The defined contribution (DC) market in Canada has some growing up to do when compared with markets in the U.S. and the U.K. In fact, according to Statistics Canada, only 37% of the country’s pension plans are DC. As more employers close their defined benefit (DB) plans and offer up DC alternatives, a growth spurt is expected—and needed—in the area of products and education to help plan members make a smooth transition into retirement.
“De-accumulation is a serious challenge for DC plans, and there is no doubt that we need to figure out solutions for lifetime retirement income,” says Oma Sharma, national partner with the investment consulting business at Mercer and lead of the DC investment consulting team.
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Farzan Qureshi, principal, institutional business, with Barclays Global Investors Canada Ltd., adds, “Income-type products have been very retail-focused in Canada. They haven’t really been part of the institutional framework in terms of group DC plans, and that’s something we think is going to change now.”
Taking responsibility
Since the inception of DC plans in Canada, plan sponsors, recordkeepers and consultants have been focused on providing accumulation solutions to plan members and educating them on the importance of saving for retirement. As a result, the de-accumulation phase has been somewhat forgotten. Many plan members aren’t aware of all of their options at retirement—that they have access to group, as well as individual retirement income solutions, for example.
Colin Ripsman, vice-president with Phillips, Hager & North, says this is because “employers are building these plans as employment benefits, and they really aren’t focused on what happens afterwards. [DC plans] are effectively designed to be a part of [employees’] compensation packages while they are employed.” He adds that employers can’t really be faulted for their lack of interest in addressing the payout stage. “The legislation and the legal system effectively encourage employers to remove [employees] from the plans once they terminate employment or retire.”
Ripsman suggests Canada look to the U.S. for regulatory solutions in this area, noting that the creation of safe harbours may put plan sponsors at ease about giving more education and direction in the payout phase. As it stands now, plan sponsors often disassociate themselves from this stage because they don’t want to assume any further fiduciary responsibility on behalf of terminated or retired employees. Ripsman adds, “I think if a safe harbour were available, protecting employers that offer prudent investment choices to members, plans sponsors would be more inclined to take responsibility for offering options in their programs that consider investment needs of employees over their lifetime.”
Early education
With most plan sponsors taking a less paternalistic approach to the de-accumulation stage than to the accumulation stage, the onus typically falls to insurers to educate plan members about the group retirement income solutions available to them upon retirement.
Now that plan members are relying more heavily on DC plans as their main retirement savings vehicles, some consultants have noticed that insurers have started to step up the communication in this area—but some still have a long way to go. For many plan members, planning for retirement means just getting a package in the mail that gives them a broad overview of their options. It’s no wonder that uptake of group retirement income products is poor.
Often, plan members go to an advisor to help them decipher the next stage of their investments, who, in turn, educates them on the retail products available to them. However, without knowing all of their options (both group and individual products), it’s hard for plan members to make informed decisions.
“Education is key,” says Sharma. “Make sure people have access to help so they can understand their investments and their options, and the decisions they will have to make as they move into retirement.”
To get people to start taking more responsibility for their financial futures and thinking seriously about retirement, Chris Walker, vice-president, institutional investments, with Invesco, says people have to start thinking about what retirement really means. “According to industry research, members should think of it as income replacement, not retirement. Retirement means sailing and golfing to people. Income replacement means something different. It’s a mindset change that needs to happen.” And it’s not just plan members who need to be educated either. Sharma adds that plan sponsors also have to commit to educating themselves if they want to do right by their members. “Plan sponsors need to understand what options are out there that may help their employees, like guaranteed minimum withdrawal benefit products,” she says. “Target date funds have their faults but they generally address a lot of issues. GMWB products should similarly be evaluated, and the plan sponsor needs to determine whether or not those products would be helpful to members and make sure members will be properly and unbiasedly educated on how and when to use them.”
Development years
Barry Noble, vice-president, distribution, group savings and retirement solutions, with Manulife Financial, expects to see a number of new retirement income solutions coming to market, in addition to those that have already been introduced.
Among the relatively new options getting more attention lately are GMWB products. “These are both an accumulation and a payout product blended into one option,” Noble says. While such products have been available to individual investors for a couple of years, the first group GMWB was launched just last year.
GMWBs are gaining in popularity with individual investors, but there hasn’t yet been a huge uptake on these products from plan sponsors. Some expect that to change in the future, due to the industry’s shift in focus to de-accumulation and the shaky economic environment the country has experienced. “This is when people fly to safety and basic concepts and easy-to-use products become important,” comments Kevin Jeffrey, a principal with Pointbreak Consulting Group. “Some may argue that it may not be the ‘best’ option, but if it lets them sleep well at night and helps reconcile their emotional and financial goals, then it is probably the right choice for that individual. I think this is why [GMWBs] have done so well as of late.”
Some even say these products have revolutionized the industry—but not everyone agrees. “When these have been introduced on the institutional side, we typically haven’t seen much pickup,” says Fredrik Axsater, head of DC investment strategy for North America, with Barclays Global Investors (BGI). “They are really complicated and difficult to understand. They are seen as expensive to use and inflexible for participants.”
However, Noble says that isn’t the feedback he’s received. “Since this option was launched to the group market last year, there has been a significant appetite for plan sponsors to incorporate this choice because it’s perceived as somewhere between a DC-type of product offering and a DB-type of product offering.” He adds, “Although the group version of GMWB products are simplified compared to their retail counterparts, they are still fairly complex and require clear communication plus strong support to be effective for group plan members.”
But products with guarantees are just the beginning. Consultants, investment managers and recordkeepers alike expect more options to come to the forefront shortly.
For example, in the U.S., BGI has a product that incorporates deferred annuities into a target date fund (TDF). In Canada, Axsater says, this type of product is on BGI’s research agenda and he expects that others are working on similar products. “Incorporating annuities into TDFs not only makes the accumulation phase easy, but also simplifies the de-accumulation phase.”
Ripsman adds that the use of TDFs with longer time horizons is another up-and-coming trend. “Target date funds [generally] assume that you are trying to build up the maximum money at age 65, and then you will take that money and do something with it. You could have target date funds that build glide paths assuming that members are going to invest 20, 25, 30 years beyond retirement age. You can even have glide paths that are structured to accommodate regular withdrawals from these programs by members in retirement.”
Be it reinvented versions of products that are already on the market or solutions that are completely new, Walker thinks the market is heading toward easy-to-use options. “Plan members are confused by the decisions required of them in capital accumulation plans. We will probably continue to see the prepackaging of investment options to take away all of the investment decisions.”
While plan members may benefit from having more choice and simplified options that help them pre- and post-retirement, if they don’t know about the products, don’t understand them, don’t have access to them or haven’t been paying attention in the accumulation phase, even the best-constructed products won’t help them in retirement. Educating plan members makes a difference—and smart plan members will push the market to mature.