The pension design pendulum: There and back again?

In the ’90s many employers switched from defined benefit to defined contribution plans, but the past three years have given employees and employers reason to doubt the merits of going DC

While a booming stock market in the 1990s helped drive many employers to convert defined benefit pension (DB) plans to defined contribution (DC) arrangements, some are now thinking about switching back.

Throughout the ‘90s, many employees pressed for the change to DC plans because investing looked so easy — and rewarding — and many did not expect to put in the full single-employer career required to get full benefit from their DB credits.

Many employers, meanwhile, welcomed the opportunity to shift investment risk to plan members and avoid future wrangling over surplus ownership. They also felt DC plans could help attract younger employees, and infuse workers with a more self-reliant, entrepreneurial spirit. So, a DB to DC conversion seemed to offer compelling benefits for both parties.

Then came the worst bear stock market since the Great Depression and the lowest interest rates since the Korean War. Today, employees are more security-conscious, especially the oldest of the baby boomers, now 10 years older and approaching retirement.

Meanwhile, employers are increasingly recognizing that a retirement program is more than a fringe benefit; it’s a key element in the company’s total rewards program and human resources strategy. In other words, plan design is about much more than funding and who bears the risk — it’s about attracting and keeping the right kinds of employees.

A growing number of companies are reviewing retirement programs to see if plans are in line with the corporation’s strategic goals. Recently, a review at TransCanada Pipelines led to a well-publicized change that would have been unthinkable just a few years ago — a shift from a defined contribution to a defined benefit pension plan.

TransCanada management recognized that the skills and depth of their highly trained workforce were competitive advantages, and they decided that long-term success would best be served by promoting a long-term relationship with its employees. As a result of the review, TransCanada moved all its employees to a DB plan at the start of this year, with a full reinstatement of past service.

Other companies’ reviews have resulted in a marked movement by sponsors of existing DB plans toward introducing “flexible” structures that enable employees to fund features such as inflation indexing and early retirement on a voluntary, tax-deductible basis — without affecting their own RRSP room.

DB plans more flexible

It is often said that one of the key failings among entrepreneurs is the inability — or refusal — to plan properly for their succession. But how many professionally run corporations have detailed workforce succession plans?

“Freedom 55” is more than a decades-old marketing slogan for a life insurance company. It has also been a mantra for baby boomers, who are now starting to reach that magic age.

Those who can afford to retire early — often the best and the brightest — are likely to do so. Those who can’t afford to go won’t — even in their early 60s. This creates a two-pronged challenge. How do you attract and retain the skilled talent you need? And, how do you gracefully and responsibly make it possible for those who should leave, to do so?

The tax rules for DB pension plans make it possible to meet both challenges through the granting of past service credits and the creation of early retirement incentives. That flexibility is generally not available in the DC world.

New rules for DC plans

Employers face yet another looming challenge. This one comes from the guidelines that pension, securities and insurance regulators from across Canada have proposed for DC pension plans, group RRSPs and other “capital accumulation plans.”

If adopted in their current form, these proposals — now awaiting stakeholder input — will create vague and open-ended fiduciary duties, thereby providing a table of contents for future litigation.

Significantly, they offer no “safe harbour” protection from member lawsuits as exists in the United States. Employers that thought going DC would eliminate investment risks may be in for a surprise. As weak stock markets and low interest rates make it ever harder for employees to realize their retirement dreams, the question is not whether companies will be sued but when.

There is no one-size-fits-all solution to the pension plan conundrum. Every company has a unique set of goals and objectives.

Nor is this just a contest between DB and DC. There are middle-ground options that use both designs to offer different features to employees. Two examples include:

•A combination structure that features a DB plan and some form of complementary DC arrangement, perhaps a DC pension plan, a voluntary group RRSP or a deferred profit sharing plan (DPSP). Retirees will have two income streams, the guaranteed pension from the DB plan plus whatever their individually run DC account can provide.

•A hybrid structure that offers a DC account with a DB floor. It’s an either/or proposition. The retiring employee gets the income stream that she can arrange with the DC balance, or the guaranteed DB pension if higher.

The question is not, “What’s the best design?” Rather, it is “What’s the best plan for your company and its people?”

Steve Bonnar and Bill Moore, are both consultants with Towers Perrin. Steve can be contacted in the Toronto office at [email protected]. Bill can be contacted in the Calgary office at [email protected].

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