The problems that have beset defined-fenefit (DB) pensions in recent years are symptoms of defects in the model itself that require tax and regulatory changes and new pension models, according to a C.D. Howe Institute Commentary released today.

In the study, David Laidler and William Robson argue that attempts to shore up classic, single-employer, defined-benefit pension plans are an inadequate response to Canada’s occupational pension problems.

The authors note that the DB sector’s immediate problems are the result of changes in the economic environment — in particular, a decline in long-term interest rates — that caused their balance sheets to deteriorate, and of changes in accounting standards to more market-based methods that revealed the underfunded state of these plans in stark form.

The immediate policy challenge, they say, is to ensure the recovery and/or restructuring of sick plans, and the continued health of sound ones. Extra time and financial scope to work off deficits are good, but current limits on contributions to plans should rise or disappear, while legislation to establish clear title to surpluses for sponsors who must cover deficits is badly needed. Accounting standards should remain strict, however, to ensure that emerging problems are seen and addressed.

In the longer run, policy should sustain and encourage a thriving occupational pension sector that helps individuals save for old age and helps finance the investment that underpins economic growth. But DB plans were in decline long before the recent crisis, and evidence is mounting that the classic single-employer DB plan has serious agency problems — evident particularly in the tendency for these plans to mismatch assets and liabilities in ways that exposed them to risks far larger than sponsors or participants understood.

Rather than simply seeking to prop up the classic DB system, then, Canadians would do better to seek alternatives as well, say the authors. Existing RRSPs and money-purchase plans tend to impose high decision-making and administrative costs on individuals. A better route would be to promote the development of plans with good features from both models. They could:

  • be predominantly money purchase, but with a small and affordable minimum benefit;
  • pool investment risk across a large number of individuals at reasonable administrative cost;
  • gear contribution rates to a target payout; and
  • steer individual portfolios toward an asset mix that would insulate them from fluctuating annuity prices as they approached retirement.

Even as Canadians seek to deal with the short-run problems of traditional DB plans, then, they need to develop new models that offer attractive ways to pool resources and save for retirement, while mitigating not only financial risk and longevity risk, but agency risk as well, the authors say.