What is the classic mistake made with TBPs?

The Ontario Ministry of Finance has released a consultation document on the regulation of target benefit pension plans, with a request for feedback by June 30.  

The C.D. Howe Institute has published extensively on this topic, including my paper last year, highlighting what’s required for target benefit plans to thrive. Earlier, in 2021, the Financial Services Regulatory Authority of Ontario (FSRA) released its own study on leading practices for defined-benefit multi-employer pension plans.  

This article is a compilation of three Intelligence Memos I authored that were recently published by the C. D. Howe Institute.  

Grading the proposals 

I grade the proposals found in the consultation document against recommendations I made last year. 

• Changing the conversation 

Under DB plans, benefits are fixed and contributions vary. Conversely, in target benefit plans (TBPs), contributions are generally fixed and benefits can vary. But regulation still views TBPs through the lens of contribution adequacy. The legislation needs to focus more on the benefits that are in play, and its language should be adjusted accordingly. Grade: F  

Ontario’s consultation document makes the classic mistake of using contribution-focused language as opposed to focusing on what is required ‒ the development and monitoring of a target benefit that can be sustained for an extended period.  

• Benefit stability 

Pension standards have typically focused on funding to prevent problems from developing in the future. With TBPs, where contributions are fixed, problems will not occur due to underfunding, but due to over-benefiting, poor assumption-setting, and inappropriate investment policies, all of which are indicators of poor plan management and/or poor governance. What’s needed are higher governance standards, not complex funding standards. Grade: D  

The document seems to equate strengthening governance with protecting against benefit reductions. The degree of benefit stability should be a decision of the relevant board, not dictated by regulation. By taking its position, the document works to restrict the range of target benefit plans that can be implemented.  

• The importance of governance and communications 

Research has shown that governance and communication play a crucial role in benefit sustainability in plans like TBPs, and recommend plans be required to have a communication policy, similar to a governance policy or a funding policy, and lay out what it should include.  

I attribute separate grades to governance (A) and communication (C). The consultation document is spot-on in indicating that governance policy should reflect guidelines published by the Canadian Association of Pension Supervisory Authorities (CAPSA), and one of the most welcome aspects of those governance guidelines is Principle 4: “The plan administrator should establish and document performance measures to monitor the performance of participants in the governance and administration of the plan.”  

On communication, the document makes the classic mistake of confusing disclosure with communication. With disclosure, which is really what the consultation document is promoting, no effort is made to determine the effectiveness of what has been done. True communication involves a feedback loop, requiring testing of whether the communication objectives were achieved.  

Consistent with this, the FSRA study recommends that plans “consider conducting member feedback sessions or surveys to gauge the effectiveness of member communication.”  

• Employ industry best practices 

Changes to laws codified in pension benefits acts happen infrequently and only after decades of lobbying. So when change is being contemplated, it is important to involve industry in the conversation from the start to ensure critical discussion can happen well before minds are set toward certain solutions. Grade: D-  

There is no mention of any attempt to bring in industry best practices for managing target benefit plans or even best practices from similar types of plans regulated by Ontario, such as jointly sponsored pension plans. There is also a clear disconnect between the focus on risk management through the funding policy in Pillar One of the consultation document and the contribution sufficiency test suggested in its Pillar Three.  

• Scale 

TBPs are complex financial instruments. Scale is needed so these plans can afford the sophisticated tools required to manage them properly. One of the primary ways to achieve scale is to allow multi-employer pension plans to include past service benefits when converting to TBPs. Grade: A+  

Here’s where the consultation document scores best, by allowing conversions to target benefit plans to include past service. British Columbia has seven years of experience with such plans converting to target benefit, with no adverse results of which I am aware.  

Overall, Ontario could have done better. Solutions for target benefit plans need to be broader rather than focused on fixing long-standing issues with specified Ontario multi-employer pension plans. While there are some good suggestions in the consultation document, it lacks an understanding of the breadth of TBPs that is possible.  

 Finding a path to sustainability 

• Assessing benefit risk 

Too much TBP legislation to date has been focused on reducing benefit risk rather than the options available to sustain a benefit aspiration. Little can be found in any provincial policy paper or consultation document about the breadth of TBP options available and the range of options regarding how to sustain them.  

A 2015 Canadian Institute of Actuaries task force report has much to say about achieving a sustainable TBP: “Best practice would involve the use of stochastic valuations at the design stage. For ongoing assessment of benefits in relation to the target, a simple deterministic affordability test with clearly defined trigger points for action may be sufficient. To supplement the deterministic affordability test, a BFI (benefit/funding/investment strategy) could require more frequent stochastic analysis, either at regular intervals or when certain triggers are met.” None of this has been reflected in any subsequent provincial TBP legislation.  

That actuaries’ commentary is supported by the recent FSRA study: “Leading risk management practices observed from the thematic review include ... Articulating how the financial health of the plan is to be assessed. This includes, for example, principles of selection of actuarial assumptions and methodologies …” 

My reading of this indicates support for plans to determine and articulate to all stakeholders their own risk-management policies and practices and not have them dictated by regulation.  

The preceding quotes are technical, but crucial to grasping the attributes of actuarial tools and their suitable application. Only at a technical level can one assess the feasibility of proposals for TBP sustainability, as I outlined in a memo last year.  

Perhaps the most crucial aspects of any TB regulations are the procedures for establishing, supervising, and modifying benefits.  

Although the consultation document may align with practices in other jurisdictions, common practice is not necessarily best practice. Ontario has a significant number of multi-employer pension plans that could easily become TBPs in the future. It’s critical these plans get a regulatory framework designed for the way they operate, not rules more suited to other types of pension plans.  

• Determining future benefit levels to match future fixed contributions. 

It is common practice to establish a PfAD (provision for adverse deviation) to act as a buffer between contribution levels and the costs of the benefit. PfAD size is critical because it directly affects the size of the benefit earned and its income adequacy for members, which is a primary measure of pension-plan quality. This differs from how PfADs operate in defined-benefit plans, where the PfAD is a complete add-on to the service cost and has no direct impact on benefit size. 

Many TBPs aim for benefit stability, which requires a relatively predictable and stable PfAD over time. The British Columbia PfAD working group, of which I was a member, concluded that the PfAD applied against contributions should be easy to determine and communicate to plan members. However, the contribution sufficiency test in Ontario’s consultation document works against this stability objective by proposing a PfAD that changes with every valuation cycle. In contrast, BC implemented a minimum PfAD at a flat rate of 7.5 percent of the service cost, leaving each TBP to specify an additional specific PfAD as needed.  

It is important to note that for mature TBPs with a significant retiree population, a PfAD requirement on the service cost has negligible effect on benefit security.  

• Assessing when and how benefits earned to date can be improved or reduced.  

The board of trustees typically makes critical decisions about benefit levels by assessing a plan’s funded status. Benefit improvements are generally determined by setting funded status thresholds (e.g., a funded ratio of at least 110 percent), while benefit reductions would likely be required if the funded status dips below 100 percent. Funded status thresholds exist as an actionable metric. While some jurisdictions require a minimum PfAD on the plan funded status for benefit improvements, none has any requirement to fund this target. There is no need for PfAD requirements to be identical with respect to their application against a plan’s service cost and their incorporation into thresholds for decision-making on benefit improvements. Different needs should be met in different ways.  

PfADs should align with the plan’s objectives and not be regulated in a way that is disconnected from those objectives. Ontario’s document could benefit from a clearer definition of the PfAD role – and its proper magnitude – in creating plan sustainability. 

Moving forward 

I suggest the following four changes to realign the consultation document:  

• Grant plans the flexibility to choose their own methodology for determining and assessing benefit sustainability. Many plans already employ multiple tests and actuarial methods based on specific circumstances, so regulatory imposition on the methodology should be avoided. 

• Establish a minimum PfAD level, similar to that adopted in BC, which would apply regardless of the actuarial methodology used to assess sustainability. 
• Mandate comprehensive disclosure of sustainability testing in filed actuarial valuation reports, encompassing methodologies, assumptions, and conducted stress tests. This would allow the provincial pension regulator, FSRA, to assess its own comfort level with the analysis. 
• Impose a standardized financial reporting methodology for all plans, such as employing the unit credit going concern funding method. This would enable FSRA to compare all plans using a common platform. This reporting exercise would solely serve as a means of disclosure and would not affect separate plan assessments regarding sustainability.  

Barry Gros is a retired actuary, chair of the Pension Board at the University of British Columbia Staff Pension Plan, and a member of the C. D. Howe Institute Pension Policy Council.