The value of a target benefit pension plan

On Thursday, the federal government unveiled itspitch for a new type of pension plan, what officials are calling a target benefit plan, with characteristics that put it somewhere between the two predominant types of plans currently in place.

This target benefit plan will only be available for Crown corporations and federally-regulated industries, such as transportation, banking and telecommunication,as long as all parties agree.

According to the most recent statistics, of the six million Canadians who have registered pension plans, 73.2 per cent are in a defined benefit plan, 16.4 per cent are in a defined contribution plan and 10.4 per cent are in other types of plans, many of them similar to the proposed target benefit plan.

• Read: Voluntary target benefit pension scheme proposed by Ottawa

So how do the three plan types compare?

How they work:

• Defined benefit (DB) pension plans pay a set benefit to members on retirement. The Canada Pension Plan is a DB plan. The monthly benefit is usually based on an employee's earning history, length of service and age. Both the employer and the employees contribute.
• Defined contribution (DC) pension plans set a fixed contribution amount for the employer and/or the employee. Benefits are determined by how well the plan's investments perform.
• Target benefit (TB) plan "benefits and contributions would adjust over time based on the financial performance of the plan," Minister of State for Finance Kevin Sorenson said in an April 24 speech in Toronto. The department of finance adds:"The proposed TBP framework would promote plan viability through its ability to adjust benefits and contributions to help ensure that the target benefit is met, and to deal with surplus or deficit situations."

Who has which plan:

• Almost 3,000,000 DB plan members work in the public sector, and about half that number work in the private sector.
• Over 850,000 private sector workers belong to defined contribution plans, as do just 150,000 in the public sector.
• Numbers for members in the new kid on the block, TB plans, are not available from Statistics Canada, which lumps all other plan types together. New Brunswick was the first jurisdiction in North America to adopt TBs, where they're known as shared risk pension plans. They started in the Netherlands and have become popular in Northern Europe.

Membership numbers for DB plans have been falling for at least the last two years, while numbers for DC plansand other types have been on the rise.

In 2011, membership in both the DC and "other" categories increased by 3.5 per cent, according to Statistics Canada.

Who likes which plan:

• DB planshave been called the gold standard for employees, especially if the benefits are indexed to inflation.
• Private sector employers, on the other hand, increasingly prefer the relative certainty of the costs for defined contribution plans. Some employers, like Canada's Big Three automakers,have stopped adding members to their DB plan and now enrol their new hires in DC ones.
• The Harper government proposes target benefit plans as a "middle ground" between the two.

Who runs the risks and who stands to benefit from the plans:

• In DB plans, the employer makes sure the plan is properly funded and therefore must cover any shortfalls. But employerssometimes cut their contributions when the plan is in surplus.

Management consultant company Aon Hewitt recently released the results of a survey of DB plans in Canada. Noting the "current strong financial health of DB plans," Aon estimates defined benefit plans have a median solvency ratio ("the market value to plan assets over plan liabilities") of 95.4 per cent, a 21-point increase in the past year.

About 36 per cent of the plans are fully funded, compared to just three per cent a year ago.

Strong performance by the financial markets is the key reason for these gains.

• With defined contribution plans, it's the employees who take on the risk, and it's usually the employees who decide on how the pension funds are invested. Their pension income will depend on the performance of the plan.
• With TBor shared risk plans, the risk is obviously shared by the employer and the employees. Because the taxpayer is ultimately responsible if a shortfall develops in a public sector DB plan, the C. D. Howe Institute and others have been advocating for TBs.

Which plans might change under the government proposal:

Both defined benefit and defined contributionplans for workers in the federally regulated private sector and Crown corporations could be changed to TB plans. But the vast majority of those arecurrently defined benefit plans, which are more highly valued.

According to the federal department of finance, there are 1,234 federally regulated pension plans in Canada, covering about one million workers.

To make a change in these, all parties must agree to change plan types.