The Myths of Shared-Risk Plans?

Hassan Yussuff, President of the Canadian Labour Congress, wrote a special for the Financial Post, Why there’s no benefit in target benefit pensions:

So-called ‘shared risk’ plans have nothing to do with sharing

Every child grows up learning the importance of sharing. It’s also fundamental to the labour movement. Unions bargain with employers to ensure that workers share in the fruits of their labour. This makes for a stronger, stable economy and a fairer society.

Sharing is also at the heart of workplace pensions. Part of the wages and salaries that unions bargain get deferred until retirement, in the form of pensions. When our negotiated pension plans experience funding shortfalls, as they have in the last six years, unions have stepped up and agreed to pay more into the pension fund, even temporarily cutting back on benefit levels. In return, unions expect that employers will live up to their commitments and pay retirees the pensions they’ve earned over a working lifetime – the essence of the defined-benefit (DB) pension deal.

Even as our pensions return to health, however, employers are looking for ways to rid themselves of the cost and headache of pension plans altogether. And the federal government is lending a hand. In April, the federal government announced that it is proposing target-benefit plans or so-called “shared risk” pension plans in the federal private sector, and for Crown corporations.

In fact, so-called “shared risk” plans have nothing to do with sharing. Let’s look at some of the myths around these plans:

Myth 1: “Shared-risk” plans split the risk and rewards between employers and employees.

These plans don’t “share” risk; they dramatically reduce employers’ risk by shifting it onto plan members and pensioners. Employers would enjoy cost-certainty and strict limits on future risk, while plan members face an open-ended risk of benefit cuts, even when retired. Employers converting their existing DB plans would be able to turn promised pension commitments (once a legal obligation that could not be revoked) into fully reducible “target benefits” that may or may not be delivered.

Myth 2: “Shared-risk” plans strike a balance between worker-friendly DB plans and the defined-contribution (DC) plans that employers prefer.

For employers, switching to a “shared-risk” plan brings significant advantages: Employer contributions are capped, no pension guarantees of any kind are made to employees, and no pension liabilities appear on the employer’s financial statements. Plan members, however, experience a massive loss of security: The legal protection for already-earned benefits is taken away, and everything can be reduced, including pension cheques being mailed to retirees.

Myth 3: If benefits are reduced in a “shared-risk” plan, they will only be temporary reductions.

In fact, there is no requirement in a “shared risk” plan that benefit reductions only be temporary. Permanent benefit reductions are indeed a possibility in this model. This means, absurdly, that temporary shortfalls in the plan could lead to permanent reductions in benefits.

Myth 4: The “shared-risk” plan is a hybrid, in which some benefits are guaranteed and some (like inflation protection) are conditional.

Not true. There are no legal benefit guarantees of any kind in “shared risk” plans. All benefits (whether basic pension benefits, or additional benefits like inflation indexing) can be legally reduced without limit.

Myth 5: Unions have embraced the “shared-risk” model.

The vast majority of unions do not support the conversion of DB plans into “shared-risk” plans. Faced with the distinct possibility that their pension plan would be wound up, a small number of New Brunswick bargaining units supported “shared risk” plan conversions for a few severely-underfunded pension plans. By contrast, “shared risk” conversions are now being proposed for healthy and sustainable pension plans, across the country.

The fact of the matter is that the “shared-risk” approach is about one thing: reducing employers’ risk and cost. But Canadians cannot allow the conversation to be restricted to just employers’ costs. We have to talk about adequacy and security of retirement income, and in that respect, we’re not making progress. Access to pensions at work continues to dwindle as a share of the working population, and a growing number of families face a retirement plagued by financial insecurity.

Over 60% of working Canadians have just one pension plan at work: the Canada Pension Plan or the Quebec Pension Plan. These plans are truly shared, paid for equally by employers and employees. The Canadian Labour Congress calls on the federal government to expand the Canada Pension Plan and Quebec Pension Plan. The government’s misguided shared-risk initiative will only further undermine the retirement security of Canadians.

In my last comment on whether Quebec is pulling a Detroit on pensions, I argued that it's about time Quebec tackles its pension deficits and introduces real risk-sharing in their municipal and other public pension plans.

In his comment above, Mr. Yussuff argues that shared-risk plans have nothing to do with sharing and only benefit employers, while severely undermining the retirement security of employees who could potentially face "permanent" cuts to their retirement benefits which they are legally entitled to.

Is Mr. Yussuff right? Yes and no and let me explain why. I went over New Brunswick's pension reforms and followed up in another comment where I revisited these reforms, discussing why Bernard Dussault, the former Chief Actuary of Canada working for the Common Front, thought New Brunswick's shared-risk was nothing more than risk-dumping:

• although not properly identified and designed in Bill C-11, the proposed increase in PSPP members’ contribution rates and the proposed increase from 60 to 65 in the age at which PSPP members become entitled to a normal (unreduced) retirement pension, respectively, are the only areas of remedies that are relevant to the unfavourable financial findings identified in the April 1, 2012 actuarial report on the PSPP;

• it is unfair, as it does make pension indexation, both active and pensioned members, dependent upon the ongoing financial experience of the PSSA through the use of inappropriate actuarial and accounting mechanisms that properly account for indexation in the contributions and assets of the PSPP but not at all in its liabilities;

• it fails to show the proportion of the PSPP cost that will be shared by active PSSA members; and

• it is too complex, which was publicly acknowledged by the Minister of Finance, as he did himself publicly stated that he does not fully understand it, and as its implementation, management and day to day administration would be an overly expensive and intricate endeavour.

In this case, I agreed with Bernard, there were irregularities in the terms for pension indexation and what proportion of the PSPP cost will be shared by active PSSA members.

But that doesn't mean that shared-risk plans should be scrapped because they are inherently unfair to employees. This is pure rubbish and I have a bone to pick with Mr. Yussuff and the Canadian Labour Congress for spreading some blatant lies and falsehoods in the comment above.

A perfect example of a defined-benefit plan that is fully-funded and has implemented a shared-risk model is the Healthcare of Ontario Pension Plan (HOOPP). In fact, HOOPP is now overfunded and looking at ways to increase benefits to its members, which can include cuts in contributions or better indexation. In this case, shared-risk doesn't mean risk-dumping on employees; it goes both ways.

Another example is the Ontario Teachers' Pension Plan (OTPP), which has also adopted a shared-risk model with its members. For all effective purposes, OTPP is fully-funded, which is quite remarkable given the Oracle of Ontario uses the lowest discount rate in the world among public pension plans to discount its future liabilities.

But both these plans did implement some forms of risk-sharing in the past to temporarily deal with their shortfalls when times were tough. In particular, they temporarily cut the cost of living adjustments to members for a period of time until their plan became fully-funded again.

In doing so, both employers and employees benefited because the contribution rates stayed the same. Pensioners temporarily suffered a marginal cut in cost of living adjustments but it wasn't a huge or permanent hit to their benefits.

There is another problem with Mr. Yussuff's comment, one that really irks me. Sometimes I feel like these unions live in a bubble, completely and utterly oblivious to what is going on in the private sector and completely clueless about how unfunded liabilities are a debt and can severely impact a country's debt rating. And he completely ignores the demographic shift and the rising challenge of measuring and managing longevity risk.

Once again, let me go back to what happened in Greece. In order to avert a full default, which would have been catastrophic to Greece and spelled the end of the eurozone, Greece had to accept savage cuts in wages and pensions forced upon them by troika which represented bondholders.

And in Greece, public employee unions were living in a bubble, completely oblivious to the plight of the private sector and the economic realities of a country living way beyond its means. What happened? The private sector in Greece had to borne the brunt of the savage cuts and only later did public employee unions succumb and accept cuts to pensions and wages.

But till this day, hardly any public sector employee in Greece lost their job. Sure, their wages and pensions were cut in half or by two-thirds, but the massive unemployment that Greece experienced in the last few years was all in the private sector. This is where troika and the bondholders really screwed things up with their myopic and idiotic austerity measures. When 50% of the Greek working population has a public sector job with the benefits that go along with these jobs, there is a serious problem. The cuts should have been in the public sector, not the private sector.

Anyways, don't get me started on Greece and troika, my blood boils. Let me get back to Canada and Mr. Yussuff's comment above. I think he's intentionally exaggerating his points and spreading lies and falsehoods to make public sector employees be the victims of shared-risk plans, but this is pure rubbish.

One area where I do agree with Mr. Yussuff and the Canadian Labour Congress is that it is high time the boneheads in Ottawa enhance the CPP for all Canadians, regardless of whether they work in the public or private sector.

I have a vision for Canada's retirement security. In my ideal world, OTPP, HOOPP, AIMCo, OMERS, Caisse, bcIMC, and other large public and private defined-benefit pensions will be working for all Canadians, just like CPPIB is doing right now. It's akin to what they have in Sweden where you have a series of large, well-governed state plans serving all Swedes but even better because the Swedes didn't get everything right.

In my ideal world, you'll have true shared-risk among all Canadians and the benefits that go along with that. There will be pushback by some banks, mutual funds and insurance companies but in time, even they will see the benefits of this approach which brings true retirement security and pension portability to all Canadians.

Below, Angela Mazerolle, Superintendent of Pensions and Superintendent of Insurance at New Brunswick's Financial and Consumer Services Commission, shares insights from her session "Shared-Risk Pension Plans" while at the International Foundation's 46th Annual Canadian Employee Benefits Conference in San Francisco. Listen to her comments and keep an open mind on share-risk plans, they aren't as bad as Mr. Yussuff claims.