Maybe Elvis Presley’s line “a little less conversation, a little more action please” can help inspire the retirement savings industry to ask themselves, “How can retirement savings be delivered more effectively for the average working Canadian?”
Is DB down for the count?
In the single-employer private sector market, the traditional retirement savings plan—the defined benefit (DB) pension plan—is on the ropes. That admission has been widely conceded of late in the U.K., U.S., and now in Canada. For anyone still not convinced, consider this: from 1991 to 2006, DB coverage for private sector employees dropped from 86% to 73% a net loss of 280,000 employees (Statistics Canada, Pension Plans in Canada Survey, 2006). And that was prior to the market meltdown of 2008.
If you think DB plans will bounce back in this space, think again. The April 30, 2010 issue of MoneySense, reported that 92% of DB plans in Canada were in a shortfall position. And with new International Financial Reporting Standards (IFRS) pension accounting rules effective January 2011, an article from CA magazine concluded that, “If IAS19 had been in effect in 2007, more than 100 companies polled would have seen their shareholders’ equity decrease by more than Cdn $9.6 billion.”
The one-two punch of a severe market meltdown and more transparent pension accounting reporting standards has created an environment where sponsors that have previously thought about moving out of DB are now taking action.
What’s the answer?
DB’s default replacement, the defined contribution (DC) plan, has, so far, been lacking for many working Canadians in the private sector. The DC plan has fixed a lot of problems for employers, but what about employees? How are they doing from a retirement income perspective?
There is a lot of talk lately about “financial literacy,” and rightfully so. After all, the average employee is expected to bear all financial risks associated with his or her retirement savings. But is it realistic to expect the average Canadian to become financially literate? Most of us don’t want to learn all the complex details of how to fix our own car; similarly, the average Canadian wants someone else to take care of most of the financial decisions required as part of a retirement savings program.
Regardless of the retirement savings or pension vehicle, what’s really at stake is whether the plan will provide adequate income in retirement. And that judgment can only be made if employees know exactly how much income the plan provides.
The future?
Benefit adequacy, or a targeted amount of retirement income, is a function of the number of years of plan participation, the amount of contributions made each year, operating expenses, investment returns and bond yields at retirement, and the number of years the pension will be paid (a.k.a, longevity risk). It’s no wonder that the traditional DC plan with do-it-yourself (DIY) investing has been referred to as an “accidental pension.”
Even the more financially savvy Canadian doesn’t necessarily have the knowledge and tools required to match the pre-set retirement income feature of a DB plan within his or her DC plan.
While DC is working to control company costs, it isn’t necessarily working to help the employee generate an adequate level of retirement income. The current DC retirement savings model, which has company contributions of less than 5%, employee contributions of less than 3% and employees making fund selections, is woefully inadequate to be seriously considered a DB replacement.
While good plan design and a well-considered investment fund line-up can improve the outcome for DC, it doesn’t go far enough to address all of the inherent shortcomings of the DIY approach.
Dynamic DC
There has been much talk about improving the DC plan platform, developing innovative solutions, learning from our global counterparts, and the like. We are at the tipping point of a DC transformation. There is an opportunity for all stakeholders—government, plan sponsors, plan members, service providers, and consultants—to take action and fix what we all know is broken and be part of a national solution. The dynamic DC, the enhanced DC plans of the future, will be able to accomplish the top priorities for any retirement savings program.
• It will provide a pre-set target retirement income, e.g. a replacement ratio of 60% to 80% for people earning $50,000 – $100,000, with government pensions included in the analysis.
• It calls for an employer contribution of at least 5% of base pay, with a possible profit sharing component.
• Employee contributions will be based on targets that auto-escalate with age.
• Investment decisions will be outsourced as in DB plans, eliminating the need for employees to manage assets, by hiring a fiduciary investment manager; and the asset mix for any individual will be based on his or her risk profile.
• It will be managed by a pension committee with employee representation, to monitor individual plan member performance towards target benefit and provide employee education that focuses on saving.
As companies and plan sponsors search for solutions, it is our industry’s responsibility to develop an easy to implement and pragmatic solution that meets the needs of employers and employees. Working Canadians not only deserve better, they need our help to make ‘better” happen. Or as Elvis would say, “A little less conversation, a little more action please.”
Kevin Sorhaitz is a principal and consulting actuary with Buck Consultants in Toronto.