When it comes to establishing a pension plan, plan sponsors have long had two options to choose from: defined benefit (DB) and defined contribution (DC). DB plans are considered administratively burdensome, difficult for employees to understand and fully appreciate, and have cost uncertainty for the plan sponsors, but they provide superior benefits to employees; DC plans are less risky for the sponsor but provide less benefits and shift most of the risk and uncertainty to the individual employees. For decades these were the sponsors’ two options, and never the twain shall meet—or will they?

Alternative formats that strike a happy medium are becoming increasingly popular. They offer some level of certainty for employees without the potential liability for plan sponsors. These hybrid models, with names such as Target Benefit Plans or Jointly Sponsored Pension Plans, offer a third way for unions and employers seeking to set up a pension plan but frustrated by the limited and polarized choices.

Throughout most of the long history of pensions, they were thought of in terms of benefit only. Veterans of wars were promised a set reward for their service, regardless of the State’s ability to pay, for as long as they lived. Organizations offering pension plans—the first in Canada was the Hudson’s Bay Company in 1840—were institutions with staying power. And the employees’ life expectancy was much lower than today; retirement was a short phase of life, if it occurred at all.

Workplace pensions became more common in the 20th Century, and the most important factor that influenced their growth was the growth of the trade union movement and collective bargaining. Between 1945 and 1960, almost entirely due to union initiatives, pension coverage increased from 19% to 40% of the workforce. These plans guaranteed a set benefit based on earnings and years of service and provided many families with security and certainty. However, as economic cycles shifted, mortality improved, and cultural shifts towards individual responsibility took hold in North America, many organizations felt they could no longer commit to providing these long-term benefits to their employees. Reliance on investment returns, decreasing (and volatile) interest rates and burdensome financial disclosure requirements made providing the defined benefit promise more challenging for sponsors.

That led to the rise of the defined-contribution plan in the 1980s and 1990s. In a DC plan, the employers and sometimes the employees contribute to the plan according to a fixed contribution amount. The actual pension payouts are only determined at the time the employee retires, based on the amount saved in the members’ individual investment accounts. Plan members are allotted individual accounts, meaning they take on all the risks (financial, disability, and life expectancy) individually. The most significant being long-term investment returns risk followed by the risk of retiring during a market downturn and the chance they will outlive their benefits. The lack of certainty makes retirement planning harder. DC plans are therefore considered inferior to DB plans, from a benefit security perspective, for members.

Fortunately, choosing to set up a pension plan no longer needs to be a fraught decision. A growing number of plan sponsors and unions are opting for alternative formats that bridge the gap between DB and DC plans. These kinds of plans strive to share the costs and risks between the participants and employers.

Target Benefit Plans are set up to provide a predetermined level of benefits but are not formally bound to it. Contribution levels may be adjusted to help achieve that goal. Like DB plans, the funds are pooled and are designed to provide benefits for life.

Multi-employer Pension Plans (MEPP) are usually associated with collective bargaining agreements covering more than one workplace. As with target-benefit plans, the benefits and contribution levels are set but subject to change under certain circumstances.

Jointly Sponsored Pension Plans (JSPP) usually have a defined benefit but explicitly share the risk of the plan’s underfunding between employees and employers. Both parties contribute and participate in the decision-making.

Quebec’s Member-Funded Pension Plans (MFPP) Were introduced in 2007 and distinguish themselves from other DB plans mainly by the fact that the funding risk is entirely left to the participants, while the employer’s contribution is fixed, and the employee’s contribution is variable. 

Unions and employers, of course, must weigh multiple considerations when creating a pension plan. There is often a challenge to find the right combination of contribution stability, adequacy, affordability, and participant equity. They must consider the costs of administering the plan and managing its investments. They need to consider the asset mix that will achieve the required returns with an acceptable level of risk. They must decide whether the final benefits will be extended to family members and if the benefits will increase to offset the impacts of inflation, both of which may be costly but very beneficial to participants.

Workplace pension coverage is declining in Canada, but in recent years the trend has slowed down, and employees are beginning to demand more from their employers. Fortunately, plan sponsors are no longer confined to the polarity of DB versus DC. Sponsors, regardless of the sector of the economy they operate in, can provide a stable, predictable, and financially viable pension for members. With alternatives to DC and DB pension plans, sponsors can design pensions within a spectrum of designs that meet both the participants’ and employers’ needs. Sponsors are now armed with the ability to provide the right balance of pensions for their members.