There’s little dispute that 2013 was a banner year for the sponsors of defined benefit pensions. At this time last year, almost half of DB pensions were less than 80% funded and about 15% were less than 70% funded. Today those numbers stand at 6% and 2% respectively, according to global human resources consulting firm Mercer.

But the damage has been done. After more than a decade of attempting to manage massive pension deficits, many DB plan sponsors are on a one-way track toward ridding themselves of pension risk.

For most, this will mean executing a variety of de-risking tactics with the eventual goal of shifting toward pure defined contributions plans. For others — namely those who are up against the collective-bargaining power of trade unions — the alternative might be a DB-DC hybrid that will create a two-tiered system within the ranks of one organization. Still others will do away with a pension option altogether, preferring to offer (if anything at all) a group RRSP or something comparable.

The key is finding a design that can meet both the company’s financial objectives as well as its talent and workforce’s objectives

Yet the understandable desire among plan sponsors to absolve themselves of pension risk doesn’t have to take an all-or-nothing approach. As Scott Clausen, a partner in Mercer’s retirement practice, points out, a happy medium does exist.

“For companies that provide single-employer DB plans, more flexible DB designs can be an alternative to converting to DC,” he says. “The key is finding a design that can meet both the company’s financial objectives as well as its talent and workforce’s objectives.”

Mr. Clausen points to alternative plan-design options that allow risk sharing and cost reductions, such as target-benefit plans and/or conditional indexing based on the solvency status of the fund. Risk-sharing arrangements have already been implemented in numerous instances within the public sector. Most recently, the Province of New Brunswick — which has been grappling for years with a severely under-funded pension for its workers — negotiated a own risk-sharing agreement via target-benefit plan.

There are also proposals in several jurisdictions to trade in guaranteed indexing for conditional indexing. “That’s really the key conditional benefit because you need to have a benefit that you can share with actives and retirees so that it doesn’t become all guaranteed after retirement,” says Mr. Clausen, noting many plans today face the grim reality that retirees outnumber active contributing members and that a mechanism to share the risk between both groups is needed.

Target-benefit arrangements — in which a targeted (but not guaranteed) benefit is set out for plan members and then raised or reduced based on whether the plan is in surplus or deficit — have been explored through multi-employer plans in Ontario, but current legislation simply doesn’t allow for single-employer funds to take advantage of such options.

“Pension legislation does not clearly accommodate conditional benefits,” says Jacques Lafrance, president of the Canadian Institute of Actuaries.

The legislative obstacles have caught the attention of actuaries and lawyers, who have been guiding various provincial jurisdictions in their pursuit of reformed pension legislation that would offer single-employer sponsored plans the flexibility to implement alternatives to pure DB or DC models.

Outside of New Brunswick, Alberta and B.C. appear to be the most progressive on this front and are seen as the mostly likely to be first to enact the needed legislation. Ontario is on a similar track but has been in a holding pattern for the past year. Meanwhile, Quebec has seen the implementation of target-benefit plans but these have been limited to the pulp and paper sector. Curiously, Ontario’s prospective pension-legislation reform would restrict target-benefit plans to unionized workplaces, says Mark Firman, a pension lawyer with McCarthy Tetrault LLP.

From Mr. Firman’s perspective, a shared-risk, target-benefit model with conditional funding or indexing offers fewer legal liabilities to plan sponsors than a pure DC plan, which — as already seen in the U.S. — could come with myriad legal headaches once the first cohort of such plans reaches the end of its lifecycle.

“The number of opportunities you have as a company to be sued under a DC plan is limited really only by the creativity of the plaintiff lawyers,” says Mr. Firman, noting sponsors’ legal liabilities are much more limited under a target-benefit design.

The governance structure of such plan could become a bone of contention should they ever have the opportunity to proliferate. In the case of OMERS’ shared-governance model, while the fund’s administrators have ultimate decision-making authority, the board has equal representation of plan sponsors and plan members, ensuring plan members have a voice and a say. Conversely, in New Brunswick, plan members have no role in the fund’s governance, which is essentially guided through very prespcriptive, preset funding formulas.

You need to be very transparent about how you do it

Mr. Lafrance points out a shared-governance model can pose significant challenges – particularly if formulas are not well prescribed from the outset. For example, in the event benefits need to be scaled back because of fund is in deficit, those already receiving a benefit (retirees) are unlikely to be amenable to seeing that benefit reduced while those still working and contributing to the pension will be reluctant to vote in favour of increased contributions to prop up the benefit of retirees.

He notes that in order to avoid friction among plan members and potential lawsuits, the sponsors of target-benefit plans would be well advised to set out in minute detail the conditions upon which benefits could be reduced and the specific degree to which those benefits will be scaled back.

“You need to be very transparent about how you do it.”

Mr. Clausen suggests the simplest way to implement conditional benefits would be through the removal of indexation in the event a plan falls into deficit. “For plans that currently provide guaranteed indexing, it may be as simple as making indexing conditional on future service. But few private sector plans today provide any level of indexing. Indexing may need to be added,” he says, noting other benefits would have to be reduced if conditional indexing were to be introduced where it didn’t exist previously.

Meanwhile, Mr. Lafrance believes a target-benefit plan is the way to go, noting that it not only serves to reduce risk by scaling back the benefit when the plan is in deficit, but also because it’s viewed as a DC plan from a tax perspective, helping sponsors save money. There’s also the added benefit of not having to show an onerous pension deficit as a liability on a corporate balance sheet.

How widely DB plan sponsors will adopt such alternatives will depend on how quickly the required legislation will be enacted. Many DB plan sponsors are already looking for the nearest emergency exit, using annuities to de-risk and eventually do away with their DB plans. In the absence of viable alternatives, they’ll likely opt for a pure DC model or perhaps no pension plan at all — and they’re unlikely to turn back once they do. Should that trend take effect, it would rob employers of one of the most effective retention tools available in Canada’s tight labour market and rob those few private-sector workers who still enjoy a DB pension the opportunity to effectively plan for their retirement — a lose-lose situation.

Source: Financial Post