The common assumption that plan sponsors are the only ones who bear the investment risk in defined benefit (DB) pension plans isn’t true as employees also bear some risk, according to a study.
The C.D. Howe Institute study, Risky Assumptions: A Closer Look at the Bearing of Investment Risk in Defined-Benefit Pension Plans, notes that the ultimate incidence of additional employer contributions to a DB plan required by poor investment performance could fall exclusively upon employees.
“If there is an unanticipated shortfall due to adverse investment outcomes,” says the study, “employees could eventually bear the cost through reductions elsewhere in their compensation package, or in the case of contributory plans, by increases in the employee contribution rate.”
On the other hand, if investment performance is unexpectedly strong and employer contributions decline, then employees could eventually receive higher wages or greater benefits than would otherwise be the case. Still, it would be the plan members—and not the employer—that bear investment risk in DB plans.
“In the absence of definitive evidence, it is not appropriate to argue (for example) that plan sponsors are entitled to surpluses because only plan sponsors bear the downside risk of investment performance.”
The study does conclude that DB plan members clearly bear less investment risk than members of defined contribution plans because DB plans provide for the sharing of investment risks across different generations of workers.
“Even if there are substantial runs of favourable or unfavourable investment returns,” the study says, “intergenerational risk sharing within DB plans should significantly lower each individual plan member’s exposure to investment uncertainty.”
To read the study on the C.D. Howe website, click here.
To comment on this story, email craig.sebastiano@rci.rogers.com.