Wrestling with alligators

This is clearly a question for the plan sponsor. While the plan administrator wrestles with the alligators, the plan sponsor should be able to focus on designing a better swamp.

Unfortunately, since the plan sponsor and plan administrator are often the same entity, the alligator wrestling, which has greater immediacy and urgency, often takes precedence, and little attention is paid to the bigger question. Avoiding being consumed by the alligators is essential, but taking a larger view of the swamp—without always getting bogged down in the details—is also essential if plan sponsors are to make effective use of the substantial amount of deferred compensation being directed toward funding retirements.

The pension plan vision should fit into the overall corporate strategy and reflect the corporate culture. But corporate strategies change and corporate culture evolves, so it’s important to revisit the essential purpose of the plan from time to time and assess whether it also needs to change to reflect the changing organization it serves.

Deep Waters
Traditionally, DB pension plans have served as golden handcuffs, providing strong incentive for older, more experienced workers to remain with an organization. Some capital accumulation plan (CAP) designs attempt to replicate this goal by providing sponsor contributions that escalate based on age or service, but such plan designs have become rare. Perhaps the conversions from DB to DC are a reflection of changing corporate needs. There may no longer be as strong a need to retain older workers. In fact, in a world without mandatory retirement, there may be a need to disincentivize older workers from hanging around for too long.

There is actually a negative correlation between employee age and job mobility. In a Statistics Canada study, about one in five workers under age 25 changed employers in a given year—whereas for workers over age 45, the number was about one in 20. Of course, causality in such a study is tricky to interpret. It may be that older workers are that much more settled in their careers and their employers never needed to worry that much about retaining them. Or it could mean that the employers were successful in building a structure that rewarded and retained more experienced workers (partly through the use of DB plans), in which case the turnover rates of these more senior workers would perhaps increase in the future.

The ongoing trend of converting from a DB plan to a CAP may simply be driven by economics. A lower interest rate environment has resulted in escalating costs. There is a realization, as DB plans mature and become larger in relation to the resources of the plan sponsor, that these plans are likely not affordable in the long term.

The increasing volatility in contribution requirements and pension expense become, at a certain point, unsustainable. However, the change in the work environment that results from the pension plan conversion may have unexpected consequences. The plan does not exist in isolation from the rest of the employee incentivization or from the rest of the culture.

The Right Alligator
The shift from DB to DC is, to some extent, a shift in corporate culture from greater paternalism to greater individual empowerment. This may be positive—or, at least, reflect the realities of the 21st century—but it may also have implications for employee loyalty and retention. Clearly, one of the consequences of moving away from a DB plan is that it makes it easier to leave.

Attracting and retaining the right employees continues to be a major HR challenge. Employee turnover is very costly. The median cost of resignations per organization for a workforce of 500 was estimated to be $1.9 million in 2010, according to Canadian HR Reporter.

So a pension design that makes it easier to leave could be making a serious problem worse. Of course, since 2009, jobs have been relatively scarce, and turnover rates have been lower. But basing the pension plan design on shorter-term economics is unlikely to build a long-term committed workforce, and employee turnover rates have been rising every year since 2009.

Ironically, while the use of pension plans as employee retention tools appears to be an increasingly archaic concept, many of the same organizations that are getting rid of this policy tool are spending an increasing amount of time focusing on issues such as employee wellness and mental health. This would seem to be a disconnect.

Personal finances and retirement planning are major challenges for most employees and major potential causes of stress. It seems disingenuous to give lip service to decreasing stress in the workplace while, at the same time, telling employees that they are on their own in plotting a course to a financially secure retirement.

A recent Society of Actuaries survey in the U.S. showed that more than half (52%) of pre-retirees (employees age 45 or older) and 44% of retirees had never used a financial planner. The reason is simple: most employees do not have sufficient savings to make using a financial planner cost-effective.

Plan of Attack
For those few entities that do decide that DB is the best fit with their culture and can be sustainably affordable, there is an obvious advantage to having a clearer pension vision. Once plan sponsors determine the pension vision, they can develop more specific objectives to achieve that vision. Benefit, investment and funding policies are all more meaningful when they are supported by a strong understanding of the pension plan’s purpose.

For example, with a clear vision, it’s possible to identify the most cost-effective benefit structure for achieving the pension purpose and to establish an investment policy within the parameters of sustainability and the plan sponsor’s risk tolerance, measured in terms of maximum affordable contribution or expense levels. The funding policy can be designed to support a sustainable DB plan, rather than just vowing to pay the minimum contribution levels required by the valuation.

The benefit, funding and investment policies should all be integrated—and it is the pension vision that provides the basis for this integration.

There is an obvious advantage to a clearer pension vision: it will help the organization to design a plan that best meets its needs, and it will provide the support—in terms of administration, communication and education—that is required to help employees make effective use of the plan.

Within the CAP space, there is still a wide range of options running the gamut from greater paternalism to greater empowerment.

At one extreme, there are plan designs with locking in, high levels of employer contribution or matching, differentiation based on age, service or type of employment, investment fund options designed to help manage investment risk, extensive communication and education support programs, and sophisticated planning tools.

At the other, the employer can dispense with a plan altogether, providing employees with increased direct compensation and leaving each individual to personally decide how much to save for retirement. In any case, the pension vision will have a profound effect on the plan sponsor’s relationship with its employees.

The pension vision must be clear, honest and specific. Otherwise, there is a danger of creating nothing more than a compilation of platitudes. “We will… deliver on the pension promise…have a commitment to excellence…invest to earn superior returns…take pride in our work…provide high-quality service….” Such mission statements are vague and often interchangeable from one organization to the next.

However, if plan sponsors can avoid this trap and build a clear, honest and specific vision for how the plan serves the organization, then all of the implementation details should flow from this vision. The result will be a pension plan design and implementation that fits the plan sponsor and serves it well. Spending a little time mapping out the swamp will help to keep the alligators at bay.

Robin Pond is a senior investment and pension consultant.

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