Making way for pension reform

In light of the 2008 crisis and the current volatility, are you now more focused on risk management? What actions have you taken as a result?

Ian Markham: The 2001/02 ‘perfect storm’ already brought a significant new focus on risk management, but there was still a tendency to think it was a one-off event. The 2008 crisis changed that thinking, and with the market events of the past few months, I doubt there is any plan sponsor, DB or DC, that is not focused on risk management now. Actions these days include: one, moving the DB investment strategy closer into line with the longer-term bond-like nature of liabilities and planning for even more of that movement as, and when, funded ratios improve; two, reviewing plan design to reduce DB reliance for new hires in the private sector; and three, being increasingly careful with DC communication strategy.

Terri Troy: We have always had a risk focus, but it is fair to say that with increased volatility over the last two to three years, we are managing the portfolio more tactically. In order to do this better, we are striving to use separate accounts where possible so that we have timely snapshots of our positions. With pooled funds, you don’t know the movements of the underlying positions on a day-to-day basis. We also strive to communicate our intentions about potential redemptions with investment managers in advance so that we can co-ordinate what we collectively believe to be opportunistic redemptions where possible.

Larry Ketchabaw: On Jan. 1, 2010, our DB pension plan was frozen to new members. Until that time, we had a very aggressive 75% equity, 25% bond investment strategy that was fully supported by our demographics and asset liability studies. Since then, we have moved to 60% equity, 40% bonds, with our bond portfolio all passive long bonds rather than an actively managed typical Canadian bond portfolio. We have amended our Statement of Investment Policies & Procedures to allow us to move even more into long bonds if we choose to do so. We replaced the DB plan with a DC plan to alleviate some of the risk with DB and provide some protection to our balance sheet.

Perry Teperson: Within our bond portfolio, we have been increasing the quality and liquidity of our corporate bond holdings. During the credit crunch a few years ago, corporate bonds became quite illiquid, and it was difficult to sell bonds and buy equities at the bottom of the market. In case we have another crisis, we want to be prepared by holding the best quality and most liquid bonds. Risk management is steering us toward these, even at the cost of a lower yield. We are also seeing some clients implement a de-risking strategy with predetermined triggers if yields rise to purchase more long bonds and sell equities. This is especially applicable to mature DB plans.

What has to change from a regulatory/legislative perspective to make DB plans a viable and sustainable option for more employers?

LK: As plan members, we want DC plans to be more like DB plans, and as plan sponsors, we want DB plans to be more like DC plans. It is all about volatility and risk. DB plans have to be made less risky for employers to continue to offer them. To do that, the risk of a DB plan must be shared by the plan sponsor and plan members. The old notion of the guaranteed benefit must die and be replaced by something more flexible that guarantees plan sponsors how much they will contribute on an annual basis, not the benefit.

EF: As the shift from DB to DC continues, so does the transfer of risk from employers to employees. As the market evolves, we anticipate that new partnerships will help share the risk, which could make DB plans more viable. This is linked to the needs of the participant and how they’re being addressed. The participant’s primary need is to secure a retirement income, so our solutions should continue to evolve to meet this need while finding the right distribution of risk among employers, participants and providers.

TT: I believe that DB pension plans are sustainable in the long run. However, they need to exist in a flexible environment to weather short-term challenges. One model worth considering is the jointly sponsored pension plan (JSPP), where there is joint governance between the employer(s) and plan members, and contributions, deficits and surpluses are shared equally. JSPPs can be single-employer pension plans or multi-employer pension plans. With a JSPP model, the need to fund solvency deficits shouldn’t be required because risk is shared equally and decision-making is made jointly between the employer(s) and plan members.

PT: A pension system that incorporates a target benefit plan, much like the multi-employer negotiated cost plans that we have in Canada, would make sense. A necessary starting point is an acknowledgement that the cost of funding $100 of pension income has gone up due to lower interest rates and longer life expectancy. No plan design or funding change solves this cost increase. Viable solutions will require reasonable and realistic expectations from all stakeholders.

IM: DB sustainability depends on the plan sponsor’s ability to absorb future cost volatility. The better the sponsor is able to absorb volatility, the less severe the actions it needs to undertake to keep the plan sustainable. Examples of sponsors that are in a better position include those whose DB plan’s liabilities are not material when measured against the corporate liabilities; those where the plan membership is not particularly mature from a demographic perspective; those where the plan costs are shared between the employer and members; or those where the mismatch impact is already being contained using a successful LDI [liability driven investing] strategy. To enhance sustainability, regulators must facilitate shared-risk plan designs and also be seen to create a fair balance between the needs of plan members and the needs of the sponsoring organization.

Is the PRPP the right direction for pension reform in Canada? What impact might it have on employers and the industry at large?

EF: Research has revealed that too many Canadians are not saving enough for their retirement. The proposed PRPP has potential to improve this situation. However, establishing a retirement plan is just the beginning. Education and communication will play a vital role in employee engagement. Our challenge as plan providers is to make sure that employees understand the long-term value of a PRPP as a retirement savings solution.

LK: From a plan member’s perspective, offering a PRPP is a great way for many who do not have access to an inexpensive DC plan to save for retirement. But, unfortunately, any time you make something optional, there will be a significant number of those who really need to benefit from an increase in retirement savings not [taking] advantage of it. Until we made our pension plan mandatory, we always had employees turn it down. That is why an increase to the CPP [Canada Pension Plan] would be a better way of handling it from a plan member’s perspective.

As an employer, I don’t want to see my contributions to the CPP increasing any time soon, so I’m quite happy to see the PRPP. The challenges for the administrator will be the same as for us as a plan sponsor: how to educate plan members to understand enough about investing to be able to make informed investment decisions. Some of that responsibility could possibly be mitigated by offering only target date funds. I wonder if we’ll see some employers that currently offer a DC plan closing it to new members or cancelling it altogether and offering a PRPP to get out of the ‘pension business.’

IM: At this stage, I prefer a voluntary approach to increasing pension coverage, so that we do not force the wrong retirement savings arrangements on individuals and to avoid imposing a heavier tax burden on employers that currently have no pension plan. And it may make a very small dent in the ever-diminishing private sector coverage. [However,] there are still many unknowns.

What regime will be used for PRPPs (will it be based more on a DC RPP system or an RRSP system)? What conditions and design details will the provinces decide upon now that [the government] has set out its broad criteria? What does ‘low cost’ mean: lower than current costs of similar investment vehicles in an RRSP? What investment choices will PRPP administrators offer to savers under the ‘low-cost’ umbrella? Why would savers choose this locked-in-for-life savings vehicle over an unlocked RRSP? How will governments and PRPP administrators help Canadians decide between a PRPP, an RRSP, a tax-free savings account, paying down a mortgage or contributing more to their employer pension plan (if allowed)?

It’s possible that some DC plan sponsors may switch to a PRPP to reduce their fiduciary burden or if it turns out that the PRPP regime ends up with some attractive features that Canadians enjoy over a DC RPP. It is possible, too, that DB plan sponsors may use the hype surrounding PRPPs to convert new hires or existing plan members into a PRPP. Those actions will not increase the number of covered Canadians and could actually diminish the amount of employer contributions made in total.

PT: Whether this is the right direction, as opposed to strengthening the CPP, is an interesting question. It boils down, in part, to a debate on DB versus DC. Employers in this economic environment are likely relieved that payroll taxes are not going up due to higher CPP premiums.

If you had a magic wand, what other pension reform initiatives would you implement?

LK: As I mentioned earlier, we want DB plans to be more DC-like from a shared plan sponsor/plan member responsibility perspective, and we also want DC plans to be more DB-like, with less responsibility on the plan member to have the knowledge and interest to invest properly. If this is truly where plan sponsors and members want to be, then why don’t the regulators allow us to get there? Change the rules to allow benefit levels to change as funding allows in DB plans. Keep DC plans very simple with target date-only investment options, if that makes sense for the plan member group.

TT: Eliminate the rule that effectively limits the tax deductibility of contributions into a plan when a certain level of surplus has been reached. The current rule limits the prudent and necessary buildup of surplus that will be needed in the future when funded status starts to deteriorate.

Fix the asymmetric surplus-sharing rules. Allow true risk-sharing of surpluses and deficits among employers and plan members, according to their contribution formula. If employers contribute to a plan and cannot benefit from future surpluses, how can they be expected to put more than the minimum required into a plan?

Create similar pension legislation across Canada. Either have provincial regulators that will monitor one set of rules or create a new joint federal/provincial regulatory body to oversee pension plans consistently. Pension regulators could leverage the Office of
the Superintendent of Financial Institutions’ expertise in monitoring the risks of financial institutions.

EF: Addressing financial literacy is the way for sustainable prosperity. Canadians need to be introduced to the fundamentals at a young age—why not make retirement planning a mandatory subject in our education system, for instance? Culture shift takes time and patience, but it’s well worth the effort to create a society in which saving for retirement comes naturally.

PT: I would have consistent funding treatment for multi-employer plans across Canada—specifically, the rules around solvency valuations. Some provinces have already moved to eliminate [solvency funding], since benefits can be reduced in these plans in the event of funding difficulty, [but] not all provinces have gone in the same direction yet.

IM: Allow letters of credit immediately for solvency funding. Permit plans to establish a pension security trust for future contributions. Seek other ways to facilitate private sector employers to fund more than the minimum. Set up a regime for single-employer target benefit plans with a sensible means of dealing with benefits already accrued to date.

Tammy Burns is associate editor of BenefitsCanada.com, and Alyssa Hodder is editor of Benefits Canada. tammy.burns@rci.rogers.com; alyssa.hodder@rci.rogers.com

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