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Living in Windsor I am a little more sensitive to what goes on in the auto industry than I was when I was living in Toronto.  In case readers missed the news, in the past few weeks Unifor, the union representing most auto workers, reached labour deals with Ford and GM.  I expect that Stellantis (formerly Chrysler) will not be far behind.

My interest in the story usually ends when the deal is made – a sigh of relief that my small town won’t be thrown into chaos with weeks or months of strikes or lockouts.  This time around however, there are some changes in pensions that warrant a closer look. 

Both Ford and GM have agreed to join the pension plan we used to call the Colleges of Applied Arts and Technology Pension Plan in respect of employees hired on or after November 7, 2016 – these are the employees that had to give up the traditional DB plan and accept a DC plan since they were hired.  The short form in the industry was always the CAAT Plan. Through careful branding and an aggressive expansion of participating employers outside the college system, the plan’s original name is almost forgotten and when anyone calls me to ask about the plan, they simply reference CAAT.

What is CAAT?

CAAT is a Jointly Sponsored Pension Plan which is a type of multi-employer pension plan and which collectively are called Target Benefit Plans (because not all benefits are guaranteed).  In the old days you had DB plans and MEPPs to deliver pensions – that was it.  Then DC became a thing – then the JSPP was invented.  To remind everyone, in DB, benefits are promised and contributions are unpredictable, whereas in DC contributions are promised and benefits are unpredictable.  TBPs sit in the middle of these two ideas.  Predictable contributions for employers and predictable benefits for employees.

This ‘have your cake and eat it too’ arrangement was made possible through what I call ‘actuarial magic’.  Actuaries, magically smoothing out the ups and downs of investments and demographics were able to deliver a carefully balanced promise of reasonable costs and reasonable pensions.  As solvency testing arose in the 1980s and the cyclical decline in interest rates reared its ugly head in the 1990s, the curtain was pulled back and actuarial magic was exposed.  The truth then, and still today, is that pension costs are unpredictable and the ‘fair value’ of a pension promise changes every day.  In the 1980s, legislation providing ‘portability’ of pensions meant that the long-term view of ‘going-concern’ valuations would no longer suffice in determining contributions and we entered a new world of ‘mark-to-market’.  For employees and employers participating in MEPPs, the difficulties of the 90s and 00s saw a mix of contribution increases and benefit reductions that left many unhappy.

Through these difficult times, three lessons were learned.  First, solvency funding doesn’t work for MEPPs.  Second, mark-to-market commuted values don’t make sense in a MEPP environment, and third, if you want to avoid unexpected contribution increases and/or benefit reductions you need to have margins in your funding.

What Did Ford and GM Workers Get?

CAAT was early to the game on recognizing the difficult balance on contribution and benefit changes and have designed its two programs, DBPrime and DBPlus around a ‘funding policy’ that very clearly moves benefits and contributions up and down as investments deliver greater and lesser performance than the actuaries ‘expect’.  In an ideal world, the margin in the funding, currently 124% funded, will ensure that the benefit reduction/contribution increase side of the coin doesn’t occur.  Most recently positive experience has resulted in contribution reductions and benefit increases.

CAAT also comes with world class governance.  In addition to a fine slate of managers well regarded in our industry, there is a Sponsors Committee focused on plan amendments and actuarial valuations as well as a Board of Trustees which carries the fiduciary duty to members and is focused on investment and administration policies.  Both these bodies have joint representation appointed by employers and members.

With close to $20 billion in assets, CAAT is among Canada’s largest pension funds.  At this scale you get access to high quality investment opportunities that aren’t available to us regular folks.  Hopefully you also get access to some of the most brilliant investment minds too.  You definitely get access to a group of administrators that care deeply about their mission and delivering on the promise of adequate and reliable pension income for workers.

The other thing members get is insurance in the form of cross-subsidization.  Workers that live a long-life will benefit from those who are less fortunate.  Workers retired in an age of higher inflation will see greater benefits than those retired in lower inflation years.  At the same time, workers retiring at the end of an investment downturn will benefit from the reserves built up during the good times.  All of these are positive contributions to the welfare of retirees and follow sound insurance principles by having everyone pay fairly and receive fairly – where fair is more focused on affordability and need.

Most important, in the Ford agreement, the employer contribution to pensions goes from 4% of pay to 7% (I didn’t check but assume the same is true for GM).  I have written repeatedly that if we want more adequate pensions then we need to look first at increasing contribution rates before we wax poetically about governance and scale.  More money in will always mean more money out.

{Side note – a friend recently sent me a Globe article about a couple who are around 50 and want advice on retirement – their combined DB pension value was $2 million.  My friend was upset because he knew that taxpayers had paid for three-quarters of the hefty contributions that built that pot of money.  Setting the transparency issue aside for now, my point is just that a comfortable retirement comes at a steep cost these days.}

What Didn’t Workers Get?

We must be clear that CAAT isn’t a DB plan as that term is generally used in the industry and the media at large.  DB plans are generally sponsored by a single-employer and that employer guarantees that there will be enough money to pay for all the promised benefits.  Poor investment results don’t cause benefits to be reduced, they cause the employer contributions to rise. 

In the 90s, fantastic investment performance meant that employers could keep their DB promise while putting little, or no, new money into the plan.  In some cases where pension fund performance was outstanding, employers were rewarded with a return of surplus.  Employees wise to the idea that they were paying too much for their DB pension saw an opportunity to ‘make more money’ in a DC plan and pushed for change.  Employers wise to the ups and downs of investment risk were more than happy to oblige workers’ demands for DC.

By the 2000s, a dot-com bust and falling interest rates turned the tide and many employers found themselves with contribution increases that were more than double the prior years – largely thanks to the short-term solvency equation.  Hearing how employers that got out of DB in the 90s were suffering no such fate, a second wave to push out of DB arrived – this time driven on the employer side.

Although CAAT comes with the name DBPlus and the media often misreports the plan as a DB plan, the program is definitely not promising a lifetime guarantee for all the benefits the governors are ‘targeting’ and hope will be paid.  I used to be more negative on MEPPs because I saw the unhappy retirees when benefit cuts arose.  Not all Boards of Trustees were created equal and some were motivated more by politics rather than caution.  Being a relatively risk-averse actuary, some Boards found me too careful until a decade later when they realized the warnings were justified. 

But I see the world a little differently these days.  If investment markets collapse to the level where benefits need to be cut – then it would mean cuts for DC plan members too.  I have long advocated for annuities for some or all the balance in a DC account at retirement – but the evidence shows DC members struggle to let go of the nest-egg to insure their future income and continue with investment risk in retirement.  At the same time, a market crash could put DB plan members at risk since we have seen insolvent employers leave behind underfunded DB plans.  The bottom line is that there is risk in the DB, DC, and MEPP models and it is more of a ‘choose your risk’ discussion than an ‘eliminate risk’ discussion.

Where is the Industry Heading?

As I have written in the past (here and here), DC isn’t working as well as it needs to work to be a viable ‘pension’ plan for many of today’s workers.  At the same time, I don’t see employers wanting to backtrack and take back the investment risk – most recently evidenced in these new collective agreements.  The Target Benefit Plan seems to be the middle ground between DB that doesn’t work for most employers and DC that doesn’t work for most workers.

There has long been talk of single-employer target benefit plans but we haven’t gotten there yet across the country.  Single-employer target benefit plans would have been valuable in decades past as a stop on the path from DB to DC.  At this stage I am not sure we need to wait for the legislation as more and more employers decide that delegating the governance is an equally valuable step in the process, and programs like CAAT are already available.

Of course, if you are part of the DC industry don’t panic.  There is momentum around ‘collective DC’ which helps achieve the governance and investment scale offered by MEPPs and in the end, for many employees they don’t want the ‘cross subsidization’ offered in DB and MEPPs but rather want their own bucket on funds for their retirement and their beneficiaries.  For these folks we just need smarter DC with higher rates of contribution as the lever to drive better pensions.