Monday, June 20, 2011

Strikes over pensions: Surely there is a middle ground between defined benefit and defined contribution

A lot of labour disputes in Canada centre around the desire of some corporations to move away from defined-benefit (DB) pension plans, and towards defined-contribution (DC) plans.

DB plans pay an amount during retirement that can be calculated in advance, and depends on the employee's years of service and salary. The problem is, that corporations have a problem when the market turns down, since they rely on investment returns being at predicted levels (averaged over many years) in order to have enough money for the anticipated retirements. They rely on actuaries to tell them how much money they need to have in their fund; actuaries make actuarial assumptions. Some of these assumptions, such as the amount of time people will live, can be calculated with reasonable confidence using statistics and demographic data. However nobody can predict market performance, so corporations have a lot of difficulty in the years after each recession, since their plans go into 'deficit', meaning there is a need to contribute more for a while, and this affects the corporation's profitability, or even its solvency. Sometimes pension plans have a surplus (more than is expected to be needed), in which case the corporation can take a breather, making lower payments for a while, but this situation seems to rarely last.

The DC plans get rid of all this complexity by simply setting aside a defined amount of money each month the employee works. Employees then get a pension at retirement that depends on how well the investments have done over the years. Sometimes employees can get really great pensions with a DC plan, but after a recession is not a good time to retire, as the expected pension would be considerably lower. And that is the crux of the problem with DC plans: They transfer the uncertainty of retirement planning from employer to employee. If an employee has to retire, e.g. due to disability, when the plan has lost value, then the employee loses out. Similarly, this means that corporations are likely to lose a lot of good employees in times when the market is doing really well.

In the recent Air Canada settlement, we are told that current employees get to keep their DB plan, but new employees will get a plan that is to be determined by an arbitrator – most likely a DC plan. This will create different economic classes of employees, which it seems to me will be divisive.

It seems to me that negotiators could find ways to better split the burden: If a DB plan is in deficit, they could make an agreement that says employees who retire in future will have benefits reduced by X% while the deficit is above a certain level, with those benefits coming back to normal when the deficit goes down below a threshold, and with a commitment to increase the promised benefits above the current level by Y% if and when a surplus occurs at some point in the future.

It is unfortunate that few new DB plans are being created. It is good for society for pensioners to have come confidence in their retirement income. However I also think that splitting the burden of deficits between the employees and employer makes a lot of sense, as long as the benefits of surplus are also shared. In some sense this is blending the notions of DB and DC. I also don't mind if corporations put new employees on a plan that has a higher portion of DC than current employees. Just don't get rid of DB element entirely. Perhaps the plan could be 50% DB and 50% DC.

I have heard news reports that call DB plans 'generous'. This entirely misses the point. The two plan types simply put the risks on different parties; conceptually, the same amount of money is contributed and received, if the actuarial assumptions end up being accurate.

Some people also think that retirement savings should be left to individuals (e.g. using RRSP's in Canada). The trouble with that is that the risk is then transferred not just to the employees, but to society at large: A considerable portion of people won't have the self-discipline to save enough, so will end up needing various forms of taxpayer-funded assistance when they retire.

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