Tough economic conditions tend to boost investor conservatism and capital accumulation plan (CAP) members are no different, assuming they bother to revisit their investment mix. But even “safe” defaults require ample due diligence by both plan sponsors and members.
“Both DB and DC pension plans have been hit very hard by the recent market downturn. A lot of people think that DC plans have been less impacted,” says Ross Gilbert, Morneau Sobeco principal and defined contribution consultant. “In actuality, because so many plan members, once they set up their asset mix do very little to change it, there are a lot of DC members who are far too heavily invested in equities.”
“Plan sponsors do need to make sure that there is a safe haven of investment vehicles for their DC plan members to participate in,” he said, speaking at the Morneau Sobeco Emerging Trends 2009 seminar in Toronto on Thursday, May 21. Twenty years ago, “a lot of plan sponsors were really keen on offering guaranteed investment products, and there was a lot of emphasis on ensuring that there was a lot of variety at that end of the spectrum.”
In the intervening years, that interest has waned, but guaranteed investments are now back in vogue.
Wide variance
The guaranteed investment account (GIA) is about as traditional and straightforward as products come. Essentially the same as a guaranteed investment certificate the member could buy at a bank, GIAs are typically offered in one-, three- and five-year terms.
But not all GIAs are created equal. A snapshot of base rates offered by several top providers at the end of April 2009 shows a range from below 2% to a high of just under 3.5%. Interest enhancement beyond that base rate can also vary substantially.
Early redemption penalties also require careful scrutiny, as the plan member could see a significant bite taken out of their “safe” investment. These penalties are typically based on the difference between the book value of the investment and the current market value. Early redemption could see the investor receive a premium if the market value rises or a discount if the value has declined.
But as always, communication with plan members is vital.
Plan members who participate through a payroll deduction may believe they are paying into a single GIA with a single maturity date. Often, this is not the case, Gilbert says. If the member is investing in five-year GIAs every month, they may hold 60 different certificates by the time the first one matures. Each additional withdrawal beyond that initial, now-matured, certificate could be subject to early redemption charges.
Pooled GIAs are preferable, as redemptions are paid out of cash flow rather than through the redemption of an individual certificate. But these are not readily available from insurers, which are pushing more lucrative product innovations such as guaranteed life cycle funds or group lifetime guaranteed minimum withdrawal benefit (LGMWB) products.
Innovation at a cost
These new guaranteed products are available for CAP use but are not without their own problems.
In both cases, the product is offered by a single provider: Sun Life Financial offers guaranteed lifecycle funds while Manulife Financial provides LGMWBs. This makes benchmarking fees virtually impossible for the plan sponsor.
And in each case, the guarantee element comes at a cost to the plan member. In the case of the guaranteed life cycle fund, Gilbert says that can be as much as 60 basis points above the management expense ratio of a similar non-guaranteed product.
The guarantees come with stipulations as well. If the employee leaves the sponsor company before the guarantee has been vested, they either forfeit the guarantee or must roll the investment over into a retail version of the product.
A similar problem arises if the plan sponsor decides to switch carriers.
Fortunately, the carriers are anxious to keep the assets on their book and make the rollover relatively painless, but the investor will likely lose any discounts associated with membership in a large corporate plan.
With LGMWBs, members must remain in the plan for a minimum of five years to lock in the guarantee.
So far, the uptake on LGMWB investments has been far greater in the retail space, possibly because the individual investor retains more control over their own investments. Benefits coordinators may also be reluctant to sign up for such a new product. In fact, they appear to be waiting to see how they pan out in the retail space.
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(05/22/09)