Government of Canada proposes target benefit pension plans

On April 24, the Department of Finance Canada unveiled a proposed framework for Target Benefit Pension Plans (TBPs), also referred to as shared risk plans. If passed into law, this would allow federally regulated private sector and Crown Corporation employers to offer a TBP to their employees or to convert an existing defined benefit (DB) or defined contribution (DC) pension plan into a TBP.

The federal proposal should be of interest to plan sponsors of all jurisdictions since federal legislation permitting TBPs could be accompanied by changes to the Income Tax Act (ITA) to recognize and enable TBPs in single-employer situations. A number of provinces have been preparing to implement their own TBP legislation and could follow this federal initiative, hopefully bringing us some welcome harmonization.

The key difference between TBPs and defined benefit pension plans is that TBPs can place explicit limits on the volatility of employer contributions. In the event a funding deficit arises, part or all of it can be compensated by reducing accrued benefits whereas a traditional DB plan would require the entire deficit to be funded by increased contributions on the part of the employer. In DC plans, contributions are completely fixed and 100% of variability in financial results is reflected in member benefits. TBPs thus are a hybrid between DB and DC plans, with more variability in benefits for members than DB plans but less than DC plans.

The proposed TBP framework that the government outlined in their consultation paper is clearly modelled after the Shared Risk Pension Plans that were introduced in 2012 in New Brunswick. (Morneau Shepell’s experts were heavily involved in the design and testing of New Brunswick’s Shared Risk Pension Plans.)

Among the similarities:

  • In lieu of totally fixed employer and employee contribution rates, the proposed rules would allow employer and employee contributions to a TBP to vary within a pre-defined band.
  • Benefits could be reduced if a funding deficit develops but the plan could define two classes of benefits, i.e. base benefits and ancillary benefits (such as indexing and early retirement subsidies), with different levels of benefit protection applying to each of these two classes of benefits.
  • A funding policy would be necessary, including some provision for adverse deviation (the mechanism is still to be defined) to reduce the chances of a benefit reduction.
  • Only a going-concern valuation would be required, not a solvency valuation. As in New Brunswick, the going-concern valuation could take into account not only the existing assets but also the expected contributions and payouts to be made over the 15 years following the valuation.
  • A formal deficit recovery and surplus utilization plan would be established at the outset, in a manner that reflects how the risk is supported by the different parties.
  • Plan members would share the responsibility for funding deficits if the plan allowed for additional contributions to be made in certain situations, rather than benefit reductions.
  • A past service conversion of either a defined benefit or a defined contribution plan would be possible though, unlike New Brunswick, it would require member consent.
  • It would be possible to implement a TBP for non-unionized employees.

One notable difference, however, is that New Brunswick has adopted Shared Risk Plans for its own public sector employees whereas the Department of Finance Canada has made it clear that the new TBPs would not apply to federal public sector employees, whose plans are not affected by the same legislation as crown corporations and federal jurisdiction employers. The press release suggested that such a move was not necessary since the federal government had “already taken steps to ensure that federal public sector pension plans are more in line with the private sector”. That is a reference to an increase that was announced regarding the age at which an early retirement pension can be taken without reduction. It remains to be seen whether other changes will be made to public sector plans to bring them more in line with these new TBPs.

An interesting characteristic of the proposed rules is that they define the relevant factors to incorporate into the new scheme, while allowing a lot of flexibility in how the various parties could choose to structure the risk management under their new TBPs, rather than having to follow strictly pre-determined parameters. But since the risks will be shared by the various parties, the proposed rules highlight the importance of good governance, by stating that the TBPs should be administered by a board of trustees (as currently with multi-employer plans and with all plans in Quebec), and that it will be important to communicate the new rules clearly so the parties are well informed of the risks involved.

As mentioned above, legislation allowing singleemployer TBPs has already received royal assent (but has not been proclaimed into force) in several provinces, specifically Ontario, Nova Scotia, British Columbia and Alberta, while legislation already allows them in New Brunswick and Saskatchewan. What makes the federal proposal potentially more effective is the possibility of converting existing pension plans (DB or DC) to a TBP basis, which only New Brunswick allows so far.

The next step is a 60-day consultation process. Federally regulated employers are encouraged to participate in this process. For more detail on the workings of TBPs read Morneau Shepell’s November 2013 Vision newsletter, “Target Benefit Plans - Game-Changer or Non-Starter?

Special Communiqué (PDF) - April 2014