Pensions have long been regarded as a mainstay of benefit packages. Typically they are designed to address both the needs of the plan sponsor or employer and the needs of employees. As unionized employees have their own distinct set of needs, the types of plans that have evolved reflect the variety found between industry sectors, representing the values of the employees at given points in time. But are these approaches to plan designs still appropriate and how well will they meet future needs?
There are four popular approaches for providing pensions to unionized employees, both hourly-paid and salary:
•the “flat-dollar” approach under which increases to pensions are negotiated at regular intervals;
•the “contributory final-average” approach, popular in the public sector, which provides rich pension benefits with generous ancillary features;
•multi-employer plans under which the level of employer contributions is negotiated but the benefits resemble those benefits payable under a defined benefit plan; and
•non-negotiated plans under which unionized employees receive the same pension arrangements as their non-unionized colleagues.
Flat-dollar plans
These plans are widely used in many industries, including the autoworkers, steelworkers and mineworkers. The original concept was simple, members received a flat-dollar amount, say, $10 per month per year of service. The plans were straightforward and easy to communicate and administer. They worked well in an environment where earnings were fairly uniform throughout the group. Over time, additional features were negotiated such as:
•bridge benefits from early retirement to age 65;
•unreduced retirement following the attainment of certain age and service milestones; and
•subsidized spousal benefits.
These plans have withstood the test of time and many of them now provide significant benefits. From a member’s perspective, the main disadvantage has been the relatively low funded ratio relative to a typical “final-average” plan. This ratio exists because of the Canada Customs and Revenue Agency (CCRA) rule that limits funding to promised benefits only. This means that each time that a new benefit level is negotiated, the improvement creates a new unfunded liability, which is then amortized over a period of years.
This creates significant solvency issues relative to a final-average plan where the ultimate benefit levels can be funded. This situation is often compounded by generous early retirement provisions, which must be taken into account in calculating the solvency liabilities.
From a sponsor’s perspective, these plans have frequently created issues of parity for lower paid non-union employees who have often demanded and received a guarantee that their benefits will never be less than those provided under the flat-dollar plan. This has created some nightmarish plan designs.
Contributory final-average plans
These plans have been largely developed within the public sector in a total compensation environment that provides security in retirement for career-service employees. As the pension formula typically starts at a level close to the maximum two per cent permitted by CCRA, the main potential for negotiating benefit improvements lies in improving plan features, such as early retirement rules and spousal benefits.
From a member’s perspective, these plans provide high levels of pension income in return for relatively high employee contributions. These plans do not suffer from the same restrictions on funding as flat dollar plans, and so the same concerns over solvency do not exist. The main question now though is whether it is possible to further enhance these plans, given that most features have been improved to their limit. Two potential areas are:
•reducing member contributions; and
•changing the governance structure to provide more control to the members.
From a sponsor’s perspective, these plans suffer from inflexibility in that it is very difficult to change the design as there are almost no tradeoffs available. This is a serious issue as many large public-service plans are being subdivided, and the successor sponsors may have totally different business goals from those of the original employer.
Multi-employer plans
These plans developed within industries where there was a multitude of small employers, with a high level of employee movement between each. They are unique from a design point of view in that the contributions are defined. The benefits are calculated to be of equivalent value to the contributions, and give the appearance of being guaranteed. In theory, at least, the benefit levels may be reduced if the expected plan experience does not materialize.
From an employee’s perspective these plans appear very similar to the flat-dollar plans. However, the governance is typically shared through a joint board of trustees. In addition they provide seamless portability through a series of participating employers.
With these plans, employers have the security of knowing that their financial obligation is limited to the most recently negotiated contribution level.
However, employers are dependent on the competence of the board of trustees to make funding and investment decisions that are in the long-term best interests of the plan. The actuary for the plan has a distinct responsibility to select a funding basis strong enough to support the benefit formula through most eventualities.
Non-negotiable
In this approach to pensions, the union is asked to agree that pensions are a non-negotiable item in respect of contract agreements. In return, the employer agrees to provide a plan that fits with its corporate goals and may be identical to that provided to non-unionized employees. Frequently the employer agrees to advise the union before making any significant design changes.
From a member’s perspective, this normally provides for a satisfactory situation. However, the union loses the opportunity of negotiating regular plan improvements, which is a feature of the other approaches discussed. A particular issue these days is that the plan may be redesigned to fit the needs of the majority (non-union members) and these may not coincide with the priorities of the unionized workforce. For example, there is a general trend in salaried employee plans to reduce the benefit formula by enhancing the plan features, thus retaining the same benefit value but increasing the members’ potential RRSP room. Such a redesign may not be so appealing to unionized members who may regard the benefit reduction as a takeaway, and may not be excited at the prospect of making larger personal retirement contributions.
Employers will find this solution easy to implement. However, they should be aware that a higher level of plan communication might be required in order to provide full disclosure to the union membership.
The future
Pensions have been provided to unionized employees through a variety of approaches — each with its own strengths and weaknesses. The continued use and appropriateness of these approaches will need to be examined in context of the current political, economic and demographic trends. In closing, three key questions are posed, the answers to which may well shape the future of pensions for unionized employees.
1. How will maximum pensions affect unionized employees? As the threshold earnings level for hitting the CCRA maximum pension remains at $86,111, increasing numbers of unionized employees will have their registered pensions limited. Supplemental plans will become an integral part of the negotiation process. However, it seems unlikely that unions will accept the kind of unfunded plans currently in place for many salaried employees. This may well serve as the spur needed to develop more innovative approaches for securing supplemental pensions.
2. How will the emerging demographics affect unionized plan design? For many years, one of the features of negotiated plans has been the trend towards more generous early retirement rules and bridging benefits. This was fine as long as there was agreement that earlier retirement dates for employees were in everyone’s best interests. Now, with a clearer picture of future shortages in skilled labour, employers will be anxious to reverse these provisions in exchange for other features. Unions may not be so keen to accommodate these changes. Clearly, a win-win solution will need to be developed.
3. Will the broad unionized workforce ever embrace defined contribution plans? The classic argument against DC plans has been their inability to be retroactively applied. Hence, any newly negotiated changes can only benefit plan members on a go forward basis. In addition, DC plans lack any kind of income redistribution element, something which has always been a feature of defined benefit plans. Unions are also generally opposed to members assuming the investment risk. The answer may well lie in hybrid or combination plans, which combine the positive attributes of DB and DC plans. It is time that more work was done to develop these plans with a unionized constituency in mind.
Patrick Longhurst is a senior consultant in the Toronto offices of Watson Wyatt Worldwide. For more information contact [email protected] or 1-866-206-5723.
There are four popular approaches for providing pensions to unionized employees, both hourly-paid and salary:
•the “flat-dollar” approach under which increases to pensions are negotiated at regular intervals;
•the “contributory final-average” approach, popular in the public sector, which provides rich pension benefits with generous ancillary features;
•multi-employer plans under which the level of employer contributions is negotiated but the benefits resemble those benefits payable under a defined benefit plan; and
•non-negotiated plans under which unionized employees receive the same pension arrangements as their non-unionized colleagues.
Flat-dollar plans
These plans are widely used in many industries, including the autoworkers, steelworkers and mineworkers. The original concept was simple, members received a flat-dollar amount, say, $10 per month per year of service. The plans were straightforward and easy to communicate and administer. They worked well in an environment where earnings were fairly uniform throughout the group. Over time, additional features were negotiated such as:
•bridge benefits from early retirement to age 65;
•unreduced retirement following the attainment of certain age and service milestones; and
•subsidized spousal benefits.
These plans have withstood the test of time and many of them now provide significant benefits. From a member’s perspective, the main disadvantage has been the relatively low funded ratio relative to a typical “final-average” plan. This ratio exists because of the Canada Customs and Revenue Agency (CCRA) rule that limits funding to promised benefits only. This means that each time that a new benefit level is negotiated, the improvement creates a new unfunded liability, which is then amortized over a period of years.
This creates significant solvency issues relative to a final-average plan where the ultimate benefit levels can be funded. This situation is often compounded by generous early retirement provisions, which must be taken into account in calculating the solvency liabilities.
From a sponsor’s perspective, these plans have frequently created issues of parity for lower paid non-union employees who have often demanded and received a guarantee that their benefits will never be less than those provided under the flat-dollar plan. This has created some nightmarish plan designs.
Contributory final-average plans
These plans have been largely developed within the public sector in a total compensation environment that provides security in retirement for career-service employees. As the pension formula typically starts at a level close to the maximum two per cent permitted by CCRA, the main potential for negotiating benefit improvements lies in improving plan features, such as early retirement rules and spousal benefits.
From a member’s perspective, these plans provide high levels of pension income in return for relatively high employee contributions. These plans do not suffer from the same restrictions on funding as flat dollar plans, and so the same concerns over solvency do not exist. The main question now though is whether it is possible to further enhance these plans, given that most features have been improved to their limit. Two potential areas are:
•reducing member contributions; and
•changing the governance structure to provide more control to the members.
From a sponsor’s perspective, these plans suffer from inflexibility in that it is very difficult to change the design as there are almost no tradeoffs available. This is a serious issue as many large public-service plans are being subdivided, and the successor sponsors may have totally different business goals from those of the original employer.
Multi-employer plans
These plans developed within industries where there was a multitude of small employers, with a high level of employee movement between each. They are unique from a design point of view in that the contributions are defined. The benefits are calculated to be of equivalent value to the contributions, and give the appearance of being guaranteed. In theory, at least, the benefit levels may be reduced if the expected plan experience does not materialize.
From an employee’s perspective these plans appear very similar to the flat-dollar plans. However, the governance is typically shared through a joint board of trustees. In addition they provide seamless portability through a series of participating employers.
With these plans, employers have the security of knowing that their financial obligation is limited to the most recently negotiated contribution level.
However, employers are dependent on the competence of the board of trustees to make funding and investment decisions that are in the long-term best interests of the plan. The actuary for the plan has a distinct responsibility to select a funding basis strong enough to support the benefit formula through most eventualities.
Non-negotiable
In this approach to pensions, the union is asked to agree that pensions are a non-negotiable item in respect of contract agreements. In return, the employer agrees to provide a plan that fits with its corporate goals and may be identical to that provided to non-unionized employees. Frequently the employer agrees to advise the union before making any significant design changes.
From a member’s perspective, this normally provides for a satisfactory situation. However, the union loses the opportunity of negotiating regular plan improvements, which is a feature of the other approaches discussed. A particular issue these days is that the plan may be redesigned to fit the needs of the majority (non-union members) and these may not coincide with the priorities of the unionized workforce. For example, there is a general trend in salaried employee plans to reduce the benefit formula by enhancing the plan features, thus retaining the same benefit value but increasing the members’ potential RRSP room. Such a redesign may not be so appealing to unionized members who may regard the benefit reduction as a takeaway, and may not be excited at the prospect of making larger personal retirement contributions.
Employers will find this solution easy to implement. However, they should be aware that a higher level of plan communication might be required in order to provide full disclosure to the union membership.
The future
Pensions have been provided to unionized employees through a variety of approaches — each with its own strengths and weaknesses. The continued use and appropriateness of these approaches will need to be examined in context of the current political, economic and demographic trends. In closing, three key questions are posed, the answers to which may well shape the future of pensions for unionized employees.
1. How will maximum pensions affect unionized employees? As the threshold earnings level for hitting the CCRA maximum pension remains at $86,111, increasing numbers of unionized employees will have their registered pensions limited. Supplemental plans will become an integral part of the negotiation process. However, it seems unlikely that unions will accept the kind of unfunded plans currently in place for many salaried employees. This may well serve as the spur needed to develop more innovative approaches for securing supplemental pensions.
2. How will the emerging demographics affect unionized plan design? For many years, one of the features of negotiated plans has been the trend towards more generous early retirement rules and bridging benefits. This was fine as long as there was agreement that earlier retirement dates for employees were in everyone’s best interests. Now, with a clearer picture of future shortages in skilled labour, employers will be anxious to reverse these provisions in exchange for other features. Unions may not be so keen to accommodate these changes. Clearly, a win-win solution will need to be developed.
3. Will the broad unionized workforce ever embrace defined contribution plans? The classic argument against DC plans has been their inability to be retroactively applied. Hence, any newly negotiated changes can only benefit plan members on a go forward basis. In addition, DC plans lack any kind of income redistribution element, something which has always been a feature of defined benefit plans. Unions are also generally opposed to members assuming the investment risk. The answer may well lie in hybrid or combination plans, which combine the positive attributes of DB and DC plans. It is time that more work was done to develop these plans with a unionized constituency in mind.
Patrick Longhurst is a senior consultant in the Toronto offices of Watson Wyatt Worldwide. For more information contact [email protected] or 1-866-206-5723.
