Nowadays Concerns are growing on how to design plans that share risk. The best management plan designs range to identify different risks and methods of sharing risk. A defined benefit pension plan, and a defined contribution pension plans allocate risk directly as part of plan design, involving risk pooling so that mortality and investment risk are shared within the risk pool. In a single-employer plan, one employer bears the risk, Risk-sharing adjustments built into plan designs may include provisions such as cost-of-living increases that are temporarily discontinued if funding levels drop below a threshold; alternatively, cost-of-living additions can be discretionary or contingent on some funding level. Traditional DC plans with lump-sum payouts place essentially all risk on plan participants although some plans pool investment risk in the pre-retirement phase.
An increasing number of public and private sector employers around the world are abandoning the traditional defined benefit (DB) pension plan model in favor of more affordable and sustainable alternative arrangements or are doing away with their employer-sponsored retirement plans altogether. Canada’s pension jurisdiction has recently proposed a new pension plan to provide both public and private sector employers to have shared risk arrangements and plan that more sustainable to shift investment risks to employees. The main reason for providing a new plan to the hybrid alternative to the defined benefit and defined contribution plans most commonly used in Canadian workplaces. Pension Plan has conditional indexing to inflation, investment returns are low when goes down, contributor loses a bit of their payout or left under-funded because their benefit is not worth as much relative to rising prices. Plans towards sharing investment risk include both employee and employer contributions, a set level percentage of pay and risk is equally shared among the group of participants. Employers in Canada’s private sector have been moving away from DB plans into the defined contribution type plans for well over a decade. Benefits can also be adjusted up or down, and adjusting benefits based on share values or investment returns, or indexing retirement ages with changes in life expectancy. Over the last few years, DB plan funded ratios have reached unprecedented lows, primarily because of:
- Prolonged periods of low long-term interest rates
- Volatile investment returns below expected results
- Increases in mortality risk because of longer retired life expectancies
- Greater than expected unreduced and partially subsidized early retirement pensions.
The new approach to sharing risk has a unique way to handle investments and contributions, inflation to life-expectancy risk between employees and employers. The main challenge to maintain a balance designing a public sector retirement plan, considering public employees and employers, and taxpayers. As every group has its requirement, employees want a package that includes financial security in retirement and taxpayers want a cost-effective service. While Public sector employers want the orderly progression of personnel plus a timely retirement. “Private pension plans across Canada are facing increasing challenges in providing a secure and predictable stream of income to Canadians in their retirement,” said Secretary of State for Finance Kevin Sorenson.
By implementing risk-sharing, every employee requires contributing to the cost of their pensions that often be adjusted according to plan funding levels. In simple words retirement plans, it exposes benefits to investment risk, the risk of inflation, and higher required contributions. “Pension experts, labor unions, provincial governments, and seniors organizations all agree that the best way to tackle the looming crisis is to boost benefits through CPP/QPP,” Under the government’s plan, pension benefits would be targeted, rather than guaranteed and would be based on a predetermined formula. Contributions would be fixed or set within a range. Typically, when pension plans become under-funded, contributions from employers or employees must increase to make up the shortfall. With a targeted plan, benefits could be cut instead and would depend on investment success.
Most workplace pensions in Canada now are defined benefit plans, which provide a guaranteed pension backed by the financial health of the employer, or defined contribution plans, which provide a benefit based on investment returns. “The concept is to move the risk to the benefits side. When there is a poor performance, members bear the investment risk rather than employers.” Hamilton said the move does nothing to shift the federal government’s risk in its own massive public sector pension plans. Government plans are among the last survivors of the generous defined benefit pension plans that once dominated Canada’s public and private workplaces.
At the far end of the spectrum, there are risk transference options under which a plan sponsor may fully or partially eliminate DB plan volatility and funding risks through lump-sum transfers, ‘buy-in’ annuities, and ‘buy-out’ annuities affecting former member benefits.
Clear and accurate disclosure of any lump sum transfer option will be important and should include a sufficiently detailed explanation of the potential member financial risks. Pension legislation in most Canadian jurisdictions provides an express discharge to the employer from further liability in connection with lump-sum transfers that comply with statutory requirements. This involves the payment of a cash settlement equivalent to the lump sum value of the member’s pension benefit.
Annuity Buy-In can be used to reduce the risk associated with both active and former members, once the annuity premium is paid, the insurer is responsible for benefit funding, but the plan remains responsible for payment administration.
This is a traditional annuity contract most often be unilateral. Buy-outs contributions are required if the annuity premium is paid from an under-funded plan and liability they transfer liability risks from the plan sponsor to the insurer. And the employer to remain responsible for annuitized benefits if of any insurer default.