Supplemental Employee Retirement Plans, or SERPs, are an important component of the total rewards package provided to many Canadian employees. To employees who are approaching retirement, a SERP entitlement can confer a significant amount of financial well-being.

SERPs were originally created to provide a pension top-up to senior executives, primarily because limitations in the Income Tax Act (ITA) prevented the target levels of defined benefit (DB) retirement income from being paid from a Registered Pension Plan (RPP). From the mid-1970s until 2004, the ITA pension limits barely moved, significantly increasing the number of plan members whose RPP entitlements were limited by the ITA.

To illustrate this change, all we need do is compare the benefits payable by an RPP—using a 2% accrual formula for illustration—to the average Canadian wage. In 1976, RPP members started to exceed the ITA limits when their pay was close to 10 times the average Canadian wage. In 2009, members can exceed the ITA limits when their pensionable earnings reach $125,000, or roughly three times the average Canadian wage.

As a result, a number of plan sponsors have either rolled out broad-based SERPs, or extended their executive SERPs to all employees, as part of their total rewards strategy. This is consistent with Towers Perrin’s research that employees aged 45 to 54 view competitive retirement benefits as one of the top-five attraction/retention drivers; for employees aged 55 and over, competitive retirement benefits is rated number three, just behind base pay and health care benefits.

In 2008 Towers Perrin conducted a survey of over 200 employers covering a broad cross-section of organizations by industry, size, and geography. The survey was intended to capture the practices of this large employer group, of which roughly two-thirds have more than 1,000 employees and over 90% have Canadian revenues over $100 million.

The survey revealed an increase in recent years in the number of organizations that view their SERPs as an important tool in the attraction and retention of key talent. Of greater interest, however, is the finding that the number of organizations providing some level of security for their SERPs has also increased.

Over the last decade, a number of global and Canadian companies became insolvent or, at the very least, approached the edge of the solvency abyss. Employees are no longer willing to take it on faith that their employers will be around to pay their retirement benefits after the employment relationship has ceased. Based on the survey, it appears that plan sponsors have turned their focus to the financial security that their SERPs can or should provide. After all, what good is a SERP if circumstances evolve such that it cannot pay the promised benefits?

While traditionally the employer was viewed as being a constant—always there to provide the benefits—from a financial health perspective, this may no longer be a prudent position for employers and employees to take. As a result, while 41% of the companies surveyed funded or otherwise secured their SERPs in some manner in 2004, 52% provided some level of funding or security by 2008.

There are two main methods to secure a DB SERP: (i) funding with invested assets in a trust (or, occasionally, using insurance products); or (ii) security through a Letter of Credit (LoC). In the survey, we found that roughly 33% of broad-based DB SERPs are funded with invested assets (or are insured) and 18% are secured through a LoC. For executive DB SERPs, these figures are 28% and 23% respectively.

These figures do not include the companies that have earmarked certain assets for the SERP but have not placed them in a trust. Some DB SERPs also allow or require the employees to commute/settle the full SERP entitlement at retirement, thereby limiting the risk of employer default to the period of his/her employment. As an aside, defined contribution (DC) SERPs have one other security option available—an upfront settlement—where eligible employees are provided with a “pension bonus” in respect of their DC SERP accrual for the year.

In addition to the objective of providing benefit security, some organizations have increased the funding/security of their SERPs to remain competitive, or for plan governance and fiduciary reasons. Considerations that may influence plan sponsors include:

  • Upcoming changes in accounting standards that will bring the unfunded SERP balance onto the corporate balance sheet;
  • Concerns about potential risk/liability from a governance perspective should the plan fail to settle its obligations (particularly if the executive SERP is secured but not the broad-based SERP);
  • Provision of a level of security consistent with other employers in their industry; and
  • Employee concerns about the solvency of the SERP.

There are several reasons supporting the decisions by some organizations not to secure their SERPs, including:

  • Benefit security is not viewed as an issue for the organization;
  • The organization can generate a greater return on the capital within the business;
  • The SERP liability is not large enough; and
  • Current cost constraints.

Given the many demands on capital faced by employers, the decision to fund/secure SERPs is not a simple issue. All of the reasons above need to be considered as an employer establishes its financial priorities.

All the same, the survey was conducted just prior to the market turbulence of late 2008 and early 2009. Some organizations may find that the costs to secure a letter of credit or to borrow funds may be higher in 2009, and in some cases may not be readily available. It will be interesting to see whether companies re-assess their decisions to fund/secure their SERPs; particularly for those in industries which are most affected by the current economic downturn.