The past year has seen many new ideas foster around how to improve defined contribution (DC)-type retirement savings arrangements, many involving governments playing a much more active role. The Alberta-B.C. (ABC) plan is probably the one concept that has attracted the most attention. Is Canada ready for such (potentially) drastic changes?
What needs fixing
The shift from defined benefit (DB) to DC is leaving an increasing number of employees responsible for managing many risks previously taken on by employers: investment, longevity, inflation (to a certain point), planning (setting the right contribution rate that will lead to a pre-determined retirement income level), and—to a large extent—fees. That said, in these turbulent economic times, some DB plan members and retirees would probably comment that employers take on these risks only for as long as they can afford it, or are still in operation.
Most employees never had a pension plan and need to prepare for retirement solely on their own, which means they need to add funding to the equation. Canadians with no employer-sponsored pension arrangement do have access to numerous savings programs (such as the RRSP), but at retail fees, which severely eat into their investment returns, dramatically increase the pressure on funding.
As simple as ABC?
Tackling the issues of low pension coverage and high fees are two of the main objectives pursued by the ABC plan, introduced by Alberta and British Columbia’s Joint Expert Panel on Pension Standards late in 2008. By effectively having the government become a DC pension plan sponsor, the ABC plan, thanks to economies of scale and absence of the need for profit, would provide access to auto-enrolled, low-cost and limited-frills retirement savings where both employee and employer would contribute (although employers would be able to opt out).
The idea certainly has merit and is a common feature of pension reforms around the world. Thought must be given, however, towards possible unintended consequences of such a profound change. Case in point: in the 1990’s Australia underwent significant pension reform, which has resulted in the virtual disappearance of employer-sponsored plans.
An additional concern is the potential risk that members might be more likely to opt out of the ABC Plan than out of an employer-sponsored plan, partly because employers more actively promote their own plan. The end result could be reduced coverage of employees who previously were members of occupational plans—the exact opposite of the original intention.
A key recommendation of the report is for the ABC Plan to have low fees. But as indicated above, reasonable fees—albeit crucial—are only part of the elements leading to an effective DC arrangement. Hence one needs to determine the value brought to plan members by additional fees. If higher fees result in superior communication and education, asset allocation tools, lifecycle investment funds and call centres that provide member support, then the more expensive option may be in members’ best interest.
DC service providers in Canada generally do a good job at providing these member services at a reasonable price, partly due to margins they are making on their investment offerings. One would need to see if larger economies of scale in providing such quality services would compensate for reduced or nonexistent margins on investments under the ABC plan.
It is worth noting that there has been a lot of pressure to hold a national pension summit, which would discuss—among other things—the ABC concept. A national approach certainly would appear to make sense if economies of scale are pursued.
Other emerging ideas
Proposals were recently made to introduce design changes to both the Canada Pension Plan (CPP) and the Quebec Pension Plan (QPP). One of the proposed ideas is to increase covered earnings, which would ensure improved pension coverage, on a DB basis.
The QPP has also put forth the idea to allow participants to make voluntary contributions on a capital accumulation (DC) basis, to be converted into an additional QPP pension upon retirement. This idea adds to the ABC plan, with low-fee investments and low-cost annuitization.
Is Canada ready?
Discussions around possible improvements, if not a complete rethinking of retirement and savings schemes, are a sign that the pension community in Canada is taking important steps towards finding solutions to the problems at hand. Any change, however, creates uncertainty, particularly from those who have vested interests in things remaining the same, and the ideas being put forth are already attracting their lot of detractors.
The important thing is that we continue forging a vision to bring us to pension 2.0. It’s in everyone’s interest to have a successful retirement environment.