Double Vision Part II

Two industry experts weigh in on the DB vs DC debate: advantages and disadvantages, plan sponsor and member perspectives, and the future viability of both plan types.

Why member participation through defined contribution plans may be the way of the future.

No taxation without representation’ is an early example of the importance of individual involvement in the decision-making process. When the Crown levied a severe tax on tea, the colonists dumped it into Boston Harbor as a symbolic protest against their lack of input. If there is one lesson that we can take from history, it is that rights will empower the holders, allowing them to participate in the decision-making process and to assume a measure of control over their own destinies.

The evolution of the pension plan has been a mirror of the rights-granting process to the individual—from ‘contributions without representation’ to ‘contributions with representation’ and, finally, ‘contributions with participation.’

With the introduction of the defined benefit (DB) pension plan in the early part of the 20th century, employees began to realize the benefits of their lifelong labours through schemes that provided ‘participation without representation.’ The theory was that your pension would allow you to retire, a concept that differed from the prevailing work-till-you-expire notion. While plan members had no input into their pension decisions, these plans at least offered a measure of support.

With the rise of labour unions from the 1940s to 1960s, negotiated settlements focused more on pension benefits. This gave rise to the introduction of the workplace pension committee, which gave members a limited amount of involvement in the pension process. The evolution to ‘contributions with representation’ had begun.

But this level of involvement still did not solve the fundamental problems of the DB plan—which, for sponsors, include but are not limited to the asymmetry of surplus ownership, solvency funding issues and myriad pension regulatory authorities. For members, lack of understanding, limited portability and lack of direct involvement with the end benefit remain the key issues that must be overcome.

Emergence of DC Plans

The shift to defined contribution (DC) plans gained momentum in the mid-1990s. By the early 2000s, the shift to ‘contributions with participation’ was well under way. In terms of sponsor flexibility, the DC plan offers a number of options, including registered pension plans, group registered retirement savings plans (RRSPs) and deferred profit sharing plans (DPSPs). Combined with a stock ownership program, it can provide added incentives and motivation beyond the typical retirement benefits.

This shift was the result of many financial and demographic factors, the net result being an increased level of control, flexibility and empowerment for members, who are now better able to manage their financial destinies based on their particular life plans.

Managing Risk

The employer’s capability to manage risk, operate its business efficiently and provide benefits to employees in a cost-efficient manner has always meant the difference between success and failure. With the average lifespan of a Fortune 500 company being 40 to 50 years, does it make sense for organizations to lock into pension obligations that can span well beyond this period? <pagebreak/>

DC plans offer sponsors the ability to provide employees with a portion of their retirement income while simultaneously motivating them to achieve corporate goals and to assume a measure of responsibility for their financial well-being. A DPSP, for example, is a DC arrangement that allows the company to make contributions based on a formula tied to profitability. Combined with a group RRSP, a DPSP allows for the creation of a comprehensive retirement arrangement with equitable cost-sharing, mitigates risk for employers and acts as a motivator for plan members.

By establishing a clearly defined purpose for the plan (as outlined in Section 2.1.1 of the CAP Guidelines) and communicating this to all stakeholders, plan sponsors have fulfilled one of the difficult aspects of plan governance that falls on their shoulders. Plan members need to understand the purpose of the plan, and use the tools and services provided so that they can take responsibility for their future.

Member understanding of investment risk has certainly been tested in the last several months. With the S&P/TSX Composite Index down over 30% in the last 12 months, many members—and sponsors, too—must be wondering how they will be able to retire.

But again, the DC plan offers choices that can help to mitigate the effect of the recent downward market movements. Members can choose to defer their retirement income by transferring to an RRSP and taking income only at age 69. Many will be able to bridge the gap with a combination of government benefits and non-registered savings. In cases where retirees need access to the retirement income right away, the group registered retirement income fund or life income fund offers a solution. By continuing to invest in the markets, members have the potential to recapture some of their losses while at the same time drawing a portion of their income.

Control and Flexibility

When looking at the retirement equation, we must understand the plan member’s perspective. In today’s workplace, employees expect to change jobs at least four or five times, making portability of retirement benefits an important issue. The DC plan allows members to extract the full value of the plan when they transition to other careers. And, in the case of a group RRSP, the plan can help fund the purchase of a home or continuing education.

While these may not be traditional uses of retirement plans, it can easily be argued that we no longer live in traditional times. Today’s employees, especially those at the younger end of the demographic curve, are looking for flexibility and options. They are also looking for control over their own destinies— they want to feel empowered to make decisions and control their fate. The DC plan responds exceptionally well to these needs.

Of course, plan sponsors and members alike have concerns about their responsibilities under DC arrangements. After all, members have to ensure that their contribution level is sufficient, that their investment selection is in line with their investor profile and that they understand the nature of investment risk and return.

Communication to members within a DC plan is one of the major keys to success. Having a comprehensive program in place that engages members at every life stage and addresses their financial realities will help lessen the member’s exposure to downside risk. Communication comes in many forms and should not be limited to seminars, enrollment guides and bulletin board messages.

Plan sponsors and members are better served with retirement funding vehicles that allow for the empowerment of both parties and positive financial outcomes. With DC plans, sponsors have control over costs and can easily create a governance structure that satisfies their fiduciary concerns. For members, the DC environment provides flexibility in allowing them to meet their particular financial realities while at the same time giving them the representation they deserve to take control of their retirement destinies.

DC plans provide for “contributions with participation” and allow for the future security of workplace retirement plans with flexibility and good governance.

Claude Leblanc is senior vice-president, group savings and retirement, with The Standard Life Assurance Company of Canada.

claude.leblanc@standardlife.ca

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