Canada’s federal and provincial finance ministers will gather at a summit meeting today in Whitehorse to discuss, among other things, the state of the nation’s pension system. The outcome of these talks could well be a pivotal defining moment for privately-sponsored pension plans.
Media attention on pensions over the past few months has been intense. Less visibly, but with no less intensity, politicians have been studying pension issues, with plenty of input and lobbying from key players in the pension industry.
These are exciting times for many pension practitioners. The eve of the Whitehorse Summit represents an irresistible opportunity to use this forum to offer some reflections regarding past public policy around capital accumulation plans from which future policies might be shaped.
Significant reforms of public policy concerning workplace pension and individual retirement savings last took place a generation ago, principally in the period from 1985 to 1990. There were two fundamental aspects to the reforms: changes to provincial and federal pension standards legislation, aimed at minimum benefit standards and prudential funding requirements, and the federal pension tax reforms aimed at integrating tax deferral treatment in respect of all types of registered plans (defined benefit, money purchase/defined contribution and individual retirement savings plans). Since then, both pension tax and pension standards legislation have been tinkered with around the edges, sometimes in apparently significant ways (but only marginally relative to overall policy structures), to accommodate regulatory experience and common law developments.
A generation ago, the term “capital accumulation plan” (and its acronym “CAP”) had not been coined. Defined contribution (DC) pension plans (also known as money purchase pension plans) were relatively rare and may even have been outnumbered by deferred profit sharing plans (DPSPs). Group RRSPs existed only for employee contributions, and investment choice for plan members was not widely available—plan assets were mostly invested in pooled balanced funds only or guaranteed investment accounts. Pension standards reform did not differentiate between DC and defined benefit (DB) pension plans, except that pension funding standards were not really applicable to DC plans, where assets and liabilities were generally always in balance. Consequently, little regard was given to pension reform in DC plans.
In those days of no investment choice, plan investment, administration and custody were relatively cheap, and guaranteed interest rates provided excellent and secure returns. This began to change in the 1990s consequent to pension tax reform, which most notably increased (more than doubled) the contribution limits available for DC pension plans, DPSPs and RRSPs. A new idea then emerged: that employers could make contributions to group RRSPs as an alternative to offering a pension plan. This was a very significant, but unintended, development directly attributable to the pension reforms of a generation ago.
The concept of making employer contributions to group RRSPs first took root with banks, brokerage firms and mutual fund companies that did not have the technology to administer DC pension plans—in particular, the capability to meet the consolidated plan-level reporting required for such plans. They began, quite successfully, to market an attractive value proposition to employers and employees: a retirement program that offered broad mutual fund investment choices, avoided all of the regulatory requirements imposed by pension standards legislation and gave employees the right to cash their savings—if not during their term of employment, then at least any time after they changed employers.
While this was happening, DB pension plans began to wane in popularity with many workers, primarily due to two factors that were consequential to pension reform. The first factor was the new portability requirements of pension standards, coupled with the corporate downsizing trends of the late ’80s and the ’90s, which revealed to workers disappointingly small lump sum values for their DB pensions. The second factor was the impact of the new pension adjustment (PA) under pension tax rules, which was perceived to limit the personal retirement savings opportunities of DB plan members.
Employers’ interest in alternatives to DB pensions grew significantly in the ’90s as they became aware of the challenging consequences of legislative pension reform and also pension accounting reform (which took hold at the same time as pension legislative reforms), coupled with the increasing dissatisfaction of employees with their DB pensions.
As RRSPs began to gain in popularity, insurers, who dominated the delivery of services to DC pension plans, began to re-tool to competitively match the investment offerings of their banking, brokerage and mutual fund company cousins. By the mid-’90s they began to overtake their competitors in the group RRSP market by enhancing their investment offerings in the form of segregated funds and extending them to DC pension plans and DPSPs as well.
Insurers also benefited from a regulatory regime that was much lighter than that imposed upon competitors subject to securities regulatory regimes, which also underwent significant consumer-focused reforms during the ’90s. Insurance regulation still does not require the prospectus and “know your client” requirements that are applicable under securities regulation, although some relief is now available to some CAPs under the securities rules.
Regulators began to have concerns about group RRSPs and the emerging shape of DC pension plans and DPSPs in the late ’90s as complaints to pension regulators by members of group RRSPs began to surface, and certain institutions subject to securities rules began to complain about the lack of rules applied to the insurers they were competing with. Politicians and policymakers, however, appeared to be oblivious to such concerns, leaving regulators to establish the “extra-legal” regime of the CAP Guidelines, which became effective in 2005. The regime depends on the development of common law to establish compliance principles, as there is little in the way of any statutory framework behind the CAP Guidelines.
From a pension policy standpoint, the use of RRSPs to replace workplace pension plans was unintentional and is not without its flaws. First, there are no assurances that RRSPs will provide retirement incomes. A key objective of the last round of pension reform was to ensure the provision of pensions through lock-in rules. Second, RRSPs—group or otherwise—are at root individual arrangements between financial institutions and RRSP accountholders. Employer sponsors of group plans have no clear fiduciary role in such arrangements to ensure that they are, in fact, managed in the best interests of their employees or even at appropriate cost levels (costs are most often deducted from investment returns credited to member accounts).
However, many positive things have come out of the growth of group RRSPs and other CAPs. Financial institutions and employers have become engaged in promoting greater investment literacy through decision-making tools and educational workshops, and individuals have become more aware of the need to take on more responsibility for their own retirement income security.
When the country’s finance ministers meet in Whitehorse this week, they should be mindful that the state of pensions in Canada today is quite likely more reflective of the consequences of pension reform a generation ago than of the changes in the interim in financial markets, workplaces, technology or consumer behaviour. It is time for pension reform that takes into account the impact of past reforms together with policy requirements that can be readily adapted for the needs of future generations.