The single-employer pension plan model is dying. We do not need to mourn its demise, but we do need to replace it.
In a recent report published by the C.D. Howe Institute, we promote the implementation of new private-sector pension plans in Canada based on a better governance model. Rather than being sponsored by single employers, the new plans would be sponsored by multiple employers and governed by independent management boards that include representation from all stakeholders. Scale is of the essence. These new plans could be either of a target-benefit pension plan variety (TBPP) or of a collective defined-contribution pension plan type (CDCP).
The names sound complicated, but the essential elements aren’t.
A TBPP and a CDCP have much in common. They both allow multiple employers to participate. They both share resources on behalf of all plan members, thereby reducing expenses. They have similar governance structures. They have similar administrative and investment needs and solutions. They have the same overall primary goal: to provide good lifetime pensions.
In this paradigm, that is all the pension plan does. It provides lifetime pensions. It is not part of another entity, it exists for its own purpose.
The TBPP and CDCP also have important differences that allow sponsors to opt for more of a defined-benefit flavour or a defined-contribution flavour.
A TBPP allows for cross-subsidization between members. That means a contribution made on behalf of a member can be used to support another member’s benefit, if necessary. A good example of this is when a TBPP provides for subsidized early retirement. Members who retire early benefit at the expense of those who do not. (A CDCP does not allow cross-subsidization. Contributions made on a member’s behalf must be used to support that member’s pensions.)
A TBPP can allow for intergenerational transfers. For example, a TBPP management board could increase current member contributions to protect pensions already being paid if plan finances are weaker than expected. In this case, the current employees are helping out the current pensioners by paying more. Or the TBPP management board could decide to maintain current contributions while reducing future pensions or scheduled increases to future pensions. In this case, the current employees are not helping out the pensioners. Under a TBPP, the management board decides.
When is a TBPP preferred over a CDCP?
The best example comes from the public sector. The Ontario Teachers’ Pension Plan has many of the elements of a TBPP. It is governed by a board that has representation from both the sponsoring employer and unions. It is a very successful plan, the envy of many in the worldwide pension industry.
The Teachers’ plan works, in part, because it provides pensions to teachers, and only teachers. Almost all teachers begin their careers in their twenties, teach for several decades and retire in their mid-fifties to early sixties. Careers are similar and differences between members are not material. Cross-subsidization and even intergenerational transfers are viewed as necessary and appropriate. A teacher is a teacher is a teacher.
The Teachers’ plan has all the advantages of a larger pension plan that provides one benefit target for all of its members. No reinventing the wheel for different member groups. One administration system, one investment strategy.
When is a CDCP preferred over a TBPP?
The private sector comprises many small employers and self-employed individuals. The workers do not necessarily have much in common. Their career trajectories are likely different. Some people change careers multiple times, unlike a teacher.
In designing a pension plan to meet the needs of small employers and the self-employed, it becomes difficult, if not impossible, to be fair to all members if there is any element of cross-subsidization or intergenerational transfer. No one wants to pay for someone else’s benefit. If there is any cross-subsidization, many potential members just will not join. A CDCP becomes the only option.
It is important to recognize, however, that once a member retires under a CDCP, they do have much in common with other pensioners. The benefits of pooling and sharing resources are again paramount. For a pensioner, a TBPP and CDCP can offer all the same benefits. A pension is a pension is a pension.
We should embrace both types of plans and provide them the same support as a society. They are both needed to support a complete pension system.
All Canadians, not just teachers, are entitled to worry-free retirements with income for life.
Published in the Globe and Mail
Robert L. Brown is professor emeritus of actuarial sciences at the University of Waterloo; Stephen A. Eadie is founding partner of the pension firm Robertson, Eadie & Associates.