May 31st, 2013: New Brunswick is taking a new and controversial approach to public pension plan restructuring with the introduction of the Shared Risk model. With a $1 billion shortfall in the Public Service Superannuation plan, which covers employees who work directly for government departments and NB Power, action was required, but not everyone is convinced that the changes are in the best interest of active and retired employees. And with New Brunswick being touted as the first test case, all Canadians with defined benefit pensions should pay close attention.
Shared Risk Pension Model
New Brunswick’s new Shared Risk pension model emerged from a 2010 task force of pension experts convened by the government to seek solutions to the province’s apparent pension crisis. The task force concluded that New Brunswick needed a new approach to its public pension plan, recommending that the province move ahead with the new Shared Risk model. The province acted on the recommendations of the task force and enabling legislation for the Shared Risk pensions was passed in July 2012.
“Shared Risk” largely means what the name suggests. With defined benefit plans, the funding shortfall risks are solely the responsibility of the employer. Defined contribution plans download all risk to the employee. Shared-risk plans represent a kind of hybrid. For example, should contribution levels need to be raised or benefits adjusted, both employers and employees will share the risk.
The Shared Risk model is a target benefit plan. It is similar to defined benefit plan in that annual contributions are determined by a formula used to calculate the amount needed each year to accumulate funds sufficient to pay a predictable (target) retirement benefit to employees. But like a defined contribution plan, it does not guarantee exact benefits and both contributions and benefits can be adjusted.
Expected Changes for active and retired employees
Active employees face the brunt of the changes. For starters, and to help amortize the existing funding shortfall, employees will pay higher, but stable, contributions than are currently being paid and the age of retirement will be increased gradually over 40 years from 60 to 65, but benefits will not increase. The target benefit feature means that employees can hope for predictable benefits, but may be subjected to automatic targeted adjustments given pension fund and market volatility. Pensions going forward will be calculated on enhanced average earnings, not the best five years as is currently the case.
The big change hitting retirees is the loss of guaranteed cost of living increases. The new model features ‘conditional indexation’, which means that current and future retirees will only be paid cost of living increases if the plan is funded at 105% of capacity. Retiree benefits will otherwise remain untouched. If the plan is funded at less than 105%, retirees will not receive indexation until the plan reaches or exceeds that amount, at which point indexation will be paid retroactively.
Given the track record of public pension plans and a slow growth economy, retirees are right to worry that indexation may not be paid very often or in time to materially benefit existing retirees. Removing indexation may be legal, but retirees are justifiably upset by the perceived attack on an important feature of their retirement benefits. And with a seemingly arbitrary decision to only pay indexation at 105% funding, retirees are doubly justified in their anger.
Retirees are also expressing fear that the changes may eventually lead to reduced base benefits as well, something that happened in the Netherlands when a similar pension system was instituted in that country. For now, base benefits should be safe. Retroactive changes to earned pension benefits would require changes to both provincial and federal pension legislation.
Experts who pressure tested the new model suggest that there is a 97.5-per-cent probability that the basic pension benefits will never be reduced and that the average indexation for extra benefits will be at least 75 per cent of the consumer price index. But models rarely hold up to real market fluctuations.
To add insult to injury, the New Brunswick government failed to properly consult retirees ahead of the changes. “I am embarrassed to be in this position at this time, where discussions were not held to the degree where they should have been”, admitted Minister of Finance, Blaine Higgs.
A number of plans, including those of the cities of Fredericton and Saint John, have adopted or are in the process of adopting the Shared Risk model. Most public sector unions in New Brunswick, including CUPE, support the shift to Shared Risk, but the province hasn’t given them much of a choice. Plans that choose not to convert to Shared Risk model, may be allowed to continue with existing plans for active members, but all new employees would be moved to a much less desirable DC plan.
While it’s true that most public sector DB plans are underfunded, it’s not necessarily the case that restructuring on the order being done in New Brunswick is strictly necessary. According to Bernard Dussault, Consulting Actuary and Pension Officer at the Professional Institute of Public Service of Canada in Ottawa, there a number of reforms that could and should have been explored prior to wholesale changes. For starters, existing DB plans should adopt greater funding/financing discipline by prohibiting contribution holidays, which have contributed significantly to past and current shortfalls. Raising contribution rates would also help close funding gaps as would a slow and gradual increase in the age of retirement to 65.
Pension plan reform may become increasingly necessary, but Canadians who have paid into plans for decades deserve their earned retirement income. CARP will continue to monitor and report on the progress of the Shared Risk model in New Brunswick. Despite the new legislation, the New Brunswick government may still have account publicly for the effects these changes will have on employees and retirees who are losing their end of the pension promise.