the employer or sponsor's shoulders, as in a DB plan. Target benefit plans rely on fixed contributions that aim to achieve a target benefit level. Benefits can then be adjusted according to investment returns and economic conditions. TB plans are also sometimes referred to as a "shared risk-plan," which is the type of target benefit plan introduced in New Brunswick in 2012. "A target benefit plan kind of looks like a defined benefit plan. The difference is, in a defined benefit plan, if costs go up… you have to contribute more toward the plan," says Fred Vettese, chief actuary at Morneau Shepell in Toronto. "In a target benefit plan… the cost is fixed. So the only other thing that can vary is the benefits, so the benefits have to be reduced." For the employer, TB plans work exactly the same as a defined contribution plan, according to Robert Brown, president of the International Actuarial Association, based in Victoria. "The employer makes (a set) contribution — that's the end of his or her responsibility. The risk is carried more by the worker than it is in the defined benefit plan, but because we're targeting a benefit and because we can make midstream adjustments, there's a much higher probability of getting what you want." 'Middle ground' between DB, DC It's for these reasons that target benefit plans are often described as the middle ground between DB and DC plans. "Those are the polar extremes," says Brown. "What a target benefit plan tries to do — it really works hard to find something in the middle, where the worker and the employer share the risk, where the employer doesn't have a highly volatile, unknown cost, but the worker still gets some sense of real security." There are advantages to both parties, but TB plans are likely to be most attractive to employers. "The advantages are mainly for the employer. So if the employer has defined benefit right now, they're going to like target benefit a lot better because it takes away most of the employer risk," says Vettese. "From an employee point of view, it's not going to be as good as defined benefit. It looks like it, but benefits can actually be reduced… The only reason why employees do go along with target benefit is because it's better than the alternative (DC plans)." Target benefit plans offer clear advantages over DC plans because they remove the necessity for employees to manage their own investments. "In defined contribution… it's tough from an employer's point of view because they have to educate the whole workforce on investments," says Vettese. "We've tested this and people just don't really understand investment basics, so they can't really make informed decisions in a defined contribution plan. So, as a result, employers feel at risk that one of these days they might get sued by the employees who maybe misunderstood and may have made bad decisions and will be looking to the employer to make things right." Potential drawbacks It's certainly not a perfect alternative — there are still potential drawbacks to TB plans, says Andrew Harrison, chair of the Association of Canadian Pension Management (ACPM) and partner at Borden Ladner Gervais in Toronto. "From an employee's point of view, I think the key drawback is even though you have a target benefit… you do run the risk that if the performance of the assets in the plan is not sufficient to provide that, then that benefit could be less," he says. "That's obviously less attractive to an employee than a defined benefit plan. But very often for employees, they don't really have an option of a defined benefit plan." There's also the issue of intergenerational tensions within TB plans, according to Ian Markham, Canadian retirement innovation leader at Towers Watson in Toronto. For instance, in the New Brunswick shared-risk plan, current pensioners may face the possibility of a reduction in benefits after five years. 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