Wednesday, November 24, 2010

Target Benefit Alternative to DC - NOT

The Wednesday, November 24, 2010 Daily News Alerts of Pension and Benefits Monitor reported on the Target Benefit Alternative To DC.

"Defined Contribution pension plan sponsors who realize their members do not have enough to retire – and who don't understand that they don't have enough – may want to move to target benefit plans, says Jill Wagman, a principal at Eckler Ltd. In the ‘Target Benefit Plans – An Option for Single Employers’ session at the ACPM’s 'impACT 2010,' she said while they don’t really exist yet, the multi-employer plan concept uses a target benefit plan approach and they have been around for years. The advantage of these plans for employees is that they provide certainty over surplus ownership and give employees a say in the governance of the plan. For employers, they promise cost certainty and do away with solvency funding concerns because when there is a shortfall, the benefit can be reduced. The Ontario Pension Reform Commission has recommended they be set up. However, she said there are still some obstacles including an Ontario requirement which says an agreement with employees needs to be in place. At this time, that would seem to suggest that they would only be available in union environments where the terms of the plan could be set by collective bargaining."

A key point in the above report is the analogy to multi-employer pension plans (MEPPs). If the plan design works for MEPPs, it must be OK for non-unionized employee groups. What is not mentioned is that the reason MEPPs have some success is that the members of MEPPs actually retire from these plans. When they reach retirement age they tend not to terminate and cash in the pension to receive its commuted value.

If members decided not to take a pension from the plan but take the commuted value instead, the MEPP would collapse. This is due to plan benefit levels being based on the assumption that the MEPP will earn a high long term rate of return, which keeps the benefit high and the cost and value within the plan low. Commuted values, on the other hand, are based on a small margin over government bond returns, which produces higher values. The difference is significant. A plan that is financed on the first basis can't afford to deliver on the second.

The reason MEPP members chose retirement and a pension, rather than termination and a commuted value, often has nothing to do with the pension plan. Members who retire generally then quality for benefits such as medical, dental, life insurance and a variety of other benefits that their union decided are important for retirees. If the member terminates, these benefits are forfeited. In the absence of these benefits - non-unionized employers are not so generous - the member's financial advantage tilts towards termination and a commuted value. And, this advantage remains even if the commuted value is used to buy an annuity from an insurance company.

If employees are thinking about buying into the target benefit promise they really need to look at the whole picture. Without a union and promises of post retirement benefits, the plan may not be able to deliver anything close to a favorable long term outlook. Instead, the plan will be left financing the delivery of commuted values. The result - a very complicated DC plan.