Do target benefit plans reduce costs and risk?

A panel held at last month’s Defined Benefit Summit concluded that there are many pros and cons associated with TBPs for both employers and employees.

Essentially, TBPs—from a plan sponsor perspective—provide greater security in determining the long-term cost associated with the plan, said Jana Steele, partner, pensions and benefits at Osler, Hoskin & Harcourt LLP. “Target benefit plans take elements from both DB and DC.”

Read: The myths of target benefit plans

Under a TBP, the sponsor and plan member contribute fixed amounts to the plan, which provides a DB-type benefit at retirement. Though in this structure, the plan administrator may have the flexibility to adjust combined plan contributions within a narrow range, as required, and the administrator would have the ability to reduce benefits depending on whether the plan fails certain asset tests relevant to anticipated benefit targets, she said. “With target benefit plans, benefits can be adjusted up or down–in years where the plan has a surplus, additional benefits can be paid out for say, cost of living adjustments”

Fred Vettese, chief actuary at Morneau Shepell, noted that TBPs do not necessarily reduce risk or investment volatility. Introducing the target component means that the plan sponsor is required to essentially achieve this objective.

However, Vettese pointed out that TBPs, due to there more simplified investment options will most likely outperform DC plans with less risk volatility. “In this regard, you don’t have to turn your plan members into financial experts,” he said.

Read: More myths about DB and target benefit plans

There is a significant advantage to plan members of a TBP in that it is structured to provide life-long pension income, even if the benefits paid go a little up or down, Steele added.

So, why then have TBPs not attracted more attention from plan sponsors?

“The fact is that DB plan sponsors do not have a good understanding of target benefit plans, or shared risk plans, and how they work,” said says Leo LeBlanc, vice-president of human resources and corporate affairs at Co-op Atlantic. “If their DB plans are in good health, they don’t see the urgency to change, and also there are substantial administration costs in switching plan format.”

Another issue which has snagged introduction of TBPs is that many Canadian provinces have yet to introduce or amend legislation enabling the introduction of such structures when it comes to single plan sponsors, Steele noted.

Read: 5 pension trends to watch

“There are still a lot questions out there [relating to provincial pension regulations as well as taxation treatment] pertaining to target benefit plans,” she explained. “At this point, I do not see target benefit plans plans as a viable option for single employer sponsored plans in most jurisdictions…due to the lack of qualified legislation and tax rules.”

However, LeBlanc noted that should legislation in key economic centres such as Ontario and Alberta be amended to accommodate TBPs and if as a result, there was a shift by public DB plans to target benefit-type structures, “then I think we’ll see an avalanche of demand.”

Vettese concurred with this prediction, but with a cautionary note. “The fact is that target benefit plans cannot offer guarantee to employees/plan members that the final pension benefit as prescribed by a DB plan will be 100% fulfilled.” In this respect, he strongly believes that plan sponsors looking to a switch in plan design have to be very clear, and very transparent, with regard to the shared risk and volatility facing the plan member.

Steele added that DB plans are by far the best option from a plan member/employee perspective. “If I have the option to be in a DB plan, then that’s where I want to be. If the alternative is a DC plan versus a target benefit plan, then I would definitely opt for the latter.”