An in-depth look at BC public sector pension plans

Transcription

1 An in-depth look at BC public sector pension plans The context for Municipal Pension Plan The focus Funding, risk sharing and governance frameworks for the British Columbia public sector pension plans 1 (BC plans). Our position BC s public sector pension plans are structured and governed in a way that makes them more sustainable than many plans in other jurisdictions, including the U.S. and U.K. The BC plans are pre-funded so each generation pays in advance for its own pension benefits, and the costs and risks are shared between employees and employers. What s happening in our world The issue of defined benefit public sector pension plans and how they are funded has been gathering increased media attention in industry publications and the mainstream media over the past few years. We are frequently seeing articles about public entities (typically U.S. state or municipal governments) that are experiencing financial difficulty as a result of pensions and post-retirement health benefit funding. We are also seeing business and public-interest organizations focusing attention on the difference between the type and cost of pensions provided in the public sector and those available in the private sector. The funding of public sector pension plans varies considerably between jurisdictions. In the U.K., for example, most of the public sector pension plans are managed on a pay-as-you-go basis. There is no prefunding, and the pension benefit is paid out of general revenues as the pension liability comes due. Given the retirement of the baby boomers, pension costs are expected to increase sharply over the next 20 years and, 1 College, Municipal, Public Service and Teachers pension plans

2 unless changes are made, could pose a significant burden on current and future generations of U.K. taxpayers. In some cases there is an element of pre-funding of the pension benefit, but not at a level sufficient to cover the liabilities being accrued. The local government pension plans in the U.K. and many of the U.S. public sector pensions fall into this category. As one would expect, some pension plans are in better shape than others. However, there are some state pension plans that are so poorly funded they are predicted to run out of money in the next eight to 10 years. The cost to fix the underfunding problem is expected to have significant impacts on future generations and the states ability to provide basic levels of services. In some extreme cases it could even result in bankruptcy. Why are the BC plans different? The design of the BC plans is very progressive and includes funding, risk sharing and governance frameworks that have addressed many of the concerns currently being expressed about public sector plans in the U.S. and U.K. Before looking at some of the funding, governance and risk sharing considerations, it is first useful to be reminded of the overall plan design model used by the BC plans. There are three basic elements to the BC plans: The basic pension is the primary element of the plan and is based on a defined benefit (DB) formula calculated using the member s pensionable service and salary. This benefit is guaranteed and is subject to certain vested right protections under the Pension Benefits Standards Act (PBSA) and common law. Contributions to fund this benefit are calculated by the plan actuary and may change depending on the funding status of the plan. The second element of the plan is inflation protection. This is not a guaranteed benefit and is provided based on the availability of funds. Contributions to fund this benefit are fixed based on rates negotiated by the plan partners. The third element is post-retirement group benefits (PRGB). PRGB include the Medical Services Plan, extended health and dental plans. Some of the BC plans provide subsidies for some or all of the elements while others provide no subsidies. The PRGB program is not guaranteed. 2

3 Basic pension The pension plan is a pre-funded plan. It is designed to make each generation pay in advance for its own pension benefits. Both employers and employees contribute to the plan. Any increases in costs are shared and are not borne exclusively by either the employer or employee. There are several advantages to these financial arrangements for the basic pension: members get the advantages of a defined benefit pension promise that will cost-effectively deliver a predictable and reliable retirement income; a public sector pension plan is an effective tool to help employers attract and retain the best employees, as it is becoming increasingly understood among the labour force that a DB pension is a valuable employee benefit; employers and employees equally share the risks associated with funding the defined benefit portion of the plan; pension payments flow straight into British Columbia s economy, supporting businesses and creating jobs as retirees purchase the goods and services they need; and pension funds are an important source of capital for many BC businesses that want to expand, hire more people and improve their infrastructure to be more successful. Inflation protection Most public sector pension plans, including those in BC, the U.S. and the U.K., provide some form of inflation protection. The protection ranges from being fully guaranteed in some jurisdictions to being based on the availability of funds, as is the case in BC. Historically, inflation adjustments to pensions were provided on an ad hoc basis, typically in response to retired members lobbying about the eroding purchasing power of their pensions. Today, most plans have arrangements in place for granting inflation protection. Inflation adjustments to pensions are a very significant value to retired members. For example, consider a member who retired in The pension 24 years later would have lost about 70 per cent of its purchasing power without the annual inflation adjustments granted by the BC plans over the period. Given the fixed member and employer contributions and the nonguaranteed nature of inflation protection, it is the members who bear the financial risks associated with the inflation adjustment arrangements. 3

4 Post-retirement group benefits (PRGB) Most North American public sector jurisdictions arrange for some post-retirement health benefit coverage. In the U.S., unfunded postretirement health benefits are often the largest component of the financial pressures associated with retired public sector workers. For the BC plans, PRGB arrangements vary depending on the pension plan. Some form of coverage under a dental plan and an extended health plan is made available to retired members of the BC plans. In some cases the PRGB arrangements are entirely unsubsidized and are paid for by premiums paid by the retired members. In other cases the arrangements are partially subsidized by employer contributions up to a pre-determined contribution limit. In both the subsidized and unsubsidized cases there is no financial risk borne by the employers with respect to increasing costs of these PRGB arrangements. It is the members who bear all of the financial risk associated with their PRGB benefits. Managing sponsorship risk As the public sector employers (and indirectly the taxpayers ) financial risk in the pension arrangement is limited to a 50 per cent share of the basic pension liability in each of the BC plans, it is important to understand how this risk is managed. 1. Joint trusteeship and the Pension Benefits Standards Act The BC plans are well managed due to a strong and effective governance structure. The move to a joint trusteeship model in represented a significant governance change for the plans. Prior to this time, government was the sole sponsor of the BC plans and was not required to fund the BC plans based on any minimum standards. This was due to the fact that the BC plans have a statutory exemption from the going concern and solvency pension funding standards as set out in the PBSA. In other words, the government had absolute control over the amount of funds that were to be directed to the BC plans. This is similar to the arrangements still in place in many US public sector pension plans. The BC plans remain exempt from going concern and solvency provisions of the PBSA, but the Joint Trust Agreements (JTA) require our pension plans to be pre-funded on a going-concern basis. Unfunded liabilities are addressed through triennial actuarial valuations whereby any unfunded liabilities identified must be funded over a period to not to exceed 15 years. The inclusion of this funding requirement is a significant improvement for the sustainability and prudent financial management of the BC plans. The continued exemption from solvency funding requirements is appropriate for the BC plans given the large, multi-employer nature of the 4

5 plans. They are not exposed to sponsor insolvency risks in the same way as non-public sector DB plans are. The exemption facilitates managing the plans sustainably with relatively stable and reasonably predictable contribution rates. Each pension plan s board manages its assets to ensure there is enough money for current and future pensions. Every three years, an independent actuarial valuation is conducted by the plan actuary to determine if the plan is sufficiently funded. (An actuarial valuation is an assessment of the financial health of a pension plan by an independent actuarial consulting firm.) If this valuation determines that there will be insufficient funds to meet the board s basic pension promise to members, the board must increase employer and member contribution rates. The intent of this process is to keep the plan at or near a funding ratio of 100 per cent. This approach is different from that applied in some U.S. states, where employers may not be required to fund their plans on a going-concern basis. Fiscal pressures mean that some states pay considerably less into their plans than recommended by their actuaries. Over the past decade since the BC plans implemented joint trusteeship, the main actuarial assumptions for each of the plans have gradually become more conservative. This ensures the plans are not using unrealistic assumptions, such as inflated rates of return, to cover up the true extent of the pension liability. 2. Investment management The board of trustees for each of the BC plans is responsible for investing their pension plan s funds, and each plan uses the BC Investment Management Corporation (BCI) as its investment agent. BCI provides expert support and advice to the plans along with sophisticated, industry leading, low-cost investment management of the funds. Each of the plans has in place a Statement of Investment Policy and Procedures (SIPP), as required under the PBSA. This is a long-term asset mix policy used by the boards of trustees to allocate plan assets across different asset classes. Both the boards of trustees, and BCI as their agent, act in the best financial interest of the pension plans and their members. The investment process is insulated against interference by outside parties such as government, employers or unions. 3. Administration The plans boards of trustees use the BC Pension Corporation (Pension Corporation) as their administrative agent to handle the day-to-day operations of the BC plans. The Pension Corporation is one of Canada s largest pension benefit administrators, serving over 440,000 active and retired plan members, and about 1,000 plan employers. 5

6 The large scale and professional management of the pension plans enables them to operate very efficiently. The total cost of investment management and pension administration for the plans is about one quarter of one per cent, which is significantly less than what individual investors commonly pay for investment management fees. 4. Risk management The plan boards of trustees also conduct risk management and audit activities to ensure the BC plans are being managed appropriately. The Pension Corporation and BCI, as the administrative and investment agents respectively, each conduct their own corporate risk management and audit processes to supplement the activities of the plan boards of trustees. 5. Plan rule amendments A further consideration is the governance model in place for the amendment of plan rules. Under the joint trust agreements for each of the BC plans, the boards of trustees have a limited capacity to amend the plan rules. The boards of trustees can amend the rules without prior approval of the plan partners in two situations: where an amendment is required in order to maintain compliance with statutes such as the PBSA, Income Tax Act (Canada) or the Family Relations Act; or where there is no resulting increase in cost to the plan and the amendment is consistent with the trustees fiduciary responsibilities. Any other amendment must be approved by the plan partners in advance. The plan partners can direct their respective boards of trustees to amend the plan rules, and the board must do so, subject to the following parameters: the partners must have first received advice from the board of trustees about cost and administrative impacts; the amendment must be consistent with the law and the trustees fiduciary responsibility; and the amendment must not result in the plan failing to be funded in accordance with the going-concern funding requirements of the PBSA. The plan rule amendment model ensures the boards of trustees do not have the capacity to make changes to their respective rules that would enhance the value of the pension formula or otherwise increase the cost of delivering their plan s pension promise. At the same time, the model is flexible and allows the boards of trustees to deal with rule amendments to maintain compliance and other amendments that do not have a cost impact to the plan. 6

7 In closing Public sector pension plans are efficient and well administered, and designed to make up a portion of a person s retirement income, with Canada Pension Plan, Old Age Security and personal investments serving as other sources of income. BC s public sector pension plans are structured and governed in a way that makes them more sustainable than many plans in other jurisdictions, including the U.S. and U.K. Employers and employees equally share the risks associated with funding the defined benefit portion of the plans. Further, the pre-funding of BC s plans means they are not highly exposed to demographic risks such as the shifting ratio of pensioners to contributors because each generation is self-funding. This pre-funding of the plans makes them more sustainable, more cost-effective and fairer between generations. MPP EOP IN-DEPTH