PRPPs: The Unintended Consequences

broken eggs2Bill C-25 Section 3 states that the purpose of the PRPP Act is to provide a type of pension plan accessible to employees and self-employed persons that “pools the funds in members’ accounts to achieve lower costs in relation to investment management and plan administration fees.

There are a number of issues that have been overlooked and these may undermine the objectives of the proposed legislation. Before it is enacted, these should be considered. In this blog post, I discuss the major, unintended consequences of the PRPP legislation for Canada.

Unintended Consequences

Section 3 of the proposed legislation states the legislation will provide a framework for a plan accessible to “employees and self employed persons.” Employers already offering a DC or RRSP as a pension program may also participate in the PRPP and transfer an existing DC or RRSP to a PRPP  (i.e., the proposed legislation does not preclude an employer from transferring an existing Capital Accumulation Plan into a PRPP).

Under Section 22 the financial institution becomes the administrator and a trustee of the plan hence the sponsors’ current administrative and fiduciary role responsibilities will be transferred to a financial institution. The transfer of the administrative role and fiduciary role provides a significant legal, financial and competitive advantage: employers are relieved of the onerous and risky administrative, communication, education and fiduciary responsibilities to their employees.

From a corporate governance perspective, an employer would be remiss if it did not transfer its DC or RRSP pension programs to a PRPP to relieve owners and shareholders of the potential legal and financial risk associated with defined benefit or CAPs. Employers will also achieve cost savings given the administrative portion of the fees paid to the PRPP administrator will now be paid by the employee. This combination of factors represents a huge economic incentive for an employer to move their current pension programs to a PRPP.

Is this the real objective of PRPPs?

The inevitable switch to PRPP by employers will result in a significant change in the Canadian pension environment which should be brought to the public’s attention for before enacting the legislation.

“Low-cost” Retirement Savings

The government releases and financial industry lobbying emphasize that PRPPs will provide a low-cost retirement savings opportunity for PRPP members. Other than citing volume of investments, however there is little indication how this will be done or reason to believe it will be achievable.  Many large CAP sponsors have already negotiated fees that are significantly lower than those available to individuals using “retail” RRSPs but this appears to have been ignored.

A close look at the management fees charged in CAPs also reveals that the majority of fees paid by DC and sponsored RRSP members go to the  record-keeper (usually a financial institution) and to financial advisors: fees paid to the actual investment fund managers used in the pension programs generally do not make up the bulk “management fees” paid by members.  In addition, a significant portion of the investment fund management fee actually goes to the record-keeper. Achieving significant fee reductions in a PRPP therefore will not likely come from negotiating lower investment management fees as implied by the government and financial institutions.

Will financial institutions in fact significantly reduce the administration portion of the management fee paid by PRPP members to get fees down?

Section 22 of the proposed legislation states that the administrator  “must administer the PRPP and assets as a trustee for the members.”  What are implications of this?

The administrative, legal and fiduciary roles and responsibilities of the employer will be transferred to the financial instruction(s). The role of a trustee is already considered to be onerous: financial institutions and custodians are very reluctant to take on a trustee role for DB plans because of the inherent fiduciary and financial risks. If they do assume the role of a trustee it comes at a price. The responsibility and administration costs in a PRPP for providing communication, education, and decision-making tools will become a cost of the financial institutions(s). Since there will be several financial institutions providing PRPPs it is difficult to imagine they will individually be able to achieve the economies of scale needed to significantly reduce their administrative costs.

It is not a given that PRPPs will result in significantly lower fees for their members.

Conflict of Interest

Under section 22 and 23 of the proposed legislation, the administrator must act prudently and offer a diversity of investments to PRPP members. Many financial institutions have proprietary investment funds as part of their retail retirement program. These funds are often used in their asset allocation and/or target date products. These products are not necessarily the lowest cost or best performing nor do they necessarily provide optimal diversification. The risk of a financial institution using and promoting its proprietary funds is already acknowledged in the pension industry and will likely become a bigger issue with PRPPs.

To mitigate this area of potential conflict of interest the financial institutions should only be allowed to offer low-cost passive investments in a PRPP.

There are already a number of tax-assisted vehicles similar to the proposed PRPPs (i.e., DC plans, RRSPs, TFSAs available through financial institutions). Perhaps the lack of retirement savings for many Canadians is a shortage of discretionary income rather than a lack of tax-assisted retirement savings opportunities. A Segregated National Annuity Program (SNAP) that invests in federal, provincial and high quality corporate bonds may be more economically sound and a less complicated and less risky approach to providing Canadians with the type of savings approach they need.

A “ready shoot aim” approach often leads to serious and unintended consequences. The federal and provincial governments should take some time, step back and consider some of the potential unintended consequences of implementing the proposed PRPP legislation.