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Health * Benefits * Employee Assistance * Retirement Business. Needs. People.
Atlantic Connection ConferenceNew Brunswick’s Shared Risk PlanJuly 9, 2014
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Challenges facing traditional pension plans
Confidential – Not for Distribution
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DB plans are proving to be costly
Falling interest rates
Increasing life expectancy
Investment losses and volatility
Earlier retirements
Confidential – Not for Distribution
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NB asked: are DB benefits secure?
Most believe DB plans are guarantees
The DB promise is only as good as the sponsor’s willingness and
ability to pay
When there is no longer an ability to pay, plans close and
benefits are cut (Fraser Papers, Nackawick, etc.)
When there is no longer a willingness to pay, benefits are
curtailed or changed
Confidential – Not for Distribution
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DB plans create inequity across generations
Current DB legislation does not allow for reductions in accrued benefits
Only corrective pension actions areIncreasing active member contributionsReducing future active member benefit accrualsIncreasing employer contribution
Confidential – Not for Distribution
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DB plans create inequity across generations
Increasing employer contributionsRevenue base relatively fixed If more of this money is diverted to the pension plan then
Maybe wage freezesMaybe fewer jobsMaybe reductions in other employee benefitsMaybe new equipment desperately needed isn’t purchased
The net impact of all of these actions is felt by active members only
Confidential – Not for Distribution
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The New Brunswick JourneyConfidential – Not for Distribution
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How NB approached these problems
Appointed an independent Task Force
The mandate of the Task Force was to achieveSecuritySustainabilityAffordabilityTransparencyEquity
Confidential – Not for Distribution
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How NB approached these problems
Public consultationConducted research on best pension systems in the worldProcess was consultative among the Province, Unions and the Task ForceUnions played a large part in the final design
New Brunswick Nurses UnionCUPENew Brunswick Union of Public and Private Employees
Confidential – Not for Distribution
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The Shared Risk Plan is created
Process resulted in the creation of the Shared Risk Plan (SRP)
Draws inspiration from both DB and DC designs
On a high levelIntroduces benefit flexibilityIntroduces strong stable funding requirementsIntroduces rigorous risk management requirementsIntroduces independent governance
Legislation introduced on July 1, 2012 allowing any plan sponsor in the Province to adopt an SRP
Confidential – Not for Distribution
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SRP has high security but no guarantees
Contribution rates set to provide very high security for base benefits and reasonable probability of achieving the benefit intention
However, accrued base benefits can be reduced in very poor economic scenarios
There are no absolute guarantees
Confidential – Not for Distribution
Two levels of benefits are defined:Base benefits and Benefit Intention
BASE
INTENTION
BENEFITS
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SRP benefits absorb volatility
Confidential – Not for Distribution
Typically conditional pre and post retirement indexing varies and absorbs a lot of the plan volatility
Surpluses to be used on member benefits
Sponsor has no right to surplus
Sponsor has minimal opportunity for contribution holidays
BENEFITS
Benefits fluctuate based on plan performance
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SRP has strong legislated governance
Confidential – Not for Distribution
Funding policyGives Trustees a set of benefit and contribution instructions agreeable to both parties under which they are to operate
Investment policySets out target asset mix and investment goals
Rigorous risk managementAnnual monitoring and complianceAt least 1,000 20-year scenarios tested each year
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SRP governance requirements work together
Together they must satisfy benefit security tests set out in the Regulations
97.5% probability of not reducing base benefits over a 20 year periodAt least a 75% probability of providing benefit intention
Typical best estimate DB contributions have about a 50% chance of providing fixed DB
Confidential – Not for Distribution
All aspects of these requirements work together
FUNDING POLICY
INVESTMENT POLICY
RISK MANAGEMENT
ANNUAL MONITORING
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SRP has certain employer advantages
Employer commitment is only the contributions in the funding policy
Employer has no responsibility to backstop deficits if they arise
Cost stabilityEssentially works like DC (with a narrow range of contribution levels) for the employer
Confidential – Not for Distribution
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SRP has employer trade-offs
Contribution holidays are not permitted unless required by the Income Tax ActSuch holidays are expected to be very rareLarge majority of generated surplus spent on member benefits
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SRP has certain advantages for the member
Employer can’t take contribution holidayLarge majority of generated excess funding spent on member benefitsGoverned by Arm’s length TrustUpside potential to participate in plan gains for both active members and retireesStable contributions within a narrow range
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SRP has certain advantages for the member
Very high benefit security
Intergenerational equityAll members participate in surpluses and deficits, not just active members
Still providing DB-like benefit to membersStill pooling longevity riskBase benefit based on salary / service history
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SRP has member trade-offs
Base benefit likely less than current DB “promises” to meet security targets
Base benefit not guaranteed
Ultimate benefit difficult to predict
Contributions may be higher than current
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Why consider SRP?
Cost stability for sponsors and members
High benefit security
Rigorous governance and risk management
Investment and longevity risk pooling
Benefit aligns with what the plan can afford to payContributions + Investment income = ultimate level of benefits
Confidential – Not for Distribution
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What lessons did we learn
Be collaborative and transparent
Be realistic about the problems
State outcome goals up front
Take a long term approach
Think differently!
Confidential – Not for Distribution
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Appendix: Progress made
Confidential – Not for Distribution
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What’s happened since SRPs were introduced
SRP legislation was effective July 1, 2012
We know of at least 10 plans that have converted or have announced their intent to convert including:
Certain Bargaining Employees of NB HospitalsCity of FrederictonCity of Saint JohnPublic Service Superannuation Act (Province of NB)University of New BrunswickSaint John Energy
Confidential – Not for Distribution
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What’s happened since SRPs were introduced
On April 24, 2014 Canada’s Federal Department of Finance issued a consultation on target benefit plans
Many proposed concepts similar to NB SRP
Would allow SRP-like plan design for federally regulated pension plans such as
AirlinesTelecommunicationsRailways
Confidential – Not for Distribution
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What’s happened since SRPs were introduced
Province of Prince Edward Island recently made similar changesFlexible benefits pre and post retirement to reduce cost volatilityExpropriation of vested indexing rights to improve intergenerational inequityStochastic measurement and communication of risksFunding policy to manage contributions and benefits
These changes were made to their two largest public sector pension plans
Confidential – Not for Distribution
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What’s happened since SRPs were introducedGovernment of NB successfully negotiated a pension deal with Teachers’ union
In the fall, op-ed in the paper from three union presidents supporting the design
National and international attentionAn entire chapter in Jim Leech’s book “The Third Rail”A large Ontario plan worked with us to explore SRPMultiple industry speaking engagements all over Canada and the USMultiple articles in Benefits Canada
We’re here talking to you today!Confidential – Not for Distribution
Confidential – Not for Distribution
Visit us: morneaushepell.comFollow us: @Morneau_Shepell
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Thank YouPaul T. Lai Fatt, FSA, FCIA
Partner
[email protected](902) 474-3236