*** ***
Guide to good governance
Glorianne Stromberg speaks out on education, investment options and financial advice. Here's an
excerpt from her presentation on good governance.
When I talk with people about DC pension plans, there is a lot of unease about the suitability
of relying on current plans to provide employees with an assured, employment-based stream of
retirement income. There is concern about whether employees are being required or encouraged to
accept an inherently unmanageable, and therefore inappropriate, investment risk.
These issues and concerns highlight the fact that Canadians have never really come to grips
with the role of the workplace in providing retirement income.
The DC Plan Summit focuses on developing best practices to address the surface aspects relating
to the issues of responsibility, accountability, liability and the provision of safe harbours
for employers. But it stops short--as did the Association of Canadian Pension
Management/Pension Investment Association of Canada Joint Task Force Recommended Model--of
considering the appropriateness of requiring or encouraging employees to rely solely on DC
plans to provide an assured employment-based stream of retirement income.
It is essential to establish a clear understanding and agreement between the employer and the
employee as to what the employment promise is, including any express or implicit pension
promise. Governance procedures and their sufficiency flow from this core relationship.
I was surprised that the description of the employer's role and expectations in the Joint Task
Force Report to the Joint Forum Working Committee on Investment Disclosure in Defined
Contribution Plans did not seem to recognize the degree to which DC plans are an integral part
of employment compensation. Nor did the report address the sufficiency of the plans as
currently structured to form a core component of the Canadian retirement system.
Essential areas in your DC plan to examine are:
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Design. Does your plan design fulfil the express and any implicit pension promise that
flows from the employment covenant?
-
End-date bias. DC plan designs leave employees vulnerable to end-date bias. They do not
provide employees with the benefit of risk sharing. If the market happens to be up when
their plan matures, they are laughing. If it happens to be down, they are not.
-
Plan demographics. Are there liquidity and/or funding issues? What impact will the need to
make payments out of the plan have on remaining members?
-
Complexity. How many people really understand your plan? Does your board of directors? Do
your employees?
-
Investment choices. There seems to be an assumption that DC plan sponsors must offer
investment choices--and the more, the better. Perhaps employees would be better served if
they simply were able to participate in a prudently managed pension fund and the plan
sponsor focused its education and communication efforts on helping employees understand how
to build on this component of their retirement income.
GOVERNANCE TIPS
The impact of inadequate governance mechanisms is devastating. This is one reason why it is
important to beware of complacency. Don't think you are immune from the fallout just because
the problems may originate with suppliers.
Here are a series of observations that may be helpful in your ongoing thinking about governance
and risk management procedures:
1. Encourage individuals to adopt governance into their behaviour and decision-making.
2. Help members set goals.
3. Provide life-skills education. Most people would benefit from this before embarking on the
financial planning exercise.
4. Help employees gain a better understanding of the economic and financial issues that will
help them make better decisions.
5. Teach employees to apply what they have learned.
6. Value the employee's relationship with a financial planner.
7.Help employees select a financial planner. Making them aware of what factors they should
consider, what questions they should ask and how to assess the answers.
8. Clearly explain what the different types of insurance are, what and when such insurance is
suitable, and what to look for in choosing insurance coverage.
9. Stress the importance of a financial plan.
10. Explain benefits. This includes explaining what the options are--both during the
accumulation stages and when employment terminates for whatever reason.
11. Report to employees. Clear, accurate and timely reporting on the goals and performance of
any DC pension plan is essential.
12. Ensure privacy. It's unrealistic to expect the employee to disclose non-employment related
information.
13. Augment employee skills. Account consolidation technology seems to be the next new thing,
and it would be a useful tool for employees to be able to access.
14. Choose education material carefully. Look out for packages designed to support product
sales. Recognize them for what they are.
15. Watch costs. In offering investment choices or selecting managers, keep a close eye on
costs. They do matter.
16. Know your money manager.
Glorianne Stromberg is the author of two key industry reports: Regulatory Strategies for the
Mid-90s and Investment Funds in Canada and Consumer Protection
*** ***
Money management under the microscope
Canadian securities regulators are renewing their emphasis on corporate governance among money
managers. Today, it's more important than ever to select and monitor managers carefully.
Prudent money manager selection and review are two of the most important fiduciary duties of
running a pension plan. And it's too easy for DC plan sponsors to become complacent about the
latter, particularly in a bull market. This issue has become more important of late, with cases
such as RT Capital and Yorkton Securities--in which the Ontarion Securities Commission (OSC)
took a high profile role--making headlines.
Paul Malizia, assistant vice-president, investment management services with Manulife Financial
in Waterloo, Ont., provides employers with some valuable tips on carrying out the tasks of
selecting and reviewing money managers.
He says manager selection must be based on a comprehensive qualitative and quantitative
analysis of firms. One important question to ask current and prospective managers is: Does [the
firm] have a code of ethics for employees? "You would be surprised at how many [companies]
don't [ask this]," says Malizia.
Other important selection factors (which can also apply to monitoring managers down the road)
include:
-
Turnover rate of staff, as this can be disruptive.
-
The quality of investment professionals in the firm.
-
A clearly defined investment process.
-
An analysis which demonstrates there has been no style drift over time.
"To benchmark success there is generally no need to go back further than five years," says
Malizia, "as the people who created the success are no longer there or were in lower
decision-making positions at the time." To measure risk and volatility, he recommends using
semi-standard deviation as it doesn't view all risk as bad.
MONITOR YOUR MANAGER
Monitoring your money manager is a three-pronged process based on qualitative reviews,
quantitative reviews and ensuring compliance with investment policies and procedures. Malizia
encourages plan sponsors to go on-site at least once a year. He adds that it is important to
consider how the firm communicates information such as breaking news or changes in staff, and
how timely this information reaches the plan sponsor.
In the quantitative review, plan sponsors should conduct a risk/return analysis, a style
analysis to ensure there isn't any drift as well as an attribution analysis, which provides
employers with "a better idea of where value is coming from," says Malizia.
Malizia adds that it is valuable to use investment tools such as analytic software and
databases to assess performance. He says that manager monitoring is an ongoing process and plan
sponsors should conduct a comprehensive review of their managers at least once a year.
"Fulfilment of fiduciary responsibility entails the implementation and maintenance of these
steps," says Malizia. "Does this ensure that problems will never occur? No."
THE NEW OSC
Scandals in the money management industry over the past year have demonstrated that problems do
indeed occur. This is where securities regulators come into the picture.
Murray Gold, a partner with Koskie Minsky in Toronto, questions whether money managers are
being held to a new standard in light of RT Capital and Yorkton Securities and the high profile
role played by the OSC in these cases.
Gold says these cases have demonstrated that the OSC "won't be absent but will be [present] in
a more formal way" than it has been in the past. "It has taken on a more high-profile
enforcement [role]," he adds.
Gold says the OSC has had to deal with some "very big issues" since it became a self-funding
entity a few years ago. He believes the commission has made "some progress" in setting new
standards for money mangers.
"[The] Yorkton and RT Capital [cases illustrate] a renewed emphasis on fiduciary and governance
obligations," he says. "That has changed the governance debate and its parameters, extending
them down to suppliers and money managers."
He adds that "self-regulation in the investment industry has failed--that is the premise upon
which these changes are being made."
Gold also raises the issue of discrepancies between legal recourses that U.S. investors can
take when regulations are breached. Notably, American shareholders can sue if continuous
disclosure is broken, and they use this option as a means to enforce continuous disclosure.
Canadian investors, however, cannot sue over continuous disclosure.
"Institutional investors will conclude that they are better protected in the U.S.," says Gold,
while also pointing to the failed attempt of Bre-X shareholders to launch a class action suit
in Canada.
"Our securities and class action laws have frustrated investors. We have little choice but to
keep up with our southern neighbours," he adds.
The backdrop for the apparent new crackdown by Canadian securities regulators is a fiercely
competitive investment landscape that features the rapid development and introduction of new
technologies, consolidation and heightened competition for liquidity among all stock exchanges.
Paul Malizia, assistant vice-president, investment management services, Manulife Financial
Murray Gold, partner, Koskie Minsky
Q. When a money manager's style is out of favour, how long should a plan sponsor wait before
making a change?
A. "A lot of it comes down to faith in the manager. As long as you still have faith, there is
no reason to change. Is the manager coming in [to see you] and explaining what they are doing?
Are they exuding confidence? Some managers sound as if they have lost faith in themselves--and
you can definitely tell. If nothing significant has changed at the [money management] firm,
there's no reason to change. But if you do let them go, don't look back."
--Paul Malizia, Manulife Financial
*** ***
Back to school
St. Thomas University is tackling governance issues head on by sending its pension committee to
fiduciary school.
Sponsors of DC plans are well aware of the need to educate plan members on their investment
choices and other financial matters. But educating pension committees on their fiduciary
responsibilities should also be a key component of any governance program.
St. Thomas University in Fredericton, N.B., recently decided to start educating members of its
pension committee by sending them to a fiduciary school of sorts. The university has had a DC
plan for its 150 faculty and administrative staff since 1967. The plan is governed, in part, by
a small pension committee made up of three unionized faculty and two representatives from the
non-unionized administrative workforce.
Historically, the university has reacted to the whims of a small group of people on the
committee. But there has never been a formalized process for adding or removing investment
funds, says Colleen Comeau, director of human resources at St. Thomas University.
"The biggest challenge we've had is when you have a very small, but vocal, minority of people
who control the agenda. When you have people on a committee who don't know a lot about
pensions, they tend to follow what the others are proposing, whether or not it's in the best
interest of the members," she says.
Comeau describes the majority of plan members as passive investors. "Over 80% of them
are in our default fund and have never made a change in their investment selection and probably
never will make a change." The pension committee members--particularly the faculty
representatives--tend to be active investors.
"When we've added funds, it's typically because this small group wants to maximize their
foreign content or do something that's going to benefit them," says Comeau. "And they're not
considering that the majority of members might not be interested in this fund and that we
haven't done any education around this fund."
For example, she says, one committee member decided recently that the plan should offer an
ethical investment fund, even though plan members have not expressed any interest in such
funds. "[But the attitude of the committee is] there are ethical funds out there, so we should
have one because we're a university and there may be some academics who might want an ethical
fund," says Comeau. "To me, that's not good governance. It's not a good way to make decisions
about our plan."
FIDUCIARY SCHOOL
To address these issues, Comeau and the pension committee have agreed to go back to school.
"We've agreed to start a course where we're going to start putting some thought into getting
some policies and procedures in place for recommending investment funds or changes to our
platform," says Comeau. "We've never done that in the past."
In terms of formal documentation, the committee has terms of reference but no governance
document. "The same issues come up year after year and they either just get put off or
decisions just get made because the committee thinks we need to do something," says Comeau.
"There's been no method to the madness."
By formalizing its governance procedures, Comeau hopes the pension committee will start to
recognize its responsibility to the rest of the members in the plan. "Slowly but surely, people
[on the committee] are realizing we need to be able to justify why we're [making certain
decisions]," she says. "We don't have an orientation in place. Our committee has not had
training in fiduciary responsibility and things like that [so] that's another aspect we're
going to build into our governance plan."
The role of pension committees varies from province to province. In some provinces, pension
committees are mandated by statutes and have decision-making powers. In other provinces,
pension committees are strictly voluntary. Calgary-based Petro-Canada, for instance, has an
11-member employee pension advisory committee for its DC plan. The committee is voluntary and
acts as a recommending and reviewing body only.
"[The employee committee] has terms of reference but no decision-making power," says Elaine
Noel-Bentley, senior director, total compensation with Petro-Canada. "But we consider them
representative of the DC community so what they say is important. I certainly appreciate the
insights we get from them because I think we can get pretty remote from the employee population
if we don't have a vehicle to hear from them."
*** ***
Making the grade
Education efforts are well received among DC plan members, a new survey reports. But there are
concerns about teaching the basics to employees who need help the most.
DC plan sponsors' education efforts are scoring well among the majority of plan members,
according to a recent survey of members conducted by Toronto-based Morneau Sobeco. Members say
they understand how to invest to help achieve their retirement goals, with half reporting that
they know which options in their plan are the best investment vehicles to help them achieve
their retirement goals.
While the feedback on education is generally positive, plan members' knowledge level is "not as
high as we would have hoped for," says Peter Gorham, a partner with Morneau Sobeco in Toronto.
Gorham says after discussing the issue with plan sponsors at the DC Summit, he believes that
the industry is "missing the employees who need very basic information." He adds: "There is an
audience--the bottom layer in terms of knowledge level--that understands far less than we think
they do."
Jean Paradis, director of compensation and benefits with Provigo, a division of the Loblaw
Companies in Quebec, confirms this perception. He notes that the results of the Morneau survey
would be quite different at his company, where general education levels are lower and only 10%
to 15% of the workforce earns more than $60,000 annually.
He adds that members' lack of investment education and confidence is evident in the high
percentage of employees who have the bulk of their DC plan assets in guaranteed investment
funds. "We realize how much we have to communicate, given that so many of our members are in
guaranteed investments," says Paradis.
Howard Slaney, director of employee benefits at J.D. Irving Limited in New Brunswick, says
that, like Provigo, his organization is concerned that plan members are too conservative. Once
again, employees are relying on guaranteed investment funds to build their pension plan. Slaney
says the company clearly needs to do more investment planning with its members.
In response to these concerns, Gorham encourages DC plan sponsors to work with members to
establish investment goals that enable individuals to see if they are on track. Slaney agrees
with this approach, adding "the average member needs to know 'how much do I have in the bank
right now?' "
EFFECTIVE EDUCATION
Gorham emphasizes that plan sponsors should have a thorough understanding of members' needs in
order to design effective programs. "Find out what employees are interested in," he says.
Gorham adds that organizations must "create interest in advance and focus the [education
seminars] so that they do address different levels of knowledge."
In the study, plan members identify personalized statements and one-on-one meetings with an
expert as the most preferred ways to learn about their organization's plan. Internet services
and seminars at work were also rated favourably. However, toll-free lines giving members access
to experts and booklets and memos distributed by the plan sponsor were not as popular.
Overall, Gorham points out that plan members are looking for credible and objective sources of
information on their plan and investment options. Interestingly, plan members rank their
employer below newspapers, magazines and a financial adviser in terms of a source of good
investment information. A solid majority (81%) prefer to have a paid industry expert as a
retirement planning speaker compared to 21% who cite "someone from management."
Colleen Comeau, director of human resources at the University of St. Thomas in Fredericton,
N.B., says that her organization realized members weren't coming out to education seminars
because they were uncomfortable with their level of investment knowledge. The organization
re-designed its seminars to target different levels of investors and opened these sessions up
to spouses--two changes that are proving to be more successful.
Peter Gorham, partner, Morneau Sobeco
SURVEY HIGHLIGHTS
Morneau Sobeco surveyed more than 1,000 DC plan members from nine organizations last year to
get their feedback on investments, retirement savings and their employers' education and
communications efforts. The survey also assesses members' investment knowledge. More than
one-third (37%) of participants were ages 35 to 44 and 24% were ages 45 to 54. Respondents also
tended to be well educated with 36% holding a university degree.
Here are a few highlights from the survey:
-
70% of participants under age 35 do not believe that government pension programs will be
available when they retire, compared to only 47% in the 45- to-54 age group.
-
In addition to the contributions made to their organization's plan, 30% of plan members
surveyed say they save more than 6% of their total earnings for retirement, while 18% say
only 1% to 2% and 19% say almost nothing.
-
88% of members surveyed have Internet access at home and 74% of respondents with
paper-based as opposed to electronic-based plans say they feel comfortable using the
Internet.
*** ***
A view to advice
Most plan sponsors aren't diving into the uncertain world of financial advice. But this benefit
could be the wave of the future.
When Calgary-based PanCanadian Petroleum Limited rolled out its DC plan in 1996, it took the
unusual step of offering individual financial counseling to plan members who re-quested it. The
oil company selected fee-for-service provider T. E. Financial Limited to conduct educational
sessions, as well as provide financial advice. "There wasn't controversy in those days [over
advice]," says Doreen Mattson, co-ordinator, HR shared services, with PanCanadian.
Today, in addition to regular educational seminars, the company pays for up to two hours a year
of tele-counseling with a registered financial planner from T. E. Financial for each of its
1,700 active plan members in Alberta, Saskatchewan and Nova Scotia. "Employees love this
benefit," says Mattson.
The road to financial advice is fraught with anxiety for plan sponsors, who worry about
potential conflicts of interest and liability associated with providing access to a financial
advice provider. But for PanCanadian, the benefits of financial advice far outweigh the risk of
liability down the road, says Mattson.
While PanCanadian takes its financial education program to a new level by offering access to
financial advice, it's not a step many plan sponsors seem ready to make just yet. "I think the
majority [of employers] are still at the head-scratching stage, rather than the execution
stage," says Gordon Powers, president of The Affinity Group, an Ottawa-based financial
consulting firm.
When selecting an advice provider, Powers recommends plan sponsors look for an organization
that's independent, has a national focus and is technologically savvy. Mattson says
independence was one of the key criteria for PanCanadian. "When we selected a financial
planning firm, we said it had to be an independent organization, they had to be giving
objective information and it had to be fee-for-service. They could not sell product," she says.
"Those were, and still are, our criteria."
Another concern for plan sponsors, notes Powers, is the fear of lawsuits. "What if, despite
[the plan sponsor's] best efforts, John Smith retires with a pension that is woefully
inadequate and at age 55 comes back and says 'I can't even buy a snowmobile, let alone retire,'
" says Powers. "You can delegate some of the work and responsibility but ultimately, you cannot
discharge yourself from the process, as much as you might like to."
Liability and fear of lawsuits have prevented Ball Packaging--which has a DC plan for its 180
salaried employees--from dipping its toes in the advice waters. "It is a possibility we might
look at at some point in the future but we're well aware of the risks involved in that so we're
treading very gingerly," says Wilma Millar, manager, pension administration, with the can
manufacturer in Hamilton, Ont.
Millar says she has had plan members ask for her advice on which investments they should
choose. And while she doesn't give them advice, she does tell them what other plan members in
their age bracket have done. "And I recommend they get their own financial planner," she adds.
Many plan sponsors express a desire for regulators to step in and give them a definitive
position on financial advice. According to a poll conducted at the second annual DC Plan
Summit, 100% of plan sponsors who attended the conference feel regulators should be giving the
DC industry a definitive position on advice. When asked if they support providing advice to
plan members as long as any potential conflicts of interest--commissions, for example--are
disclosed, 39% said yes (see "Advice dilemma," below).
At the best of times many plan sponsors worry about lawsuits--whether or not they opt to
provide financial advice. "We give people an investor profile to determine where they should be
investing, there's a retirement planner that kicks out this magic number at the end that says
'if you want to retire at this age, you will need this amount of money' but we really don't
know if that's going to work 20 years down the road," says Millar. "That risk is always going
to be there. And I think anyone who says they are not concerned about that is dreaming a
little bit."
Gordon Powers, president, The Affinity Group
*** ***
A new approach to DC plan design
There's nothing standard about Standard Life's DC plan.
Montreal-based insurance company Standard Life decided to revamp its pension plan three years
ago to meet the needs of an increasingly diversified workforce. The company has 1,500 plan
members across Canada. Many are long-term, dedicated employees who are satisfied with their
traditional defined benefit (DB) plan. But employee surveys indicated that younger workers were
not satisfied with the traditional DB option.
To address the dilemma, the company mandated a task force to review the existing DB plan and
come up with a solution that would satisfy all of the various demographic levels of plan
members.
In March 1998, Standard Life rolled out what it calls a "dynamic DB/DC plan." The DB component
of the plan remained the same and the company added a new defined contribution (DC) option (see
"Plan dynamics," below). What makes the plan dynamic, says Alain Brunet, senior vice-president,
marketing, with Standard Life, is that plan members can switch back and forth between the DB
and DC options once a year. Plan members were first educated about the difference between the
two options, then more traditional investment education sessions were held for those employees
who chose to go the DC route.
Inspiration for the new plan came from the company's flexible benefits plan. "That concept
[choice] has existed in group life and health for as long as flex benefits have been around,"
says Brunet.
To illustrate how the plan works, let's say John Smith, 30, joined the DC option in 1998. John
earns $40,000 a year. With an employer contribution rate of 5%, John receives $2,000 to put
into the DC plan. He now has a DC account in his name. The following year, John decides to stay
in the DC plan. Again, he gets $2,000 to invest in the DC option (assuming John doesn't get a
raise and the employer's contribution rate remains the same). At the end of 1999, John wants to
go into the DB plan for the following year. Since it is a final average earnings plan, John
accrues one year of pensionable earnings, which will be used to calculate his pension upon
retirement. His DC account, meanwhile, remains invested in the funds he chose and he can choose
to go back to DC at year-end or remain in the DB plan and accrue a second year of pensionable
earnings.
So far, less than 5% of plan members who chose the DC option have switched back to the DB plan,
says Brunet. "It's a fairly new plan, it's only been around for three years and retirement
planning is not a three-year process," he says. "We have yet to see the impact of people aging
and how people will look at it at different times during different economic cyles." Today, 52%
of plan members are in the DB plan, while 48% are in the DC option.
Alain Brunet, senior vice-president, marketing, Standard Life
Plan dynamics
For the DB portion of Standard Life's plan, the company incurs the full cost of the plan. In
addition:
-
The plan is available to all members at all times.
-
The pension at retirement is based on a final salary formula, integrated with the
Canada/Quebec Pension Plans.
-
The normal retirement age is 65.
-
Early retirement is available from age 55.
-
The plan provides a bridge pension until age 65, should the plan member choose early
retirement.
The new DC component, meanwhile, offers the following perks:
-
The plan sponsor incurs the full cost of the plan.
-
The DC option is voluntary.
-
Contributions are deposited in the plan member's account.
-
Members select their own investment mix from 18 investment options.
-
At retirement, plan members purchase an annuity or life income fund or transfer the funds
to a locked-in retirement account.
-
In December of each year, plan members can switch from DB to DC, or vice versa, for the
following year.
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