One of the key elements of the new collective agreements
recently reached by the Canadian Auto Workers with Ford, GM and
Chrysler is a "hybrid" pension plan for new employees. It
has both "defined benefit" (DB) and "defined
contribution" (DC) components. This hybrid solution follows a
similar arrangement between Air Canada and the CAW reached in
Hybrid pension plans appear to meet
both employer needs for predictable funding and employee wishes for
predictable benefits. But employers should look at a better choice:
"target benefit" plans.
A few basics:
DB pension plans guarantee
pensioners a specific benefit calculated by formula, usually based
on past earnings and years of service. The employee knows what will
be paid in retirement, but employer funding obligations are
uncertain. Today's low interest rates and volatile markets have
exacerbated the uncertainty.
DC pension plans do not provide
guaranteed benefits. Instead, contributions are made in predictable
amounts. The pension that is paid is based on the accumulated
contributions plus net investment returns. The employer has cost
certainty, but the employee bears the investment risk.
Hybrid plans usually provide a
guaranteed minimum benefit, or "floor" (the DB component)
with a top up tied to a DC account.
Hybrid plans avoid the choice between the stark alternatives of
DB and DC plans, but they may simply include the worst of both: the
funding obligation for the DB component and the benefit to be
received from the DC component are both uncertain.
In contrast, target benefit plans can combine the best of both
DB and DC plans.
Under a target benefit plan, contributions are made at a fixed
rate, the best feature of a DC plan. The plan also sets a
"target" DB calculated with reference to a formula that
the fixed contributions are intended to fund in full. That helps to
provide the certainty in benefits enjoyed by employees in a DB
As for the certainty in cost that employers want, the target
benefit plan has built-in flexibility to deal with the vagaries of
the market. If a surplus arises, contribution levels may be reduced
and/or the target DB may be increased. If a deficit develops,
contribution levels may be increased and/or a lower target may be
To make this work, target benefit plans are often jointly
administered by equal numbers of employer and employee
representatives, and sometimes also retirees. Joint administration
ensures that members have a say in crucial decisions affecting
Some Canadian jurisdictions allow single-employer target benefit
plans, but further advantages can be gained with multiple employer
arrangements: A larger asset base means that investment management
and other services can be obtained at preferential rates, and
members employed by a number of different employers can pool
longevity risk to deal with the problem under DC plans of retirees
outliving their savings.
Not every Canadian jurisdiction allows target benefit plans, and
some of those that do impose additional requirements.
Federally-regulated target benefit plans are subject to the
regulator's veto over decisions made by the plan's
administrators to deal with funding shortfalls. In Ontario, target
benefits plans are not available to the vast majority of employees
who are not covered by a collective agreement.
The good news for employers in BC is that the new Pension
Benefits Standards Act (Bill 38), will allow single-employer
and multiple employer target benefit plans. Bill 38 will also
empower the administrator to reduce accrued benefits if the
plan's funding level requires it – without the need
for prior regulatory approval.
Bill 38 is not yet in force but it should provide BC employers
with a new option to bridge the DB and DC solitudes without the
inherent limitations of a hybrid plan.
We will keep you posted as new regulations are passed and Bill
38 comes into force.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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