What Happened?
Addressing a $1 billion deficit, New Brunswick officials have decided to implement a new pension reform strategy that would incorporate a shared-risk model for more than 30,000 public service employee pensions. While the model is being tested in Canada, the structure of the changes could have beneficial applications in the United States, where state and local pension plans continue to increase unfunded liabilities amid growing deficits.
The Goal
The New Brunswick government is facing similar financial constraints and threats to its public employee pension system as states and local governments in the United States are dealing with as well. New Brunswick officials created a shared-risk pension reform model created to respond to shocks in a predictable way to prevent drastic cutbacks in pension funding as was experienced during the 2008 financial crisis, The Atlantic Cities reported.
The shared-risk model features splitting all benefits into base and ancillary components. There are strict, agreed upon steps in place to adjust benefits and contributions, as well as develop a risk management framework to ensure public employee pension plans are supported despite dips in financial performance and market activity.
Breaking It Down
According to The Center for Retirement Research at Boston College, the New Brunswick shared-risks model has three main components:
- Benefits split into highly secure base benefits and moderately secure ancillary benefits
- Protocols for pre-determined actions to change benefits, contributions and asset allocations in light of financial conditions
- Risk management regulatory framework to maintain pension plan funding and stability
Canada is already renowned for its stress-test methods of supervising banks and insurance companies, and has combined that methodology with benefit categorization strategies from previous models. The model uses a stress test to assess the ability of the plans to pay out promised benefits to public employees based on certain financial conditions and government contributions.
If the funded ratio falls below 100 percent for two years in a row or the plan does not meet risk management goals laid out, contributions can be increased by up to 1 percent of earnings to be split between workers and employers evenly. The government may also change the rule for calculating early retirement benefits to a full actuarial reduction, or reduce base benefit accrual rates for future service up to 5 percent. Otherwise the government may reduce base benefits for all members in equal proportion until risk management goals are met.
If the funded ratio rises above 105 percent, some of the surplus can then be used for reverse previous deficit-recovery measures such as undoing any increase in contributions, any reduction in base benefits or any lowering of early retirement benefits. Portions of the surplus may also be used to index pensions and base benefit accruals up to the full consumer price index, increase individual benefits or provide lump-sum payments to offset past shortfalls.
Netherland Example
Much of New Brunswick’s shared-risks plan is based on foundational principles developed by the Netherlands. When the United States found itself facing unfunded liabilities in public pensions, most states responded by closing defined benefits plans and implementing individual defined contribution strategies.
In the Netherlands, however, the government developed collective nature pension plans that act as a hybrid between defined benefits and defined contribution plans. The resulting model includes yearly accrual of pension rights similar to a traditional defined benefits plan with flexible contributions dependent on the financial conditions surrounding the pension fund. It also has annual indexation relative to the financial position of the fund tying in investment returns similar to a defined contribution plan.
The Netherland pension system has created three pillars: state, supplementary pension funds, and individual life insurance and annuities. The framework offers superior risk management potential, as well as welfare gains attributed to intergenerational risk-sharing abilities, Harvard Law School reported.
Reforms At The Ready
Gov1 has reported on varying pension reform strategies nationwide many of which are using unique solutions to pay off unfunded liabilities.