In speaking with many organizations, it’s clear that a large number of DB plan stakeholders have little real understanding of the risk they are carrying in their pension fund and how this risk has been growing as their plan has matured. Over time, the size of DB plan assets and obligations increases significantly. In fact, unless growth in the plan sponsor’s business has been keeping pace, the size of the pension plan will have become much larger relative to the size of the business than in the past. In this scenario, any significant deterioration in the funded position of the plan could have a serious impact on profit / loss and corporate cash flow, potentially threatening the survival of the business. While the sponsor of a young pension plan may be able to deal with a given level of volatility in funding, the sponsor of a more mature plan will be much more impacted by the identical scenario.
The first step to managing risk is to understand the level of that risk and determine whether it’s within your tolerance level. If it isn’t, then you will want to consider alternatives. Morneau Shepell’s Pension Risk Assessment can help you understand your risks.
One risk management strategy is to share the risk as broadly as possible while being respectful of existing pension regulations. Target Benefit Plans (TBPs) (i.e., broad definition) offer that opportunity. One key advantage of TBPs from a plan sponsor perspective is that contributions can be kept relatively stable as TBPs are monitored on a going-concern basis and are typically exempt from solvency funding obligations.
An important area that remains to be clarified is the appropriate accounting treatment for TBPs. While the cap on contribution requirements would seem to be consistent with a cash / DC accounting treatment (as currently applies to MEPPs), the accounting profession has yet to provide definitive guidance on this matter. For many plan sponsors (particularly those in the private sector), it is critical to resolve this issue.
In addition, given the current focus on retirement savings in the media, employees are becoming more aware of the value of a pension. A TBP could prove more effective in recruiting and retaining workers.
The primary disadvantages of TBPs from a plan sponsor perspective are as follows:
- Plan member communication may be more challenging than with a DB plan. Members must understand that certain benefits can be reduced in certain situations.
- There is a greater governance burden as more formal funding and benefit policies must be established and maintained in order to administer TBPs.
- The ability to benefit from future plan surpluses is reduced or eliminated as contribution reductions are unlikely or unavailable.