Sounding Board: Considering the legal risks of CAPs

One of the reasons for the switch from defined benefit to capital accumulation plans is that employers assume CAPs are less financially and legally risky, as well as less expensive to administer.

However, with the switch to CAPs, employers are shifting all the investment, longevity and inflation risk, as well as responsibility for managing pension outcomes, to their employees, which can increase the opportunities for litigation.

While a CAP member faces more challenges than a DB plan member, a CAP sponsor also has significant fiduciary and legal responsibilities. This includes providing appropriate tailored communications, education, investment information and tools, as well as overseeing fees.  

Read: Fees, member communications top priorities for U.S. DC plans in 2020: survey

CAPs appear simple, but they open up many opportunities for litigation and class action suits. Low interest rates, volatile equity markets, increasing longevity and inflation contribute to retiree angst. Members are beginning to realize their DC and other CAP income may not be adequate.      

In Canada, legislation, regulations and jurisprudence with respect to a CAP sponsor’s responsibilities are limited. However, in the case of any litigation, the Canadian Association of Pension Supervisory Authorities’ guidelines would be used.   

The guidelines recommend that plan sponsors: administer the plan in accordance with federal, provincial and income tax legislation; provide investment information and decision-making tools; consider relevant factors when selecting the investment options; select and monitor prudent investment options; provide ongoing communications; provide written information, education and tools; and monitor the activities and performance of the administrator and service providers.

The guidelines state plan members are responsible for: using the information and tools provided; making investment decisions; assessing and monitoring their retirement goals; and obtaining financial and retirement planning advice.

Read: CAPSA updates guidelines on DC plan payout, responsibilities and advice

The CAPSA guidelines also recognize that different information, communication and tools are required during the accumulation and decumulation phases. Legislation also requires that specific prescribed information must be communicated to beneficiaries, particularly if they’re responsible for making investment decisions. 

The communication, education, tools and investment options available to plan members will depend on their demographic, as well as the type of plan that’s available to them. For example, the purpose of a tax-free saving account is short term rather than for retirement savings, so its investment strategy and objectives will differ from a long-term plan, like a registered retirement savings plan.

While plan sponsors can’t provide financial advice to plan members, they can make it available through investment professionals or their plan record keeper. Neglecting to provide long-term performance information could lead to legal action. 

Pension plan administrators argue that providing all this information will make communication and education more onerous and will only confuse members. In many cases, this may be true; however, from a fiduciary and communication perspective, it’s safer to provide both basic and advanced performance indicators to cover the needs of all investors. Under the CAPSA guidelines, members are responsible for trying to understand and use the information provided.   

Read: Beware the legal risks of providing financial advice to staff 

When it comes to selecting their investments, it’s important to encourage CAP members to adopt a long-term approach. While long-term performance data (more than 10 years) is required in selecting long-term investments, it’s seldom provided. In many cases, only one to 10-year performance data is provided. This is a major shortcoming. It limits a CAP member’s ability to manage their investment and is a potential issue for litigation.  

Fees and other costs, which are automatically deducted from a CAP account, also have a major impact on returns, retirement savings and income over time. The chart below shows the cost of a one per cent fee over 40 years:

While different contribution, return and timing assumptions will result in different estimates of fees, they obviously have a significant impact on retirement savings over time. Therefore, plan sponsors should be highlighting to members the impact of compounding on both fees and returns. 

Read: CAPSA must clarify sections on fees in DC guidelines: ACPM

The CAPSA guidelines recommend that plan sponsors provide members with a description and the amount of all fees and other expenses paid from their accounts. Pension legislation in British Columbia and Alberta, as well as the federal pooled registered pension plan rules, require annual disclosure of fees and costs.

From a governance perspective, plan sponsors should be regularly reviewing service providers, administrators and fund manager fees, as well as the results, and well document any changes or decisions.

They should also be providing long-term investment data so CAP members can effectively manage their investments. Failure to ensure fees are reasonable and the annual payments are communicated to members, as required by legislation and the CAPSA guidelines, is an area for litigation. 

It’s essential for a CAP sponsor to have a comprehensive governance process and active monitoring to ensure major issues and risks are addressed and to mitigate financial and litigation risks. A lack or failure to follow a governance program increases legal risks.

Read: How plan sponsors can avoid U.S.-style lawsuits over DC fees

Many DC and 401(k) plans are involved in legal actions in the U.S. and this is expected to become more common in Canada. Due to the reliance on the plan sponsor and lack of sophistication and understanding of pension matters, the courts may sympathize with CAP plaintiffs.  

Plan sponsors may believe that providing a CAP minimizes administrative costs and financial and litigation risk, but the reality is quite the opposite. As long as an employee is part of a workplace CAP, it’s the plan sponsor’s responsibility to act in their best interest.

Gerry Wahl is managing director at The Pension Advisor.