Whether operating in Canada or the United States, defined contribution plan sponsors are facing the same challenges around demographics, plan design and their employees’ retirement readiness.
On the demographics front, more baby boomers are retiring and taking their pension balances with them. As DC plans lose members, plan sponsors may see a rise in costs since plans with more scale are more likely to have fee negotiating power, says James Veneruso, senior vice-president and DC consultant at U.S.-based Callan. To avoid this cost creep, many employers want retirees to keep their assets in the plan.
But if DC members are allowed to stay put through retirement, then focusing on decumulation and ensuring options are available becomes that much more important. With the U.S. slightly further along on this journey than Canada, what are the current trends on both sides of the border?
Historically, some U.S. plans let employees take a lump sum from their pension savings at retirement.
But plans are looking to move away from an all-or-nothing approach, says Veneruso. Some examples, he notes, include paying members through installments and periodic distribution. The industry has also seen ongoing product development in payout funds, which don’t have a guarantee but do have a recommended rate of withdrawal.
However, only 50 per cent of plan sponsors surveyed by Callan in its 2019 DC trends report said they offer some type of retirement income solution for their members. And in Canada, according to Benefits Canada’s 2017 CAP Member Survey, 69 per cent of plan sponsors said they feel employees are on their own once they retire or leave the organization.
One potential reason for these findings is the U.S.’s safe harbour legislation, which provides plan sponsors that offer active and retired members appropriate choices and advice some protection from liability for losses arising from those offerings. In Canada. similar legislation doesn’t exist.
“From the perspective of a plan sponsor, if they were to allow these variable benefits to be paid out of the pension plan, they’re wrestling with the issue of ‘Are we exposing ourselves to more fiduciary liability in respect of members who are no longer active employees?’ and ‘Do we want to take that extra liability on?’” says Bita Jenab, principal at RetirementWorks Services Inc.
In February 2019, the Canadian Association of Pension Supervisory Authorities revised guideline No. 8, which provides some direction on the payout phase. While historically, most Canadian plan sponsors haven’t wanted to keep members in their plans post-retirement, this has been changing, says Zaheed Jiwani, principal at Eckler Ltd., though he notes this is mainly the case for larger plans.
Goodyear Canada Inc. cites two reasons why its DC plan allows members to remain post-retirement, according to Thak Bhola, the company’s manager of pension, investments and administration. First, since the plan is relatively new and most employees are still in the defined benefit plan, it wants to ensure equality across its population. “We closed our largest DB plan in 2015, and we certainly don’t want to have two classes of associates,” he says.
The second reason is that everyone benefits from a fee perspective because providers charge based on the amount of money in the plan, adds Bhola.
Longevity risk insurance — often called qualified life annuity contracts — is another option that’s building south of the border, though it isn’t prevalent, notes Kevin Vandolder, DC client practice leader and partner in investment consulting at Aon Hewitt in the U.S. “That’s something we continue to see many clients talking about and encouraging their service providers to improve their offerings with.”
Longevity risk insurance is a contract between the individual and the insurer at the point of retirement. The plan member can allocate a small portion of their retirement wealth to the insurer at the age of 65, retaining their full set of accumulated assets and then, at a certain age, the longevity insurance kicks in to provide regular income, says Vandolder.
“The participants that have this type of insurance regard their retirement, on average, better because they’re doing everything possible to live a healthy lifestyle into retirement, so they can get a large set of that income after the age of 80 or 85.”
In January 2018, a report by Bonnie-Jeanne MacDonald, senior research fellow at the National Institute on Ageing at Ryerson University, proposed a pooled risk savings program that could provide more security for retirees of an advanced age. The report suggested the longevity insurance could replace annuities as an income stream, but noted Canada’s tax environment doesn’t favour private market longevity risk products.
Indeed, while the concept of longevity insurance is under discussion in Canada, it isn’t here yet, says Jiwani, highlighting the federal government’s 2019 budget proposal to allow advanced life deferred annuities, which can help mitigate longevity risk.
“Likely, the insurance companies will offer it in some capacity to their existing plan sponsors and potentially their prospective plan sponsors,” he says. “What remains to be seen though, of course, is how they’re priced.”
The Saskatchewan Pension Plan is interested in how these details will play out, says Katherine Strutt, its general manager. The plan allows members to remain post-retirement through a level annuity, which was grandfathered in before tax rules changed. However, even with this option, she says plan members are requesting more choices because they want to stay with the plan without locking themselves in with an annuity at age 71.
“We have had more of our members requesting to stay with us, but not have to annuitize. . . . At age 71, they either have to take a pension from us or transfer it to the private sector to a prescribed [registered retirement income fund] or a guaranteed life annuity there. And more and more of them have been asking about a variable benefit type of arrangement because they want to stay with the plan.”
The plan’s board is working on rolling out a variable benefit option to provide members with more flexibility at retirement, says Strutt. “People know and trust us and they want to stay with us, or at least have that option of staying with us, without having to lock into an annuity if they don’t want to.”
Taking a step back to the accumulation side, target-date funds are front and centre in the U.S., says Veneruso, noting the Pension Protection Act gave the funds the blessing as a default in 2006.
These funds are also the top DC plan investment choice in Canada, says Jenab. “Target-date funds were probably the best thing the investment industry has done for DC plan members because it takes that decision-making out of the equation.”
In the U.S., many plan sponsors are revisiting the glide path and, particularly, the level of risk relative to the circumstances of their plan, says Vandolder.
Canada has also seen an increased focus on digging into the glide path, says Jiwani, noting it had been widely accepted for plan sponsors to set a TDF without significant due diligence on the glide path. “There’s a lot more focus now by plan sponsors on understanding the glide path before they select a target-date fund or understanding the glide path of the target-date fund that they’ve selected previously.”
Many plan sponsors offer investment options through a tiered structure, where TDFs would be the first tier, followed by index funds and then actively managed strategies, says Vandolder.
For plan members who want very customized options, many U.S. plans offer a brokerage window. But Veneruso notes employees who use this option have to understand no one is monitoring these options or performing due diligence. “All the employer has to do from a fiduciary standpoint is make sure that there’s reasonable fees and reasonable execution on the transactions, but they do not in any way have an obligation to monitor what’s going on [or] the usage within the brokerage window.”
In Canada, brokerage windows are very rare, says Jiwani. “That’s actually been around a long time in the U.S. and . . . even 15 years ago was discussed in Canada, but very few plan sponsors have gone that route. I would safely say it’s less than one per cent of plans [that] would have something like that.”
He also agrees brokerage windows make proper due diligence difficult, and notes the CAPSA guidelines require plan sponsors to be responsible for their plan’s investment options.
In the U.S., another evolving trend is DC plans moving to an outsourced model. “There’s varying flavours of that discretion — it could be just over investments — but it could be over the plan design,” says Veneruso. In Canada, the outsourced model for DC plans hasn’t really taken off, says Jiwani. “We are starting to see some providers offering outsourced defined contribution. We have yet to see any plans really interested in that offer.”
While Goodyear outsources its U.S. DC plan administration, its Canadian plans are managed internally. One reason is the company only recently moved to DC, so the team that works on the DB plan is also working on the new plan, says Bhola. Other considerations, he adds, include fiduciary obligations and insurance companies’ dominant role delivering DC plans in Canada.
While Jenab hasn’t seen Canadian plans using outsourced chief investment officer models, she says she wouldn’t be surprised if it becomes a trend as more plans are discovering they need to invest in private markets. “So as the investments for DC plans reach the level of sophistication that DB investments have, I think we’re going to see a spur of OCIOs.”
Yaelle Gang is editor of the Canadian Investment Review.