In Greek mythology, the god Apollo granted the princess Cassandra the ability to see the future. When she later rejected his advances, he cursed her so that no one would believe her prophecies. Her story segues nicely into the Canadian DC pension landscape of 2013. When pension lawyers warn about the legal risks of DC plans, we sometimes all feel like Cassandras.
Over the past few decades, the received wisdom has been that DB plans are “riskier” than DC plans. This can be true, but it depends on what kind of risk is meant.
While DB plans give rise to greater funding risk, most pension lawyers agree that DC plans give rise to greater legal risk. For all their complexity, the rules governing DB plans are at least predictable. The rules governing DC plans are vaguer. Moreover, DC plans offer employers and administrators more points of contact with members and their beneficiaries, which can lead to more opportunities for errors and misunderstandings. As DC plans become more prevalent, some recent cases give a picture of the potential claims that we may start seeing more of in the future.
Investment information to members: Lingering uncertainty
One of the most significant challenges facing administrators under DC plans is the development of clear and complete member communications, especially for the majority of DC plans in which members must make their own investment choices.
The administrator has a fiduciary duty to disclose to members what the Ontario Court of Appeal calls “highly relevant” information. The difficulty is that Canadian courts have so far not had much opportunity to delineate what information is “highly relevant” to a member of a DC plan with responsibility to direct the investment of his or her account. What will or will not be appropriate for a given plan will ultimately be a question for the administrator’s judgment. As some employers/administrators have learned, the devil can be in the details.
In Dawson v. Tolko Industries Ltd. (2010), a group of British Columbia employees affected by a 1997 plan conversion from DB to DC sued both their employer and its actuarial consultant. Among other things, they alleged that the employer (in its role as administrator) and consultant failed to advise them of the personal considerations they should have taken into account when choosing to participate in a member-directed DC arrangement. The employees claimed that they should have been told to consider their assets, liabilities, living costs, available RRSP room, personal health history, expected obligations to dependents and their investment skills (or the skills of their investment advisor) when making decisions as to the investment of their accounts.
The dispute was settled before the court rendered its decision, and so it is impossible to know what merit, if any, the employees’ claim had. At the same time, the case serves as an example of the broad claims that DC members may make in relation to investment-related communications.
As a side note, one consequence of these risks is that many of my clients have come to appreciate that the legal risks around investment choice in DC plans can be dramatically reduced by not giving members investment choice in the first place. Because the proposition seems so counterintuitive, it is only starting to gain traction. Like Cassandra’s prophecies, though, it is true whether or not we choose to believe it.
Plan conversions: A balancing act
Plan conversions from DB to DC present another challenge for employers, administrators and consultants. Again, one of the main reasons is because conversions require detailed member communications and both group and one-on-one interactions with members. The increased points of contact heighten the risk that someone makes a misleading statement or omission.
If the conversion is optional (i.e., existing members may elect either to continue to accrue benefits under the DB component or to join the DC component), special care is required to ensure that the employer is not “overselling” the DC component. Overly optimistic projections of retirement income, investment returns and future conditions can, and have, come back to haunt employers and administrators down the road.
In Beaulieu c. Compagnie Abitibi-Consolidated du Canada (2008), a group of Quebec employees successfully sued their employer based on statements that HR staff had made to them when Abitibi introduced a new, optional DC component in 1995. Members had a one-time option to elect to remain in the DB component or to transfer to the DC component for future service. In meetings leading up to the deadline for the decision, staff told employees that the company would not improve benefits under the DB plan in the future.
A few years later, the company decided to harmonize benefits under its various pension plans. Consequently, it improved benefits under the DB component of the plan in issue. A group of employees who had elected to transfer to the DC component sued. They claimed that they had made their decision on the basis of HR staff’s statements that benefits under the DB component would not be improved. The Quebec Superior Court agreed and awarded almost $4.4 million in damages.
As employers continue to close or terminate DB components, cases like Beaulieu offer a warning. Communications should be clear, and any statements about the future, if necessary at all, should be qualified. Consultants and pension lawyers can provide a valuable second pair of eyes and ears.
Fee and expense lawsuits: The future of DC plan litigation?
While there haven’t been any reported Canadian decisions in which fees under a DC plan were directly in issue, this has been a fertile area for plan member litigation in the U.S. There have been a number of high-profile cases in recent years. For example, in 2011, Wal-Mart and Merrill Lynch agreed to pay members of the retailer’s DC plan $13.5 million to settle claims that Wal-Mart negligently selected retail-class mutual funds as investment options under the plan, rather than less expensive institutional-class funds.
There is nothing to prevent similar decisions and settlements in Canada. Fees and expenses represent a significant risk, especially since fees and expenses under most DC plans are borne by members. In turn, members are not likely to appreciate, at least at first blush, that small charges in fees can have a huge impact on their total savings. According to Chris Daykin, formerly the U.K.’s Government Actuary, “a charge of 1% a year on the funds under management…would reduce the accumulated amount over 40 years by almost a quarter. A 2% charge would reduce the accumulated amount by almost 40%.” A future Canadian court could well require employers whose DC plans are paying “retail” rather than “institutional” fees and expenses to make up the lost savings, as they have in the U.S. The fact that no reported decision has yet been released in Canada (because they have been settled out of court) should not cause us to ignore Cassandra.
What should employers and administrators do?
There are strategies to mitigate this risk that can include any combination of the following:
- consider eliminating member investment choice;
- craft communications carefully and ask an expert advisor for a second pair of eyes;
- enhance governance and stakeholder engagement;
- negotiate more favourable fees; and
- consider asset pooling arrangements to reduce fees.
All is not doom and gloom. DC plans may serve a valuable purpose for both employers and employees, so long as employers and administrators recognize the legal risks in advance.