With more and more Canadian employees relying on defined contribution pensions for their retirement income, it may be time for plan sponsors to step in and make some decisions for them.

It’s been about 20 years since defined contribution(DC)plans began gaining popularity in Canada and the U.S. In the booming markets of the ’80s and ’90s, employers saw a costeffective way to help their employees save for retirement. Since then, however, DC plans have migrated from an auxiliary savings vehicle to a primary source of retirement income. This shift has placed greater pressure on DC plan sponsors to help their members adequately save for retirement. Until recently, creative education and thorough communication were the best tools for sponsors.

“We’ve spent years trying to educate members,” says Becky West, director, retirement services, Russell Investments, in Toronto, but the results haven’t been stellar. Members are still defaulting, not making effective asset allocation choices, not rebalancing their portfolios and not saving enough.

So many plan sponsors are opening a new box of tools to help them get it right. These tools are automatic plan design features such as auto-enrollment, auto-escalation of contribution amounts, and lifecycle or target-date funds as default funds or active fund choices. These features are helping sponsors help employees save more and make better asset allocation decisions.

A recent survey by the Employee Benefit Research Institute in the U.S. and Mercer Human Resource Consulting revealed that 66% of organizations in the States have already adopted auto-enrollment or are currently adding the feature. This groundswell south of the border has caught the attention of Canadian DC plan sponsors.

In addition, says Lori Satov, a DC consultant with Watson Wyatt Worldwide in Vancouver, the low savings rates in Canada and the fact that many members are not maxing their contributions in their employersponsored plans—and missing out on employer matches—are a growing problem. “The results of this will surface within the next decade as the first real cohort of DC members retires with low incomes relative to what they could have had if their plan features were optimized,” she says.

It’s in this environment that Canadian employers are considering implementing auto features. In this year’s survey of Canada’s Top 50 DC plans, 24 indicated they had already implemented an automaticenrollment policy for their plan. Another two plans reported they were considering doing so in the next 12 months. Fourteen plans responded that they have introduced an automatic contribution-increase policy, while another plan is considering introducing one in the next year. But, for Canadian DC plans, a few hurdles(such as legislative challenges and the threat of legal action) still stand in the way of going on autopilot.

American influence

The introduction of the 2006 Pension Protection Act(PPA)allows plan sponsors in the U.S. to automatically enrol their members and bump up contribution levels on an ongoing basis. The legislation also provides a “safe harbour” against future legal action by plan members who feel their retirement income is inadequate, provided that the sponsor acts prudently and within the PPA’s guidelines.

“The U.S. legislation is designed to push plan members, instead of having them be passive,” says Colin Ripsman, vice-president of Fidelity Retirement Services in Toronto. “DC plans don’t do enough to help members make effective decisions. There are some plan members who can make these investment decisions on their own, but why not create a safety net for those who cannot?”

The American wholesale retailer Costco is one of the companies that took full advantage of the legislative changes even before they were put into law. Despite some reluctance from senior management, the pension committee and the company’s administrators—with the help of their provider—introduced auto features into their 401(k)plan. In September 2005, led by Katherine Miller, manager of employee benefit and retirement plans, the organization introduced auto-enrollment after 90 days of employment and in January 2007, started escalating contributions. Under this feature, an employee’s contribution to the savings plan will go up by 1% every year until it reaches 15% or it is turned off. An employee can set it higher than 15% if she actively does so and can also set the percentage of her contribution higher than 1%.

“We’ve had one or two calls,” says Miller about the response from her 90,000 eligible members. “But no complaints.” What Costco has seen is the participation rate in the plan jump from 69% to 97%.

“There is no question that what’s happening in the U.S. is driving interest,” says Mike Collins, vice-president of marketing and communications with Manulife Financial’s group savings and retirement team in Kitchener-Waterloo, Ont. “What we’re seeing in the U.S. and now Canada is an evolution,” he says. He believes the industry has been more creative about making changes to engage more plan members, but instead of positive results, stakeholders are continuing to see non-active investment choices and underutilized sponsor-matching programs. “U.S. sponsors are setting up their plans to put their members in the best starting place, and that’s catching the attention of Canadian plan sponsors.”

Hugh Kerr, assistant vice-president and senior counsel with Sun Life Financial in Toronto, says much of the interest in auto features in Canada is coming from companies that have direct exposure to the U.S. market or are subsidiaries of U.S. companies. “Once they’ve crossed that mental threshold to say it’s right for the plan in the U.S., then it’s easier to say it might be right for the Canadian plan,” he says.

Research indicates that a total contribution rate of close to 15% is needed to provide DC plan members with appropriate levels of retirement income. “These auto features would certainly help members get closer to that goal,” says Satov. “In the best-case scenario, members will be better off in retirement.” She has heard from her U.S. colleagues that plan sponsors that implement auto features are seeing less than 10% of employees opt out. Costco saw only 7% opt out of its plan. This may be an indication that plan members want more than reading materials.

Canadian environment

Some Canadian plan sponsors can—and already do—give their members more without waiting for changes in pension law. Auto-enrollment is allowed in Canada. “Where you have a plan that has mandatory participation with a minimal level of contribution, that is an auto plan,” says Shawn Cohen, a senior investment consultant with Hewitt Associates in Toronto. What is different in Canada, says Collins, is that auto-enrollment plans are mandatory participation plans and employees can’t opt out. Unlike the U.S., there’s no grace period where plan members can opt out without tax implications. Where the issue really arises, says Kerr, is with those who don’t have that as part of their employment contract.

Auto-escalation is more challenging because of Canadian legislation. “There is no such thing as a completely ‘no-touch’ autoenrol in Canada,” says Satov, “because there is a requirement for members to sign their beneficiary election form.” In Canada, the employment standards legislation requires employers to get employees to agree to have an amount deducted—and all increases in those deductions—from their paycheques and allocated to a pension plan. It is known as positive-option consent.

Legislation in the U.S., on the other hand, allows companies to use negative-option consent, where members are automatically put into programs or funds and must actively ask to be removed. “The employees have to make a conscious decision to not be in the plan,” says Teresa Morgan, national director, member services, group savings and retirement, Standard Life, in Montreal. “In that respect, it’s attractive to plan sponsors as it will ensure that employees are taking ownership and not simply deferring and defaulting to their employer [plan sponsor].”

So for sponsors in Canada that want autoescalation, the hurdle lies in either obtaining members’ positive consent or changing Canadian legislation to make it similar to the U.S. PPA with negative-option consent, says Kerr.

Adventurous defaults

The other auto feature capturing the attention of plan sponsors is lifecycle or target-date funds. At the most basic level, these are highly diversified mutual funds that automatically reallocate assets to become more conservative as a member reaches retirement. “We’re seeing more plans move to lifecycle and lifestyle funds,” says Ripsman. Such funds are being implemented as default funds instead of the traditional money market funds, for which there is the longterm risk of underperformance relative to a more diversified portfolio. To avoid this risk, some plan sponsors are looking at money market funds for the first year an employee is in the plan, then automatically moving her into lifecycle funds if she hasn’t made a choice after that. “From a risk standpoint, lifecycle funds are the best choice,” he says.

The popularity of these funds also stems from the influence of the U.S. DC market. One of the changes to the PPA is that plan sponsors are permitted to use, as Kerr calls it, “more adventurous” default funds, and these include target-date and lifecycle funds. “[The PPA] recognizes that there are members who put their contributions into a money market fund and leave them.” Using these funds can possibly protect a member from the potential loss of returns from staying in a money market fund.

For Collins, lifecycle and target-date funds provide the simplicity that members want. “We’re seeing a lot of lifecycle as the default. The fit is obvious,” he says. “If it’s difficult for people to do and they don’t see the importance, then they won’t do it.” However, lifecycle and target-date funds are not a perfect solution. Collins is concerned with the difficulty plan sponsors may have confirming whether the funds in their plan are giving their members good value without consistent benchmarks in place for comparison. How do you align it with an investment style? “Plan sponsors have to consider the value of the fund type versus the quality of the particular fund,” he says. “Lifecycle funds are a good option to have—the question sponsors are trying to answer is How do I know my plan has the right one?”

Another concern with such funds can be the cost, which is increased, in part, because of regular rebalancing and the use of multiple fund managers. “I think they are appropriately priced,” says Satov, “and are providing value for the somewhat higher fee.” Cohen, however, says the price of lifecycle funds depends on the type of fund. Those that are actively managed will be more expensive than lifecycle funds based on a mix of index funds. “When comparing them to traditional balanced funds, they may be a little bit higher,” he says, “but the benefits typically outweigh any additional costs, which are not unreasonable.”

The biggest problem with lifecycle for Cohen is that it does not solve the dilemma of inactive participation. “These features may reinforce the level of inactivity,” he says. “Members have money in a program, but there is still a communication gap because members may not be reviewing their plan to ensure it continues to be appropriate for them.”

A few more hurdles

There are other challenges to auto features besides the legal hurdles of implementation. The most obvious is the financial implications on plan sponsors. “Cost is what’s stopping some plan sponsors from instituting auto features,” says Ripsman. Plan sponsors saved money in the ’90s by switching from defined benefit(DB)to DC plans to reduce administration costs, and they are less generous than DB plans. “These plans are cheaper to maintain since employees often don’t take full advantage of the match. Auto features such as auto-escalation increase costs, and plan sponsors are reluctant to do that.”

Collins and Morgan agree that more plan sponsor dollars are committed to a plan with these features. “Auto-escalation means a cost to plan sponsors because it’s often matching and it affects their bottom line,” says Morgan. “The cost issue is in the back of their mind, but it is not stopping sponsors from embracing these features.”

In addition, says Collins, “it’s not easy to change plan direction.” There is always some skepticism from plan members whenever changes are made to the plan. Much thought is required as to how do you get employees to consent, adds Kerr. “Whenever people are being told to defer current consumption, that always requires some convincing.”

Maturing market

Auto features in general are not a panacea, says West. “They don’t address other issues in DC plan structures, episodic withdrawals or mobility between jobs(and therefore retirement plans), making consistency of investment strategy challenging.” However, she says that as the DC market continues to mature and because DC plans are now the main retirement plan for Canadian corporate employees, there needs to be more focus on improving how members participate in them. “There is no perfect environment,” she says, “but we have to get as close to perfection as possible.” Auto features do encourage members to save more by helping them get around their own inertia.

Kerr believes that the autopilot movement is part of a recognition that DC plans are supposed to be providing a retirement income. “These features really make sense from the perspectives of all of the stakeholders in the DC plan market,” he says. “The group of members who are more passive need this gentle nudge to get them in the plan and contributing an amount of money that is meaningful and will generate a meaningful retirement income.”

Ripsman believes auto-escalation is the next logical step for the Canadian DC market. “By introducing it, plan sponsors are not creating fiduciary risk, they are helping them save more,” he says. “It will be difficult to be held responsible for being prudent.”

Costco’s Miller has this piece of advice for fellow plan sponsors: “Do it. There is no reason not to. It’s important for us to do it if members won’t. We need to make sure they’re not left with nothing.”

Barriers to failure

A 68-year-old DC plan shares its secrets for providing a healthy retirement income.

You could call the Co-operative Superannuation Society Pension Plan(CS)ahead of its time or maybe even visionary. But Bill Turnbull, general manager with CSS in Saskatoon, thinks it is the result of practical thinking. CS is a member-owned, non-profit, defined contribution(DC)pension society that is the administrator, record keeper and fund holder for the plan. Members are from 480 co-operatives and credit unions across Canada. Today, the plan has more than $3 billion in assets under management.

Back in the late ’30s when the co-ops came together to form a pension plan, they realized they couldn’t afford a defined benefit(DB)plan or its volatility, explains Turnbull. So they modelled a plan on the British Retirement Saving Society, which had the CS collecting pension contributions, buying long-term bonds and then government annuities when members retired. “You build a DC plan like a DB plan, but with members taking the risk.”

Today, the plan offers only two funds: a balanced fund and a money market fund. Most of the members are in the balanced fund. “The money market fund is for members who are close to retirement and are protecting against market shift,” says Turnbull. Participation in the plan is mandatory for full-time employees after a period of no more than two years. The society has a 50% match, and contributions can be anything between 1% and 18%. “The majority of employers do a six and six,” says Turnbull, “probably because employees, management and senior management are all in the same plan.” All members of the plan also receive professional balancing and automatic rebalancing.

What CSS does, says Turnbull, is try to set up barriers to failure for plan members. “We try to structure the plan so it produces a proper result if they do nothing. A member can do it wrong if he wants, but he has to be active to do so.” One of the secrets to CSS ’s success, Turnbull says, is that the society is memberowned. Members are doing it for themselves, so it’s a really good alignment of interests, he says. This also reduces the fear of litigation. “If members don’t like it, they’ll change it. It makes us focus on what will produce the best result versus what will give us the least liability, which isn’t the right way to run a retirement income plan.”

Turnbull is pleased to see the Canadian DC market discussing “the ‘DB -ification’ of DC plans.” He believes the market is working through problems as it matures. “We went through the same issues,” he says. “We just did it in the ’40s and ’50s.”

But CSS isn’t immune from all of the DC market problems. Turnbull says the next issue they will have to address is providing investment advice for members. The society currently offers a comprehensive communication plan with workshops and tools, but like other Canadian plan members, those in the society’s plan want personal advice. “We think the best idea is to skip the advice and just keep building the portfolio for the long-term saver and provide professional management with autorebalancing. That’s basically advice.” —Leigh Doyle

Leigh Doyle is a freelance writer in Toronto.

For a PDF version of this article, click here.

© Copyright 2007 Rogers Publishing Ltd. This article first appeared in the September 2007 edition of BENEFITS CANADA magazine.

 

Copyright © 2020 Transcontinental Media G.P. This article first appeared in Benefits Canada.

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