D’Amours report: DB or not DB?

I will let DB experts comment on the specific recommendations made to save these arrangements—which appear to all make sense from what I hear. I will say, however, that of the 20 or so DB sponsors (all from the private sector) I’ve had a chance to talk to since the report came out, none said that these measures would change their mind about getting rid of DB as soon as it was practical.

Quebec’s versions of the pooled retirement pension plan and DC changes
The report swiftly discards any possibility that DC arrangements could ever lead to decent pensions, citing high fees and poor investment performance as the main culprits. Such a conclusion is unfortunate, as it appears to only look backwards and ignore new developments in investment options as well as increasingly competitive fee levels. But this might be explained by the absence of any significant DC representation on the committee.

Still, the committee endorses the idea of a voluntary retirement savings plan (VRSP), introduced by the Liberal government last year. It also brings an interesting twist, suggesting that group tax-free savings accounts be considered an acceptable alternative to the VRSP (good news for those with lower incomes). The report, however, shies away from mandating minimum employer contributions or requiring all contributions to be locked in—two critical success factors if the VRSP is to truly address the insufficient retirement saving issue.

Recognizing that de-accumulation at a decent price is hard to come by, the report recommends that Quebec modify its pension legislation to allow DC pension plans to be used for payout purposes. This is already allowed in Manitoba and Alberta, where retired DC members can receive life income fund payments directly from their DC plan. Unfortunately, few non-public employers have implemented this approach, and I would expect the same to happen in Quebec unless some form of safe harbour rule was offered to them. DC plan sponsors simply do not see the value of keeping ex-employees in their plans if they represent additional fiduciary risks. To quote an ex-client of mine: “We got rid of DB and post-retirement benefits. We are not going to keep retirees in our DC plan.”

A new idea: the longevity pension
The committee rejected the idea of broadening the Quebec Pension Plan (QPP) coverage—say, by increasing the year’s maximum pensionable earnings (YMPE) or the salary replacement ratio—on the basis of maintaining intergenerational equity and the desire not to complicate the system further.

But in order to provide better lifetime pension coverage to all working Quebecers, it recommends the creation of a longevity pension (LP). The LP would be a life annuity payable only from age 75 and funded by mandatory employee and employer contributions in the same fashion as the QPP pension (set at 1.65% of earnings up to the YMPE for each). The pension would pay 0.5% of members’ QPP earnings per year of participation and would be indexed only if funding is sufficient.

The committee recommends that, once in place, DB plans be amended to co-ordinate their pension formula with the LP—effectively transferring part of the DB longevity risk (particularly at the tail end) to the QPP. This idea will represent challenges for a sponsor having employees outside of Quebec.

Likewise, the committee expects that employers already offering some form of DC arrangement would probably reduce their contribution formula to offset this new benefit. So, same contributions but with the benefit of a (further deferred) lifetime pension.

Finally, the report suggests that DC members use their personal savings to provide income during the retirement period leading up to age 75. This assumes Quebecers will be willing to significantly deplete their savings during their early retirement years and later on be left, for the most part, at the mercy of government-sponsored or –managed programs. This looks like a very strong assumption.

For these reasons (there are more), I’m not optimistic about the chances of the LP ever seeing the light of day.

A better twist
The D’Amours report is right about the longevity challenge in that it is very difficult for retirees to annuitize at a reasonable price.

This is due to three main reasons: one, low interest rates have rendered annuities expensive by definition; two, annuities require more capital than life insurance companies care for, so they tend to price them even higher (in fact, some simply don’t want to be in the life annuity business, period); and three, most are sold on an individual basis, so they pile up large commissions on top.

A true innovation, then, would be to take the Obama Care approach and turn the LP idea into having the QPP become a public life annuity provider, leveraging on its administrative and financial economies of scale and broad mortality risk mutualization. Any Quebecer (DC member or not) could then decide to get a life annuity quote from both life insurance companies and the QPP to compare rates. Members could decide to annuitize only part of their savings upon retirement and possibly the rest later on…say, at age 75 or higher, when they feel ready for it.

I know, it’s not DB. But it could make DC an even more attractive option than it currently is. An important point, as DC is simply not about to disappear in favour of DB arrangements—certainly not for small- and medium-size enterprises, the heart and soul of Quebec’s economy.