Pooled target benefit pension plans (PTBPPs) may offer a compromise between defined benefit (DB) and defined contribution (DC) plans.
In the most recent issue of the Canadian Institute of Actuaries (CIA)’ Seeing Beyond Risk journal, retired actuarial professor and former CIA president Robert Brown notes that many employers have backed away from sponsoring workplace defined benefit (DB) pension plans because they have become too expensive; low investment returns and the requirement to account for liabilities on a mark-to-market basis have pushed up costs.
Instead, companies have turned to DC plans and transferred much of the risk to their workers. One problem is that investment returns in individual DC accounts cannot be smoothed out over generations, and Brown points to research conducted by the Organization for Economic Cooperation and Development (OECD) which shows how a market crash near retirement can affect the future income level of a DC plan member. Someone in the U.S. who was lucky enough to reach age 65 and retire in 2007 would have enjoyed an income replacement ratio of 24%, while the person who turned 65 and retired at the end of 2008 would have enjoyed a replacement ratio of just 15%.
One solution to the dilemma may be PTBPPs, under which employers no longer bear the longevity and investment risks. Instead, assets of smaller plans and even individual accounts are commingled in order to create a single, larger plan. With pooled assets of $10 billion or more, a PTBPP would enjoy significant economies of scale; it could run lower expense ratios and buy a wider variety of investment products.
In addition, a PTBPP can shift longevity risk away from the individual worker. This can be done by either purchasing deferred life annuities for participants as they near retirement, or by managing the payout of benefits and carrying the longevity risk collectively. In the latter case, the administrative pension board would make the decision to annuitize or manage the longevity risk according to market realities (i.e., whether or not annuities represent a good deal at that particular point in time).
“In conclusion, we believe that the PTBPP minimizes risks for both plan sponsors and participants more effectively than either the DB or DC models,” writes Brown. “Because of its pooled nature, many of the pension risks can be mitigated to the extent that they become manageable. We submit the PTBPP model is one worth further analysis and debate.”