The Observer

ARTICLES OF INTEREST

New DB plans with guaranteed benefits and fixed employer contribution: a viable option for the 21st Century?

by Michel Lizée, Community and Women’s Groups Member Funded Pension Plan

With the decline of defined benefit (DB) pension plans in favour of defined contribution (DC) pension plans, we are seeing a new generation of defined benefit (DB) plans with both a guaranteed annuity and a fixed employer contribution. New regulation in Quebec has allowed Member Funded Pension Plans (MFPPs), known as a Régime de retraite par financement salarial (RRFS) in French, to be established. In 2008, two Quebec multi-employer pension plans were created: the RRFS-FTQ set up by a union federation [https://rrfs.ftq.qc.ca/] and the community and women’s groups plan called Régime de retraite des groupes communautaires et de femmes (RRFS-GCF) [http://regimeretraite.ca/site/english/]. Following that, three single-employer plans, including Rio Tinto Alcan, were created.

The Canadian Public Pension Leadership Council recently conducted a study [
http://cpplc.ca/wp-content/uploads/2018/01/2017-034_cpplc-report_the-pensions-canadians-want_20170501.pdf] confirming that most Canadians were looking for a pension plan with the features of a DB plan (e.g.: guaranteed lifetime income that increases with inflation but does not fluctuate based on return) and they were prepared to pay more to participate in such a plan. The current trend towards DC plans goes against their wishes.

Based on these considerations, two major pension funds in Ontario’s public sector, the Ontario public service employee plan, OPTrust [
https://www.optrust.com/jointheplan/default.asp], and the Colleges of Applied Arts and Technology (CAAT) plan [https://www.dbplus.ca/] have just set up two new multi-employer pension plans for employers in the public sector, the nonprofit sector and, in the case of CAAT DBPlus, the private sector (DBPlus can also accept employers from the rest of Canada). After considering a multi-employer plan tailored to the needs and constraints of its sector for several years, the Ontario Nonprofit Network [ONN] finally decided to recommend OPTrust Select to its members [https://theonn.ca/our-work/our-people/decent-work/pensions-and-nonprofits/].

These plans correct two major weaknesses in “traditional” DB plans: the volatility of the employer contribution and the accounting pension expense.

These plans, with both a guaranteed lifetime annuity and a fixed employer contribution, have the following features in common:

 
  1. Career-average pension plans, aside from one exception (flat benefit formula for certain groups in the RRFS-FTQ).
  2. Annual contribution covers the cost of the vested benefit and the indexation cost of the benefit, before and after retirement. Significant indexation reserve constitutes ±50% of the liabilities for the Quebec MFPPs  and is used to absorb market volatility and financial shocks and to pay the indexation when the plan’s financial position allows so.
  3. Comparable accrual rates of regular annual pension at age 65: 10% of contributions for the RRFS-GCF and OPTrust Select, 8.5% for the CAAT DBPlus Plan (which includes a survivor’s pension funded by the plan) and 10,989% for the RRFS-FTQ.
  4. Comparable indexation: 100% of inflation for MFPPs (max. 4%) and OPTrust Select; the CAAT DBPlus increase is based on the Average Industrial Wage index before retirement and 75% of inflation after retirement.
  5. Simple benefits structure: regular retirement age of 65, little or no ancillary benefits.
  6. More or less flexible approach in terms of allowed contributions. OPTrust Select has a single rate (3% employer and 3% employees). More flexibility with DBPlus (employee contribution between 5% and 9% and equal employer contribution). The RRFS-GCF allows for a total contribution between 2% and 20% as long as the employer contributes at least half and the employee contribution does not exceed 9%.

One specific regulatory detail about MFPPs: an unfunded actuarial liability arises only when assets are insufficient to cover the cost of guaranteed benefits, without taking into account future indexation. The very high indexation reserve level (±50% guaranteed liability) suggests a very low likelihood of an actuarial deficit. A stochastic modelling done by PBI actuarial consulting firm indicates that by the end of a 20-year period, the plan’s funding ratio at the 95th percentile would be 105%[1]. So there is a risk, but a miniscule one. If an actuarial deficit should arise, a portion of the employees’ contributions would be used to amortize it. Note that Quebec MFPPs post funding ratios of 175% or higher and have all granted full indexation up to their last evaluation.

As for the Ontario plans, “OPTrust has done scenario planning and, even with another 2008-like economic downturn, the plan would still be able to maintain the long-term funded status required to protect the basic benefits without having to increase contribution levels.” (Selecting a pension plan for Ontario’s nonprofit sector, Final report of the ONN’s Pensions Implementation Task Force, Sep. 2018, p. 16)

One major advantage of the two new Ontario plans, envied by the Quebec MFPPs, is the investment of their assets in the Primary Plan Fund, which amount to $10.8 billion and $20 billion respectively. Therefore they have instant access to greater diversification at lower cost, greater efficiency and unmatched risk management considering the size of the assets and the management teams in place. Three Quebec MFPPs have partly overcome their initial small size by pooling management of their assets in a master trust with other pension funds, while keeping their own asset allocation between asset classes.

The CAAT DBPlus Plan received strong support from two leading Canadian experts, which attests to the interest in this new generation of DB plans:

 
  • “I am thrilled by this new pension system designed and administered by CAAT. I have been promoting exactly this type of plan for the past decade in my academic research and writing.”—Robert L. Brown
  • “With its sustainable plan design, strong governance process based on fiduciary principles, and balanced investment program, the CAAT Pension Plan is truly an effective workplace pension plan for the 21st Century.” — Keith Ambachtsheer

A new generation of group pension plans that are efficient, safe and simple from an employer’s administrative standpoint.

The Quebec MFPPs and the two new Ontario plans provide a lifetime guaranteed benefit while addressing the two major objections raised by employers regarding traditional DB plans: the volatility of the employer contribution and the accounting pension expense. On an administrative level, they are no more complicated for the individual employer than a DC plan. Moreover, during a period of increasing labour shortage, these plans are a strategic tool to attract and retain staff—a not-so-insignificant factor for employers with a long-term vision.

There are several avenues for transitioning existing DB and DC plans towards these new plans: for future service only, or by terminating the existing plan and using the assets that are thus freed to buy back past service in the new plan.

Conclusion

While some believe that it is inevitable that DB plans will disappear and be replaced with DC plans, the emergence of a new generation of multi-employer DB plans with both a lifetime guaranteed benefit and a fixed employer contribution is a major development that all stakeholders in the pension community should be taking note of. This opportunity must be seized so that the Canadian pension system can still perform well and efficiently to ensure that the living standard is maintained and guaranteed upon retirement for most workers, which is currently far from the case.

Based on our experience, two additional features would help improve the performance of multi-employer DB plans and make them more attractive based on the approach described above:

 
  1. Flexibility for every employer, particularly for determining and amending the contribution rate or facilitating early retirement for older workers, especially in the case of staff reduction (buy back of past service and funding of actuarial reduction), so long as the additional generated costs are fully borne by the employer or its employees.
  2. Provide individual tools that allow plan members to increase their guaranteed annuity cost effectively: past service buy-back, direct transfer from another pension plan, payment of voluntary contributions or RRSP transfers that, at the time of retirement, may be converted into an additional guaranteed benefit with the goal of indexation, possibility of reducing or eliminating the reduction for early retirement by paying the actuarial equivalent. To compensate an average total contribution of barely 5.3% in the community sector pension plan (RRFS-GCF), nearly 16% of the plan assets as of December 31, 2017, would be coming from these individual tools. This plan thus manages to increase the effective savings rate, both on a collective and individual basis, the key to improving the Canadian pension system.

[1] Stochastic modelling (PBI 2014)—2014–2034 projections—Model where only economic parameters vary—Fund investment 60% Stocks-40% Fixed income.