• The assets of the plan are invested for the plan as a whole, and not on an individual basis. This typically translates into lower investment management fees and higher long-term investment returns. Not only can a pension plan invest in larger, professionally managed asset pools, it also has a much longer investment horizon than a given individual member, has greater access to professional advisers and can, therefore, execute a much more efficient investment strategy. The benefits of large asset pools are even greater in the case of large, commingled target benefit plans.
• The longevity risk is spread across all plan members so members can’t outlive benefits. Spreading the longevity risk over all plan members allows for the average level of retirement benefit to be higher for a given contribution than it would generally be under a Group RRSP or DC pension plan.
• Most DB plans do not allow for formal member participation in the plan’s governance. Many plan members will appreciate the opportunity to participate in the management of the target benefit plan.
Exempted from solvency funding
The OECP recommends that target benefit plans be subject to going concern funding only and that solvency funding should not apply. This recommendation is based on the premise that target benefit plans are similar in nature to MEPPs, for which the OECP has also recommended an exemption from solvency funding.
The OECP’s rationale for this recommendation is that:
• the plan has the ability to adjust benefits to accommodate changing economic environments and cope with a shortfall, and
• target benefit plan members have significant control over the board’s decisions and are fully informed as to the plan’s risks.
We agree with this rationale. Another argument against solvency funding for target benefit plans is that the solvency funded position is very volatile. Since contribution rates are typically difficult to change, the application of solvency funding can lead to large swings in benefits.
Funding the plan on a going concern basis clearly puts a greater onus on the board to ensure that the plan’s funding and investment policy is sufficiently conservative. Under normal circumstances, this would be achieved by using a relatively low discount rate assumption, conservative assumptions for future mortality and/or additional contingency reserves.
On this point, we note that it is unlikely that even an extremely conservative actuarial basis would have fully insulated a plan—in the short term—from the severe market downturns recently experienced. No board can be held to a standard of being “100% right” in the short term or completely shielding their members’ from risk, but a board should be expected to manage the plan’s funding basis so that, over the long term, members benefits are reasonably stable, especially when compared against benefits provided from an individual account in a Group RRSP or DC plan.
Transition to a target benefit plan
The OECP does not address how a transition to a target benefit plan from an existing DB or DC plan should be carried out, except to say that it favours “a simplified conversion process…driven largely by a concern for transparency and democratic decision-making.”
In most cases, however, the two key transition issues would be:
1. establishing a joint governance structure, and;
2. deciding on the treatment of benefits accrued under the existing plan.
Documentation would need to be drawn up to set out the details of the composition and operation of the governing board. And, in the absence of a union, the employer would need to facilitate the establishment of a democratic association or similar body to help govern the plan.
The OECP report talks only about applying target benefits on a going-forward basis and does not deal with the issue of accrued benefits. Current legislation does not allow accrued benefits under an existing DB plan to be reduced, so accrued DB plan benefits could not be assumed by a new target benefit plan under the current rules. A DB plan sponsor could simply “freeze” the existing plan and implement a target benefit plan going forward.
However, it is hoped that any new legislation would recognize the merits of creating target benefit plans and would allow sponsors of existing DB or DC plans to negotiate the terms of any transition with their members—including a possibility of reduction in benefits accrued under the existing plan—with appropriate requirements for member disclosure and agreement.
Transition from a DC plan should be fairly straightforward. The key consideration in terms of accrued DC benefits would be whether account balances should be transferred into the new target benefit plan. If so, a formula would have to be established for converting these balances into target benefit plan amounts for past service.
Of course, in addition to dealing with the issues of joint governance and accrued benefits, any transition to a target benefit plan would involve creating or amending the trust and working out all of the plan terms, including contribution levels.
Next steps
We are encouraged by the OECP’s strong call for innovation in Ontario’s pension system. Clearly, if there was ever a time for all stakeholders to embrace and get on with such innovation, this is it.
Target benefit plans have provided a very successful retirement income plan structure for many workers in Ontario and across Canada for decades. In addition to the OECP promoting the expansion of target benefit plans to more workplace environments, this type of plan design has also received broad-based support in the reports recently released by the Alberta/British Columbia Joint Expert Panel on Pension Standards and the Nova Scotia Pension Review Panel.
Cameron Hunter is an actuary and a principal in Eckler Ltd.’s Toronto office.
