The future of DC: Part 1 – Coping with uncertainty

This is Part 1 in our 3-part series on the 2011 DC Investment Forum. For more coverage, read Part 2: Risk and retirement and Part 3: Are we there yet?

Pension reform and concerns around employer liability are driving the trend toward DC. But in shifting more responsibility to plan members, DC plan sponsors also need to find innovative ways to communicate investment information as well as new strategies to help members balance risk and reward.

In September, more than 100 senior DC plan decision-makers, recordkeepers, academics and money managers gathered at Benefits Canada’s 2011 DC Investment Forum in Toronto to discuss the future of DC investing and how to help plan sponsors address these challenges and opportunities. Following are highlights of the sessions.

Economic outlook: An uncertain world
“Economists are used to economic risk, but political risk is new,” said Derek Burleton, vice-president and deputy chief economist with TD Bank, in the opening keynote presentation. Political risk across the globe is contributing to the volatility of the markets and leaves Canada facing the prospect of a slow recovery. “The next few months will be volatile because the problem is the uncertainty itself, and that will continue,” he added.

Burleton explained that there are two key factors causing volatility today. The first is the debt problem in Europe. “The situation has spread from Greece to Italy,” he noted. “The unsustainable countries need to default, as well as Ireland and Portugal. The sooner that happens, the sooner we all can move forward.” The political decision-making process in Europe is a step behind the markets, so when the governments make a decision to extend debt relief, the markets are already looking at the next payment issue, he explained, and that’s why the market remains uncertain.

The second factor is the economic challenge facing the U.S. The U.S. government is solvent, but the country is working on a 10-year plan for deficit reduction. “I don’t think the Democrats and Republicans will reach a deal on a plan,” said Burleton, explaining that this will add to the market volatility. “No matter how you slice it, the U.S. is in for weak growth. The target growth rate is about 2%, and that won’t bring the employment rate down quickly.

“Canada has been very different. We didn’t have a financial crisis,” he continued. But that doesn’t mean Canada isn’t facing challenges. The elevated loonie is cooling exports, but Burleton expects the resource sector to benefit from planned investments in the next 18 months. He believes that interest rates are going to stay lower for longer and that consumers will continue to spend moderately. “The Canadian housing activity has cooled, but it will cycle up and down across the country. Overall, it’s a medium story that is neutral on growth in Canada.”

Member modelling tools in volatile markets: Practical challenges for DC members
“The problem we’re facing with DC plans is that we haven’t given members the tools to make decisions,” said Marcus Turner, senior investment consultant with Towers Watson Canada. According to a 2011 Towers Watson survey, DC plan members are aware that they are responsible for building their own retirement funds. However, they don’t know what to do when it comes to making investment choices.

Turner believes the main question that DC plan members are trying to answer is, How much do I need to contribute to achieve my retirement objective? On the surface, it is a simple question, but it quickly becomes complicated. Target date and asset allocation funds are a step in the right direction, Turner explained, but they provide a false sense of security because they are packaged as “set it and forget it.”

A major problem with current DC plans, he continued, is that they do not factor in other potential sources of income. “Does a member have real estate, an inheritance, RSPs? And there are government programs, too, and there is not a clear line of sight to what those contributions will be.” DC plan models should include these other sources to help members get a clearer image of their potential retirement income and how close they are to achieving their goal.

Turner added that plans should also integrate legacy DB data and provide modelling of potential returns based on investment selection. “Ideally, sponsors would offer stochastic modelling. This will emphasize the impact of investment decisions on the member’s DC balance.”

He also believes that the DC industry needs to pay more attention to another imminent problem: the de-accumulation phase. As DC plan members inch closer to retirement age, the demand for understanding how their retirement funds will function increases. One simple feature that sponsors could add would be to show members how withdrawals affect their investments. “Projections of account balances would illustrate the impact of annual withdrawal amounts and highlight the risk of outliving retirement savings,” Turner explained. This insight provides plan members with valuable information that could help them prepare more realistically for retirement.

Leigh Doyle is a freelance writer based in Toronto. leigh.doyle@gmail.com

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