Evan Bray always wanted to be a cop, though his reasons have varied over the years. When he was a teenager, it was the prospect of driving fast cars with sirens. Later, it was a desire to make a difference in his Regina community.
“Never once did I want to be a police officer to switch our DB plan to a target benefit plan,” says Bray. A target benefit plan has both DB and DC characteristics, with fixed contributions and a targeted — but not guaranteed — benefit.
But that’s what Bray ended up doing in his role as president of the Regina Police Association. Regina’s police department folded its DB plan after the 2008 meltdown. At that time, the plan looked like a black hole that would suck ever-larger amounts of money. Tweaking it wasn’t going to work.
“We just said, ‘It’s time to stop the bleeding — we’re continually throwing good money after bad,’ ” Bray recalls. “Anybody who follows the markets knows you need to basically double the returns to make up for any losses you have. We just didn’t see any way out of this hole.”
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An increasing number of Canadian public sector employers have been closing their DB plans. This trend is hardly a surprise for DB critics, who say DB’s days are numbered because these plans are too expensive to offer. But DB supporters counter DB plans can be efficient and positively affect the economy.
What spurred the closing of the Regina Police’s $300-million DB plan was a 2009 valuation showing employees and the employer would each have to increase contributions from 12% to 18%. But, since the plan was underfunded, plan members would receive benefits worth only half of what was being paid in.
DB remains the predominant model for Canada’s police departments, says Bray, adding only one — Moose Jaw Police Service in Saskatchewan — offers a DC plan. Since Regina Police members rejected the DC route, together with the employer, they decided on a TBP instead.
How TBPs work
A TBP involves fixed contributions from members and employers with the goal of securing a target benefit in retirement. Benefits and contribution levels can be adjusted over time, depending on how the plan’s investments perform. If returns don’t meet expectations, a plan sponsor can increase contributions or reduce benefits, including benefits for past service. If returns exceed expectations, the sponsor can do the opposite.
And the design can be customized. “It can look a thousand different ways and still be a TBP,” says Bray.
For example, the Regina Police plan limits early retirement with unreduced pensions — officers have to meet certain conditions. Under the old DB plan, this wasn’t the case, and that exerted a lot of financial stress on the plan, he notes.
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The TBP model is piquing interest among more public sector DB plan sponsors, says Bray. “When we did our final presentation [on the new TBP] to our members in Regina, we had members from Alberta, Manitoba and B.C. sit in because they’re going through similar challenges,” he adds.
This shift is happening as more public DB plans close. Aon Hewitt’s latest Global Pension Risk Survey shows 23% of public sector DB plans in Canada closed for existing employees this year, and 37% closed to new entrants.
In Aon Hewitt’s 2013 survey, 12% of Canadian public sector DB plans closed for existing members, and 38% closed to new entrants.
C.D. Howe Institute president William Robson says DB plans are rightfully under pressure. “It’s very easy to imagine circumstances where it’s not going to be possible to deliver on [the plan’s] commitment,” he explains. “And there’s no provision [on] what you do if that turns out to be the case.”
Knowing their numbers
DB critics say these plans have been using high discount rates on future liabilities to downplay realities about their funded status, allowing them to promise a rich future benefit without making all the necessary payments in the present, Robson explains.
“Better performance over the past couple of years has given people a bit more fuel for that argument,” he says. “But most DB plans are badly underfunded, and that’s one of the main reasons why they’ve been winding up.”
Derek Dobson, CEO of the Colleges of Applied Arts and Technology Pension Plan, admits some plan sponsors have “a more optimistic view of what the future will hold.” But, he says, discount rates don’t influence benefits costs because the numbers balance over the long term. The use of discount rates is just a timing mechanism allowing plan sponsors to pay less today and make up for it by paying more in the future.
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The only real risk with discount rates is if the employer goes bankrupt, he says, which is why he believes more industries should adopt multi-employer DB plans that can outlive single companies.
DB critics also charge most plans have ignored demographics, operating on the assumption their members will die sooner than they likely will.
“There’s no actuary who correctly anticipated the nature of the changing demographics,” says Mark Yamada, CEO of PUR investing, a firm specializing in DC plan investments. “I’ve not seen a single actuary take responsibility for this problem. As the car is careening down the highway, the actuary is yelling directions to the driver while staring out the back window.”
These issues have caused DB plans to largely disappear from the private sector. “And I think they ought not to exist in the public sector either,” says Robson. “The only reason they still exist in the public sector is because it’s possible to push a ton of risk onto the taxpayers without them realizing that it’s happened.” Yamada concurs, saying it’s only a matter of time before all DB plans become TBPs.
“It may well be the way we’re headed, but it’s not a way I can applaud,” says Robert Drummond, professor emeritus at York University.
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Drummond, co-author of Pension Confidential, sees TBPs as DC plans in disguise. “To say, ‘This is the target benefit, but if we don’t reach it, well, too bad’ — then, in effect, you’re saying it’s a DC plan,” he explains. While the targeting may give employees a sense they’ll achieve the income they’re aiming for, there’s no guarantee. “And without the guarantee, you still put the risk on the shoulders of the employee,” Drummond adds.
And while some advocate for converting public DB plans to TBPs, others support more drastic solutions. For example, Ontario’s Progressive Conservatives have been calling for the conversion of all public sector DB plans in the province to DC arrangements.
77% cheaper
But what if well-managed DB plans were cheaper to run than DC plans?
In fact, they are, says a 2014 study by Robert Brown, president of the International Actuarial Association.
The study — funded by the Canadian Public Pension Leadership Council — asserts converting major Canadian public pension plans to DC arrangements would actually make it more expensive to produce a comparable pension benefit.
“Our modelling has shown us that for an efficient $10-billion DB plan, converting to individual account DC arrangements to provide the same value of pension benefit would increase the ongoing cost of the plan by about 77% and increase the required contribution rates accordingly,” the paper concludes.
Switching to a DC arrangement can make it harder to manage the old DB plan’s unfunded liability, it adds. In fact, the study points out, the unfunded liability will likely keep growing for decades after the DC conversion.
DB critics tend to dismiss these calculations, says Dobson. They also tend to describe all DB plans as arrangements where employers alone are responsible for plugging funding holes.
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But not all DB plans work that way. Many — including giants such as the Ontario Teachers’ Pension Plan, the Healthcare of Ontario Pension Plan and the CAAT Pension Plan — ask employees to assume an equal amount of risk.
These DB plans, known as jointly sponsored pension plans, resemble TBPs. The main difference is that under a JSPP, accrued benefits can be reduced only if the plan winds up.
So why aren’t JSPPs part of the ongoing pension debate? Lack of awareness, says Dobson.
“[Even] in the broader industry itself, when you look at advisors, actuaries, lawyers and custodians, there are very few JSPP practitioners … the bulk of the industry [is] focused on DC issues and private sector employers,” he explains. “That’s where they get most of their business, so that’s what they’re most familiar with.”
Good for the economy
There’s also evidence DB pensions are good for the government and the Canadian economy. A 2013 study by Boston Consulting Group shows only 10% to 15% of DB retirees in Canada receive the guaranteed income supplement, a benefit provided to low-income seniors. Among other Canadian retirees, this number jumps to more than 45%. DB pensions reduce annual GIS payouts by between $2 billion and $3 billion, the report reveals.
The report also says DB pensioners contribute $14 billion to $16 billion annually to Canadian government coffers through income, sales and property taxes. These retirees spend $56 billion to $63 billion annually on various goods.
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And DB plans have lots of capital. Per the 2014 Shifting Public Sector DB plans to DC study, total Canadian pension assets amounted to $1.34 trillion at the end of 2013, with more than $900 billion in public schemes. This lets DB plans finance big projects, such as real estate and infrastructure, over the long run. “Many federal and provincial finance ministers have called for more investments in our infrastructure. Pension plans have stepped up,” Dobson says, explaining infrastructure, with its steady cash flows, fits DB plans well.
Bray agrees DB plans are valuable and some are sustainable. But he’s happy to have settled on what he sees as the second best option for his own Regina police department. It’s an option that will also be available to future generations of police officers — including his son, who’s just completed his training to be a cop.
Yaldaz Sadakova is associate editor of Benefits Canada.
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