Target Benefit Plans

A Toronto Star artcle recently highlighted some of the problems of the Commercial Workers Industry Pension Plan. Covering some 300,000 workers and retirees in the grocery industry, the plan is one of the larger plans in Canada. Unfortunately, at the end of 2006 its fund had only 52% of the assets required to cover the settlement cost of the accrued liabilities. There is not much reported on what has happened since the end of 2006 - likely asset values and the discount rates used to determine liabilities have both fallen - but a good guess is that the finances of the plan have not improved.

The CWIPP is a target benefit plan. There are lots of these plans around, particularly in union settings. This type of plan provides benefits based on a pre-set formula, that takes into account the member's earnings and service or hours worked. The plan's source of contributions is limited to bargained or pre-set contributions from an employer or employers, and sometimes from members. The plan does not provide any benefit guarantees because under the contribution agreement the employer or employers are not required to make up any funding shortfalls. This means that the benefits formula and the contributions have to be carefully managed to make sure they are always in balance. For example, if anticipated high equity returns don't materialize, the plan may be short of funds, leaving contributions and benefits out of balance. It may be necessary to increase member contributions or to reduce plan benefits to achieve balance.

This need to keep plans in balance places significant responsibility on trustees, but the lack of a benefit guarantee also means that members need to know where they stand. Should they retire and take a pension or should they "terminate" and take a cash out. One of the commentators on the Star article said the latter was the preferred course. He was afraid that his plan pension might be reduced in the future. In retrospect he was likely right - better to take the money and run.

Here are a number of questions that trustees should be discussing with their actuary or, they could be questions that members ask their plan's trustees.

• What funding method is used – unit credit (year by year) or a spread cost method? – is a solvency test made each year?
• Are the valuation discount assumptions based the investments of the fund or on bonds alone? In other words, are equity returns anticipated or does the plan only count them when they materialize?
• Frequency of valuations – annual? Prior to any contribution or benefit change?
• Is the plan actuary independent of employer(s) and unions who are parties to the plan? do the trustees and the plan actuary fully represent the interest of members - are there any conflicts?
• If economic conditions deteriorate the plans could be subject to significant cash-outs at an inopportune time – how will the plan protect the remaining participants from adverse financial consequences?
• If change are needed to contributions or benefits, which gets priority?
• What is the minimum or maximum size of change? – e.g. contributions plus or minus a performance adjustment
• Is there a benefit adjustment priority – e.g. add/remove contingent benefits such as early retirement features or inflation adjustment before changing the base benefit, change the base benefit for active members only or change for all members? How frequently and under what conditions?
• What is the expected volatility of changes, either in contributions or benefits, to maintain a fully funded plan? What is the target amount of surplus to minimize volatility?
• How will the trustees avoid surprise changes (any change will be a surprise to most members) – particularly with respect to decreasing retiree pensions.
• Plans create inter-generational transfers of value – what amount of transfer is appropriate? Is the plan benefit based on a career average formulae – perhaps subject to indexation dependent on investment performance?
• How are plan and fund risks communicated to participants?
• If the plan is replacing a prior DB plan, how will the employer contribution be determined – given that risk has been transferred to the membership? E.g. a plan which cost the employer 10% of salaries, with the employer assuming all risk and a 50% equity and 50% bond portfolio, should increase contributions to 14% of salaries, if the employer withdraws from all risk. The additional amount is the value of the risk saving to the employer or the additional amount members should receive to keep the deal even.
• Will the plan promote settlement by annuity purchase for retirees? Or, will it maintain retirees as members? What impact would this choice have on the investment portfolio?
• How will the asset mix change as the plan matures? Will younger members accept a more conservative mix?