The DB versus DC debate has been boiling away for many years. Hopefully you will find the following adds a few new thoughts to this continuing saga.
The pain that DB pension plans are going through today is at least partly a good thing
Let me be clear. It isn’t a good thing that investment returns have been terrible, or that expected future returns have decreased. But this environment has impacted DC pensions just as significantly as DB pensions. The fact that the pain to DC contributors has been less excruciating is only because, in the DC world, the pain gets kicked down the road for the member to eventually deal with on his or her own.
In the DB world, stakeholders and their experts are forced to come to grips with this difficult environment in a more timely fashion. And in my opinion that is on balance a good thing.
Special payments are a sunk cost
One of the two reasons that DB pensions have become more expensive is that most of them currently have unfunded liabilities that must be paid off. While impacting current contributions, this is not really an increase in current costs. Special payments and the unfunded liabilities that cause them are a result of prior service being inadequately funded. It is a sunk cost and does not reflect the ongoing cost of the pension plan.
Some “expert” pension commentators seem to argue that the solution to expensive DB pensions is to convert to a DC pension. But conversions don’t erase unfunded past service liabilities unless past promises are in some way reneged on. And arguing that already earned benefits should be reneged on because the cost is too high is exactly like an insurance company refusing to pay when claims are high.
Normal costs have increased for DB and DC pensions alike if benefits remain adequate
The second reason that DB pensions have become more expensive is that the cost of current service has increased. This has happened because expected future interest rates and other investment returns have decreased a lot over the last decade or so. In addition, life expectancies are higher than they used to be.
But if a DC pension is to provide an adequate pension, it must also increase its normal cost to address these two realities. The unfortunate fact is that DC pensions generally haven’t increased their contributions and are instead a lot less adequate than they were expected to be a decade or so ago. This is a failure rather than a success of DC pensions.
Leaving retirement preparation to the best efforts of main-street Canadians is neither effective nor efficient
When retirement preparation is left to the individual, the task frequently gets kicked down the road, leading to later retirements. But this doesn’t work for people who are in physically demanding jobs, and it doesn’t work for the unemployed who have to compete with younger people for a job. Those who argue that I’m not giving enough credit to peoples’ ability to take care of themselves need to talk to more ordinary people.
Employers should be expected to allocate employees’ compensation packages to maximize attraction and retention
To do otherwise would be a breach of an employer’s duty to its shareholders (or taxpayers in the case of public sector). In recent years this has resulted in a decline in the adequacy of pensions, but it doesn’t need to be this way. If employees increase the importance they place on adequate retirement plans (whether DB or DC), then it will make sense for employers to allocate more of their compensation package to retirement plans.
Employers, unions and their service providers need to encourage this change in view.
Fifteen needs to become the new 10
Years ago, the author of The Wealthy Barber advocated the magic of paying 10% to yourself first. Pension plans of the era tended to have total contributions in this range. In today’s environment, 15% needs to become the new normal. DB pensions have already made this transition with the mechanics of these plans making the transition automatic. DC pensions are overdue for the same transition. Employers, unions and their service providers need to lead this charge.
Calvin Jordan is CEO of the NSAHO Pension Plan, based in Halifax, Nova Scotia.
Reprinted with permission from the Alliance for Retirement Income Adequacy (ARIA) blog: ariapensions.ca.