Two Perspectives on Pension Reform: Give Choice a Chance

But what type of action is best? Expand the benefits and contributions for the Canada/Quebec Pension Plan (C/QPP)? Create a national government-run defined contribution (DC) plan?

Both approaches have their supporters, but an examination of the reforms in other countries suggests there may be more effective methods of encouraging Canadians to save more for retirement—methods that preserve choice at both the employer and individual saver levels but also contain strong incentives to increase saving.

The Post-Whitehorse Consensus
The December 2009 meeting of government finance ministers in Whitehorse revealed a consensus among many participants: the system in which we are operating isn’t broken, and most Canadians will likely have enough retirement income to sustain an adequate standard of living in retirement. However, pockets of under-savers do exist. Estimates suggest that one-fifth of Canadians may not have sufficient savings to replace at least 90% of their pre-retirement consumption, with higher degrees of inadequacy especially for middle-income Canadians.

How can we turn our collective energy to improving the system and ensure that more Canadians are better financially prepared for retirement? Any plan to improve the retirement income and savings system should close the pension coverage gap and provide retirement income adequacy for life in an affordable way. The system needs to be sustainable during tough economic times and accessible to all Canadians. These adjustments must be doable on a timely basis, and what better way to make improvements than by sharing the responsibility between individuals and government?

Here’s a closer look at a proposed solution that meets those objectives and includes some of the features that are currently at work in varying forms outside of Canada.

A Nudge in the Right Direction
This solution involves making legislative changes to enable retirement and savings providers to create national multi-employer DC pension plans, which also include provisions for self-employed people to contribute. Under such a national multi-employer arrangement, employers without a suitable retirement savings plan would offer occupational savings options to their employees and still retain control over three key aspects: choosing their own qualified providers, determining their own employer contribution rate and, if desired, opting out of the plan completely.

But why choose to opt out when under a multi-employer arrangement:

• it is the provider that assumes the time-consuming duties of the administrator and carries out all regulatory and legislative requirements;

• the pooling of many employers and employees creates scale and offers a standardized plan design that allows for affordable plan prices and access to pooling of mortality risks; and

• employees can tap into a sophisticated customer service system that already exists, including telephone customer care centres, online financial planning tools and education materials to foster enhanced financial literacy?

To encourage working Canadians to save more, a multi-employer plan would also provide three “automatic solutions” for employees.

Automatic enrollment – Employees would be automatically enrolled into the plan at a pre-set contribution rate and invested in a default investment option. (Employees could opt out but would have to actively choose to do so.)

Automatic re-enrollment for those who opt out – Employees who choose to opt out would be automatically re-enrolled at the end of a three-year period. (Again, employees could opt out but would have to actively choose to do so.)

Automatic contribution increases – Employee contribution levels would be periodically (or at defined events, such as a pay raise) increased by a specified amount up to the plan’s maximum contribution amount.

While each of these solutions would be challenging to implement under our current employment and tax legislation, they are worth pursuing, as they’ve proven to be highly successful strategies for increasing savings in other jurisdictions.

Lessons From Abroad
People are often surprised to learn how widespread the use of automatic solutions is in many parts of the world and how successful they have been in getting more people to save more money for their retirement.

The concepts of auto-enrollment and automatic contribution increases have been enthusiastically embraced in the U.S., as evidenced by recent research on the issue from several U.S. industry leaders. For example, in a 2009 Watson Wyatt survey of 149 companies, 47% said they were auto-enrolling employees into DC plans. Of those that did not offer auto-enrollment, one-third were considering it.

Not only is auto-enrollment proving to be popular, but it’s also been highly effective. In a recently released study, Vanguard reported that plans with auto-enrollment features had an average participation rate of 84% versus only 60% in plans without auto-enrollment. Similar findings have been reported in other U.S. studies, and this trend is expected to continue. A Spectrem Group survey suggests that within two years, auto-enrollment will be in place in more than 80% of U.S. group retirement savings plans with $10 million or more in assets.

The use of automatic contribution increases has also been effective in increasing the savings rate. A study by Richard H. Thaler of The University of Chicago and Shlomo Benartzi of the University of California, Los Angeles found that a high proportion (78%) of those offered an automatic contribution increase arrangement agreed to join the plan. Of those who did, the vast majority (80%) remained in it through four pay raises, with the average savings rate increasing from 3.5% to 13.6% over the course of 40 months.

The use of auto solutions is also growing in the U.K. Hewitt’s annual U.K. DC survey indicates that the percentage of U.K. plans with auto-enrollment increased from 17% to 24% between 2007 and 2008. And, as with the U.S. experience, participation rates were significantly higher for plans with auto-enrollment than for plans without the feature (88% versus 50%).

The Value of Choice
Some have argued that a new agency should deliver a national DC pension plan, either by expanding an existing program such as the CPP or by creating a new government agency to deliver a new supplementary savings plan. However, there are risks to this approach. If the CPP is changed to play a significantly larger role, diversification would decline and risk would increase, as Canadians would be drawing a far greater portion of their retirement income from a single source.

There would also be inefficiencies through duplication. Canada’s financial services sector has already made significant investments in technology, established key investment management relationships to manage funds and built customer care centres and websites to handle millions of requests from retirement savings plan participants each year. Duplicating this effort within a new national agency would be both inefficient and time-consuming.

Finally, we live in a society that values choice. Competition is what drives product and service innovation, as well as continuous improvement among providers. For this reason, the best solution is not a system of mandatory worker contributions, even if the motive is to ensure high participation rates. Auto-enrollment and auto-increase of contributions with an opt-out is the right kind of choice: it is working well in other countries and can be successful in Canada, too.

To create a retirement income environment that permits and encourages all Canadians to save more for retirement through the workplace will take a joint effort by industry, government and individuals. Canada has a long and proud history of building public policies that serve one of the most diverse populations anywhere—while our system isn’t perfect, there’s no denying that it is admired worldwide. By working collaboratively, we can make the necessary adjustments to the retirement income and savings system that will allow and encourage workplace saving for all Canadians.

We’re fortunate to be able to choose from so many options, but we need to get it right. The financial future of generations of Canadian retirees depends on it. BC

Randy Colwell is regional vice-president, Western Canada, with Sun Life Financial Group Retirement Services.
randy.colwell@sunlife.com

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© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the February 2010 edition of BENEFITS CANADA magazine.