Actuarial Notes

Target Benefit Plan

Study guide: Exam RET-101

A Target Benefit Plan (TBP) is a retirement plan in which contributions are fixed, or may move only within a narrow band, while the benefit formula sets a target pension that can be raised or cut, for accrued as well as future service, according to the plan's funded status. Funding risk therefore falls on the members as a group rather than on a sponsor that pays whatever the benefits cost. A written funding policy fixes in advance which actions are taken, and in what order, when the plan is in surplus or deficit. New Brunswick's shared risk plan is the best-known regulated form.

C_t = c\,S_t

c_{\min} \le c \le c_{\max}

FR_t = \frac{A_t}{L_t}

I_t = \min\left(\text{CPI}_t,\ \max\left(0,\ \frac{A_t}{FR^{*}\,L_t} - 1\right)\right)

k_t = 1 - \frac{A_t + PV_t^{\Delta C}}{L_t}

  • Symbols: C_t is the total contribution for year t, set as a rate c times the covered payroll S_t and held inside the band [c_{\min}, c_{\max}]. A_t is the fund and L_t the liability for the target benefits accrued to date, so FR_t is the funded ratio. I_t is the indexation granted under an illustrative policy that pays inflation only while the funded ratio after the increase stays at or above a threshold FR^{*}. k_t is the uniform cut to accrued benefits that restores full funding once the present value of any contribution increase, PV_t^{\Delta C}, has been counted.
  • Between DB and DC: Like a DB plan, a TBP pools assets, pays a lifetime pension from a formula and pools longevity risk among the members. Like a DC plan, it caps the employer's cost, so investment, interest-rate and longevity shocks end up in the benefits. Unlike a DC plan, those shocks are shared across all members, active and retired, and smoothed through the funding policy rather than landing on one account.
  • Base and ancillary benefits: Most designs split the target into a base pension, which the policy aims to protect, and ancillary benefits, such as indexation or early retirement subsidies, which are granted only when funding allows. Adjustments run down a ladder: ancillary benefits are withheld first, contributions rise within the band next, and accrued base benefits are cut only as a last resort. Restoring past cuts comes before granting new ancillary benefits on the way back up.
  • Shared risk plans: New Brunswick's 2012 framework requires the funding policy to pass a stochastic risk management test, under which base benefits should have at least a 97.5% probability of not being reduced over 20 years. The plan must also carry a deficit recovery plan and a surplus utilization plan that act automatically on the open group funded ratio. Several other provinces have since adopted target benefit rules of their own.
  • CIA Task Force: The Canadian Institute of Actuaries' 2015 Report of the Task Force on Target Benefit Plans sets out how such plans should be designed and run. Its recommendations include a board that answers to all members, a funding policy with explicit margins and a benefit adjustment policy, a clear statement to members that benefits can fall, and fairness between generations when deficits and surpluses are shared.
  • Relatives: Collective DC plans, as in the Netherlands and the U.K., and the defined ambition designs in the RET-101 readings follow the same logic of a fixed contribution and a flexible, pooled pension. The multi-employer plan, whose negotiated contributions fix what the trustees can promise, is the older North American form of the same idea.
  • Who bears which risk: The employer bears little beyond its share of a contribution increase within the band. Members bear investment and longevity risk collectively, and the timing of the adjustments decides which cohort pays. Cutting accrued benefits spreads a loss across retirees and actives, while relying only on future accruals and contributions loads it onto younger members.

A Funded-Ratio Trigger After an Asset Shock A target benefit plan's illustrative funding policy has three steps. Inflation indexation is granted only to the extent the funded ratio after it stays at or above 105%. Below 100%, the contribution rate rises by 1% of pay for 15 years. If the plan is still below 100% after that increase, accrued benefits are cut uniformly to restore full funding.

  1. At one valuation the fund is $1,080 million, the liability is $1,000 million and inflation was 2%.
  2. A year later, after a market fall, the fund is $900 million and the liability, before any indexation, is $1,040 million. Payroll is $300 million and is expected to grow 3% a year, and the valuation rate is 5%.

Find the indexation at the first valuation and the action taken at the second.

Answer At the first valuation, the plan can afford up to 2.86% of indexation before it falls below 105%, so the full 2% is granted.

\begin{align*}
\frac{A}{1.05\,L} - 1 &= \frac{1{,}080}{1{,}050} - 1 \\
&= 2.86\% \\
FR &= \frac{1{,}080}{1{,}000 \times 1.02} \\
&= 105.9\%
\end{align*}

At the second valuation the funded ratio is 900 / 1{,}040 = 86.5\%, so there is no indexation. The contribution increase is a growing annuity-due of 1% of payroll, valued with q = 1.03/1.05.

\begin{align*}
PV^{\Delta C} &= 0.01 \times 300 \times \frac{1 - q^{15}}{1 - q} \\
&= 3 \times 13.156 \\
&= 39.47 \\
k &= 1 - \frac{900 + 39.47}{1{,}040} \\
&= 9.67\%
\end{align*}

The contribution increase lifts the funded ratio only to 90.3%, so every member's accrued pension, retirees' included, is cut by 9.67%, and the liability falls to $939.5 million. In a DB plan the same $140 million deficit would be the sponsor's, funded by special payments of about $12.8 million a year over 15 years at 5%. If markets recover, the policy's first use of surplus is to restore the 9.67% cut, and indexation resumes only after that.

How it appears on the exam

  • RET-101 (1a): Candidates describe the structure of a target benefit or shared risk plan and contrast it with traditional DB and DC plans and with the hybrids, naming where each risk sits.
  • RET-101 (2d, 3): Written questions ask how the design manages participant risk, and which sponsor risks remain, such as a contribution band that may have to rise or a legal challenge to a benefit cut.
  • RET-101 (4): A design recommendation may call for a TBP when an employer wants a lifetime pension with a fixed cost. The answer is expected to weigh the governance burden and the intergenerational trade-offs, citing the CIA Task Force report and the SOA's analysis of design options.
  • Calculations: Short calculations apply a stated funding policy: the indexation it allows, the contribution increase within the band, or the benefit cut that restores a target funded ratio.

Exam traps

  • Fixed contribution does not mean DC: A TBP pays a pooled lifetime pension from a formula. Describing it as an individual-account plan misses the pooling of longevity and investment risk that defines it.
  • The order of actions: A funding policy cuts ancillary benefits and raises contributions before it touches accrued base benefits. Cutting base benefits first, or granting indexation before restoring past cuts, reverses the ladder.
  • Count the contribution increase: The benefit cut is what remains after the present value of the contribution increase is added to the assets. Dividing the assets alone by the liability overstates the cut.
  • Intergenerational effects: A deficit funded only from future contributions or future accruals falls on younger members, and a cut to accrued benefits reaches retirees too. A question about fairness wants that distinction stated, not just the size of the cut.
  • Not a guarantee: The target is not a promise. Candidates who call a TBP's benefit "guaranteed" or treat a deficit as the employer's debt have described a DB plan.