As part of ongoing pension reform initiatives, pension legislation in various Canadian jurisdictions is being amended to accommodate a new pension plan design feature, commonly referred to as a target benefit provision (although the label differs across jurisdictions).
Plans containing target benefit provisions could come in different design forms, but, conceptually, they aim to provide employees with a DB that is funded by fixed employer (and, in some cases, employee) contributions. Although the fixed employer contributions are expected to be sufficient to enable the benefits to be paid, benefits can be reduced by the plan administrator if the plan experience proves the contributions to be insufficient, as opposed to increasing contributions to pay for the promised benefit.
Target benefit plans (TBPs) offer a solution that addresses the main risks associated with traditional DB and DC plans. The funding risk to employers associated with DB plans is seen as a key factor in the decline in DB plans in recent years. The result is that employees are left with DC plans and the risk of unpredictable retirement income.
TBPs enable employers to control their funding risks and, on a related note, can solve the issue of accounting volatility that DB plans cause many employers. At the same time, they enable employees to better plan for their retirement. Overall, TBPs offer both employers and employees the DB plan efficiencies of risk pooling and lower fees.
The essential elements of a TBP are not new and feature in traditional multi-employer pension plans; however, the circumstances in which benefits may be reduced under multi-employer pension plans vary between jurisdictions. This provides evidence that TBPs are not merely a theoretical but a viable solution to the twin issues of declining pension coverage and pension adequacy in Canada.
For the most part, the complete TBP regulatory framework remains to be seen. Only the New Brunswick provisions are currently in effect, with the other jurisdictions awaiting regulations to be published. However, the New Brunswick experience indicates that TBPs are unlikely to reduce the administrative burden associated with traditional DB plans. Instead, it reveals that TBPs will be complex, requiring annual actuarial valuations and more stringent regulatory requirements and oversight than traditional DB and DC plans.
Another critical administrative aspect of establishing and maintaining a successful TBP will be effective employee communication. Members of a TBP must understand the risk that their benefits could be reduced if the plan assets are insufficient to pay benefits. Transparency here is key, including disclosure of the circumstances under which benefit reductions will be permitted; the way in which reductions will be allocated among different member groups; and the process to be followed when reducing benefits, including any notice requirements. Enhanced disclosure requirements regarding the funded status of the plan and investment performance of the fund would also be appropriate.
If TBPs are to be widely adopted by Canadian plan sponsors, there must be a practical and functional way for employers and employees to convert existing DB accrued benefits to benefits under a TBP. This will necessitate legislative change, as pension legislation does not currently permit a reduction of accrued benefits.
Within the parameters of the regulatory framework, employers will need to decide various issues in structuring the transition, including whether to close the existing DB or DC component to new members only or to freeze future benefit accruals under the existing plan(s). In addition to any legal issues, employee relations will be an important consideration.
Although TBPs seem to strike a much needed balance between employer and employee interests, an unfortunate aspect of some recent legislative amendments to accommodate TPBs is their restriction to the unionized context (see the Ontario, Nova Scotia and P.E.I. provisions). This significantly limits their applicability and their promise for meaningful improvement to the Canadian pension system as a whole. While this restriction was presumably intended to protect members, legislated governance and disclosure requirements could alleviate concerns for non-unionized employees so that TBPs could be more widely available.
Paul Litner is chair of the ACPM National Policy Committee and chair of the pensions and benefits department with Osler, Hoskin & Harcourt LLP. Stephanie Kauffman is an associate with Osler, Hoskin & Harcourt LLP. plitner@osler.com; s.kauffman@osler.com