In the midst of an unusual or unsettling situation, such as the coronavirus pandemic, pension plan sponsors should remember that both defined benefit and capital accumulation plan arrangements are intended to be managed for the long term.
The negative impact of the coronavirus on global economies and on businesses is a concern, particularly with respect to the effect on future cash flows and solvency funding requirements. DB plans are facing low interest rates, resulting in increased solvency liability estimates, as well as significantly lower equity investment value; both of these factors contribute to higher solvency funding requirements.
Similarly, CAP sponsors should encourage their members to view the accounts as a personal DB plan where a long-term view is appropriate. CAP contributions and funding are, in fact, an estimate of the “commuted value” of the savings required to achieve retirement income objectives. Therefore, a DB approach can be an effective way for plan members to manage their retirement plan and investments.
Reversion to the mean
From time to time, equity markets experience ‘tail risk’ or ‘six sigma’ events that negatively impact equity investments and retirement savings. With the current low interest rates, volatile equity markets, improving longevity and the risk of inflation, people in DC plans or registered retirement savings plans may be concerned there won’t be enough money in their retirement accounts.
When markets are volatile, it may be appropriate for plan sponsors to remind members of the concept of ‘reversion to the mean.’ This theory suggests that asset prices and historical returns will eventually revert to the long-run mean or average level of the entire dataset. It can also apply to other things, such as economic growth or the average return of an industry. The key is time.
Encourage retirement planning
It’s critical for plan members to have a financial plan, something they can measure their progress against. Recommending that they seek assistance from a professional accountant, lawyer or advisor will likely encourage them to focus on the long term as well.
Many DB plan sponsors also provide a group RRSP to their members. In the case of both DB and DC arrangements, plan sponsors can offer a monetary incentive program to encourage plan members to seek professional assistance.
Compared to DB plans, CAP sponsors have a greater responsibility for communicating to members. With respect to investment, they should encourage a long-term view. A CAP sponsor is required to provide investment options and information to help members manage investments. This may include performance indicators commonly used by investment professionals such as different types of retirement vehicles (i.e., DC plan, RRSPs, TFSAs, RESPs); a choice of investments that accommodate a variety of member situations and needs; descriptions of the investment options; investment performance indicators; and fee costs.
In addition, plan sponsors should provide information about statutory requirements, including tax issues, issues specific to administering a CAP and the long-term impact of the cost of fees.
Return performance information is also essential in effectively managing investments and should include a return performance for one, five, 10 and 20 years (or longer if available); associated benchmarks and returns applicable to each option; and tracking error, information ratios and possibly other relevant performance indicators.
Given the long-term focus of retirement programs, long-term returns (i.e., 20 years or more) and other long-term performance indicators are important. Pension plan sponsors should consider adding this type of information if it isn’t already available.
In addition, plan sponsors should also provide a comparison of the performance of each investment option versus the benchmark, plus fees. CAP members should be reminded that it’s their responsibility to make use of this information.
Ultimately, CAP members are provided with information and it’s their responsibility to make use of it.
Management guru Peter Drucker is quoted as saying, “You can’t manage what you can’t (or don’t) measure.” In other words, you won’t know if you’re successful unless your objective(s) is defined and tracked. This is applicable to both investments and retirement plans.
Whether plan sponsors have DB plans or CAPs, they should be encouraging members to have a long-term financial retirement plan and outlook. CAP sponsors and their service providers are required to provide information, education and tools to assist in managing retirement savings. DB sponsors also often provide RRSPs as part of their retirement savings options. While communications is critical, it’s important to remind plan members that it’s their responsibility to make use of the information.
If members are feeling uncomfortable with what’s happening to the markets right now, they should be reminded that managing pension plans and investments is a challenge for seasoned pension and investment industry professionals as well. The industry has always reinforced a long-term view and taken a long-term approach, and that’s likely what’s appropriate now.
Gerry Wahl is managing director at the Pension Advisor.