Issues of cost and risk are pushing plan sponsors to close off their DB plans. But that doesn’t mean managing them ends there.

During this past year, the pension world has seen such heavy hitters as IBM, Verizon Communications, Sprint Nextel and even Nortel Networks decide to shut down or freeze their defined benefit(DB)plans in favour of other, relatively cheaper, retirement vehicles.

In fact, research from the Benefi ts Canada Top 100 Pension Funds Report shows that when asked the question “Has the uncertainty of the future of DB plans resulted in the following actions?” 12% of the Top 100 plans said they have closed or frozen their plans and are transitioning to a defi ned contribution(DC)plan.

As plan sponsors shut the door on DB, they will have to address what it means to have a closed or frozen plan and how best to ensure retirement security for those still withdrawing pension assets.

In other words, even a frozen DB plan still needs to be managed properly. The question becomes what are the best plan designs and investment strategies to achieve maximum results while the plan is still operational? And what are the legal implications of taking such a drastic step? These are some of the issues facing this year’s Top 100 Pension Funds.


The risks and costs associated with DB plans, at the highest levels, are likely the cause for the change in mindset for Canadian plan sponsors. A recent survey by The Conference Board of Canada and Watson Wyatt Worldwide asked 198 chief financial officers, human resource and other professionals to indicate the threats to the sustainability of private sector DB pension plans in Canada. The respondents said the greatest threats to DB plans are the volatility of future funding contributions (73%); the imbalance or asymmetry between plan funding risks and rewards(63%); and the volatility of pension accounting expense(56%). These were also the top three threats identifi ed in 2005, the last time the survey was conducted.

“You see plan sponsors of all types try to deal with the issue of reducing their liability exposure in a DB plan,” says Colin Ripsman, vice-president, Fidelity Retirement Services Canada. There are more risks as well as accounting issues for the plan sponsor to consider “as you move to a more mark-to-market environment, where poor investment returns have an immediate impact on the financial statements. As these plans grow larger, these issues continue to grow,” he adds.

This ultimately leads to the question, according to Ripsman, do Canadian plan sponsors want to be in the business of running a DB plan? It is, perhaps, an unfair question as plan sponsors try to deal with both providing a secure retirement for employees while at the same time maintaining costs and expenses for both themselves and their plan members.

For plan sponsors that ultimately decide to pull the plug on their DB plans, there are a variety of options. Either DB plans can be shut off to new members or accruals for existing members can be frozen—or both. In all cases, the end result is essentially the same for all involved— fewer employees with a DB plan and a greater amount of risk placed on the shoulders of plan members.

“There is a larger percentage of closed plans in Canada than people would expect, just based on what’s been in the media recently,” says Paul Forestell, worldwide partner, head of Canadian retirement professional group with Mercer HR Consulting in Toronto.

Ripsman says that despite the numbers of DB plans being frozen and DC plans growing, the amount of assets in DB plans remains significantly higher than in other plans. “DC plans just don’t grow as fast,” he adds.


Closing the plan to new members doesn’t leave plan sponsors off the hook completely. They must still manage the remaining DB assets. And perhaps because plan sponsors are still faced with large DB accounts to manage, one of the issues they continue to face is funding levels.

A lot of the plans are approaching fully funded status, based on recent returns in the equity markets and, as Forestell puts it, “ there is no prize for having a surplus in a closed plan.” And with recent court decisions such as Kerry and Monsanto, which raised the question of ownership of pension surpluses, plan sponsors are still questioning if or how much of their surplus assets they can use.

“Plans are starting to think of their end game,” Forestell says. In other words, what will plans do when they achieve, or at least come very near, fully funded status.

Another issue plan sponsors face is investment risk. Although active DB plans are embracing new strategies such as hedge funds, infrastructure or global opportunities to address their underfunded dilemmas, plan sponsors that have frozen their DB plans need to take a different approach. As existing DB plans mature and they have more retirees and fewer active members, plan sponsors may employ a more conservative investment policy, with higher allocations to fixed income, notes Ripsman.

One option, says Forestell, is to annuitize plan assets. Which would allow for a pension plan to purchase the annuity from an insurance provider, thereby allowing for a guaranteed payout facilitated by the insurance company. However, plans that are too large, such as those in the Top 100, would not have that option because it puts too much reserve strain on insurance companies.

“It’s more likely that the large plans will look at hedging their interest rate [and mortality] risk,” Forestell says. He explains further by saying plan sponsors could do this by matching assets such as longterm bonds and, depending on the size of the plan, could use interest rate swaps and derivatives to offset liabilities. But only the largest plan sponsors, according to Forestell, are looking at strategies such as liabilitydriven investments(LDI)in small numbers.

Harry Marmer, senior vice-president, institutional investment services with Franklin Templeton Institutional in Toronto, agrees that plan sponsors [with closed plans] are changing strategies. “We’re seeing a lot of asset-liability work tied back to the requirement to ensure that you have the best asset mix to meet your investment objectives.” He stresses that plan sponsors are becoming more liability-sensitive than in the past.

Because closed plans are liability-sensitive, Marmer adds, a lot of plan sponsors are investing in something called “core-plus,” which is a strategy that invests in Canadian fixed income products but also looks outside Canada to try to add value. It’s only gaining ground in Canada because the Foreign Property Rule(FPR)has recently been lifted, and this particular fixed income “core-plus” market will explode in Canada, he stresses, in the next five years or so.

Forestell adds that, down the road, once plan sponsors are 100% funded or near that benchmark, they will reevaluate whether a 60-40 ratio of equities to fixed income is the right strategy for the future. “I think most will decide it is not,” says Forestell. Interestingly, when one looks at the trend lines over the past number of years(see “Ten-Year Allocation Trends” below), especially since the removal of the FPR, plan sponsors have steadily moved into non-Canadian investments.

For example, U.S. equity investments grew from 11.9% of a plan sponsors portfolio in 2005 to 12.4% in 2006. In dollar figures that part of the portfolio grew from $63 billion to $72.9 billion. Similarly, non- North American investments moved up from 12% in 2005 to 14% in 2006 or from $69.1 billion to $87.8 billion respectively. And over a 10- year period, plan sponsors have increased their Europe, Australasia and Far East investments from 6.7% in 1997 to 11.9% in 2006. Emerging markets, which had a slow start 10 years ago have seen a steady rise since about 2002.

On the other side of that coin, Canadian equity investments fell in the period from 2005 to 2006 from 26.4% to 23.9%, respectively. Also, investments such as cash and real estate have remained relatively flat and, in some cases, have even declined over the past 10 years.

Other strategies that have changed this year include the management of funds. This past year, DB plan sponsors have significantly reduced their balanced portfolios from $87.3 billion in 2005 to $34.5 billion in 2006. Consequently, the use of specialist management has increased from $233 billion in 2005 to $291.6 billion in 2006.

Even more than investment policy, plan sponsors that are going through a closure can look at plan design as a way to make the transition as seamless as possible for DB plan members.

When a plan sponsor freezes accruals that is the point where it would normally add a DC plan to accommodate future accruals and future service, says Ripsman. “If you are a plan sponsor that wants to keep the change neutral for employees, what you might be doing is providing a more generous DC formula for people with more service.” In this way, Ripsman adds, you can try to approach the DB accrual formula.


Besides investment strategies and plan design, plan sponsors must also consider how the closure of a DB plan will affect them from a legal standpoint. Any change to a plan can be, and usually is, a significant alteration for the terms of employment, “and a pension is a very significant term of employment,” states Mark Newton, national practice leader for the pensions and benefits practice at Heenan Blaikie in Toronto. Therefore, employers must give proper notice of any change to the retirement plan or face claims by plan members of constructive dismissal.

He says some employers use focus groups or group meetings to determine how plan members would react to the closure of a DB plan and will use the sessions as a way to telegraph that a change is under way. Also, a formal written notice should be provided to plan members with a definite date for the change. “That also alleviates claims for constructive dismissal,” he adds.

Sometimes employers face a situation in which younger employees who are in a DB plan want the option of participating in a DC plan, says Newton. However, the desire to be in one plan over another is less a legal concern for the plan sponsor and more of a human resource issue; plan sponsors need to clearly communicate to members what their options are.

Quite often, when plan sponsors freeze a DB plan and provide a new DC plan, they give projections to their workers about future payouts, which allow the members to understand what the new plans may hold in store for them.

[But] “if you’re providing those projections, you’d better make sure they’re accurate because 20 years down the road, if those projections don’t hold out, you might have a bunch of very irate plan members who may very well have the basis for legal action,” says Newton. As a result, when freezing plans, plan sponsors should avoid making promises that cannot be honoured, stresses Newton.


While assets continue to grow for the Top 100 pension plans, the fact of the matter is, DB plans are diminishing and DC plans are growing in their place.

Ultimately, the freezing or closing off of DB plans to new members creates investment and legal challenges for the plan sponsors. Generally, the market will see a gradual movement toward conservative investments as plan members get older and plans are closed off to new workers. Until then, plan sponsors that retain their plans will need to plan for an aging workforce and create investment strategies that work well with frozen plans.

The numbers

• In 2006, the Top 100 Pension Funds in Canada amassed $693.0 billion in assets, up $85.1 billion from the 2005 total of $607.9 billion.(2006 and 2005 figures do not include government debt, which appears in the government of Quebec’s public accounts. Prior years included this figure.)

• The total market value of the Top 100’s Canadian equity assets was $138.1 billion, a 6.3% increase from the $129.9 billion held in the asset class in 2005.

U.S. equity: $72.9 billion, up from $63.0 billion in 2005.

EAFE equity holdings: $87.8 billion, up from $65.2 billion in 2005.

Global equity holdings: $87.8 billion, up from $65.2 billion in 2005.

Canadian bond holdings: $154.5 billion, up from $149.6 billion in 2005.

Average asset mix:

Canadian equities 23.9%(2005: 26.4%);
EAFE equity 11.9%(2005: 11.4%);
Global equity 5.5%(2005: 4.3%);
Global bonds 0.5%(2005: 0.2%);
Real-return bonds 2.5%(2005: 2.7%);
Managed futures 0.1%(2005: 0.01%);
Real estate 4.2%(2005: 3.8%);
GICs 0.04%(2005: 0.03%);
Non-marketable securities 0.3%
(2005: 0.5%);
Infrastructure 0.5%(2005: 0.2%);
U.S. equities 12.4%(2005: 11.9%);
Emerging markets equity 0.9%
(2005: 0.6%);
Canadian bonds 27.8%(2005: 30.4%);
High-yield bonds 0.2%(2005: 0.2%);
Hedge funds 1.1%(2005: 0.9%);
Private equity 1.3%(2005: 0.6%)*;
Mortgages 1.5%(2005: 1.4%);
Cash 1.7%(2005: 2.2%);
Income trusts 0.2%(2005: 0.3%);
Commodities 0.2%;
Timber 0.03%;
EAFE plus emerging markets 1.1%;
U.S. bonds 0.1%;
Other 2.2%

*Venture capital and private placement have been removed from the survey. They are now included in private equity.


One, two step

Closing the DB plan wasn’t a straightforward process for Bell Aliant. “It was like ballroom dancing,” says Vivian Jennings, director of rewards for Bell Aliant in Halifax, about manoeuvring through its defined benefit(DB)plan closure. “In a waltz you keep on going in one direction but sometimes you have to take a sidestep or a back step to get forward, and that’s what it felt like when we went through our conversion.”

In 1993, Aliant and its four predecessors(Maritime Tel & Tel Limited, NBTel Inc., Island Telecom Inc., NewTel Communications Inc.)began closing DB plans. When the companies merged in 1999, one of the four existing plans was already outright closed, two were closed to management but not union employees, and one was still open.

As the company settled into its new structure, the goal was to become a defined contribution(DC)company, says Jennings. All the DB plans were then closed to new hires and only DC plans were offered. Those in DB plans could convert to a DC plan voluntarily. Bell Aliant closed the DB plan, says Eleanor Marshall, vice-president and treasurer in Saint John, N.B., because it doesn’t fit with the changing workforce, the cost was too high, and “it had the potential to really affect cash flow and financial results due to the volatility.”

The changes sparked dissatisfaction among the current employees. “There was inequality between the existing offerings,” says Marshall, adding that in some cases, employees were sitting next to one another and had different plans. “It created a lot of noise from the employees,” recalls Jennings. In addition, the weak performance of the markets in early 2000 added to the frustration of those in DC plans. Jennings started on a strategy to align the DB plans and the DC plans to address concerns.

By 2004, there was a labour disruption and pensions became a critical issue. “People wanted back in the DB plans,” says Marshall. After five months, the union and Bell Aliant came to a deal. The management employees who were previously in the DB plan and had voluntarily switched to DC were allowed to convert back. All union employees were put into the DB plan. Any new hires—management or union—were only offered DC. In total, four plans now exist: a DB for management and one for the union and a DC for management and one for the union. Both DB plans are closed.

Jennings embraced this complex challenge as a chance to help employees. “Employees have a tendency to focus on their pensions only near retirement or when there are changes. It gave us the opportunity to go out and conduct pension education sessions,” she says. The company currently offers separate sessions for DB and DC members. Jennings plans to introduce advanced education sessions in the future along with a substantial online component for pensions with tools and information.

On the investment side, says Marshall, now that the DB plan is closed they are changing the asset mix to focus on matching assets to liabilities. The DB plan liabilities could double in the next 10 years, she says, and the goal is to get it to a fully funded status, reduce volatility and surplus/deficit so it doesn’t severely impact future years.

Regardless of how many steps were taken, Bell Aliant reached its goal of becoming a DC company and equalizing its pension offerings. But, says Marshall, “you don’t start seeing the benefits of [the decisions to close a plan] for years.” —Leigh Doyle


Freeze frame

Helping employees transition to DC is Sears Canada’s primary focus. In just over a year, Sears Canada will freeze its defined benefit(DB)plan and introduce a defined contribution(DC) plan for its associates. This leaves little time to work through the administrative changes required for the switch. For Lee Hornberger, pension and benefits manager for Sears Canada in Toronto, the focus is on the plan members. “We’re very committed to educating people through this transition,” she says. “We want to make sure we give people the appropriate tools and knowledge to take action.”

In February, Sears Canada announced that it would freeze its DB plan as of July 1, 2008. The formula for calculating the benefit will still recognize compensation growth, but will not include years of service. “The volatility of the cost of administering a defined benefit plan was the driving reason for the freeze,” says Hornberger. A DC plan will be opened at that time for all existing plan members and new hires.

During the planning for the freeze, Hornberger started on a communication strategy so members would have information they needed when the changes were announced. “We wanted to [give] as much information as possible to our associates through written communication,” she says, “and then [we held] a series of presentations for three or four weeks across the country.” More than half of the plan members had attended these mandatory sessions within two weeks. Sears Canada also sent mail-outs to all employees about the changes and had a toll-free number for questions.

So far, Sears Canada has had success with its communication plan and Hornberger wants that to continue. In the coming months, there will be optional education sessions. When enrollment starts in early 2008, there will be mandatory meetings again. “We want to make sure we reach everybody—especially during enrollment—so members will have the tools to make decisions.” —Leigh Doyle


Phased-in retirement: Win, Win?

One solution to the DB dilemma for some has been the recent passing of the federal government’s 2007 budget— specifically the portion specifying the allotment for phased-in retirement. The new rules allow employees to receive pension benefits from a DB registered pension plan and simultaneously accrue further benefits. And despite many in the pension world seeing this as a win-win for employers and employees, not everyone thinks this is the case. Paul Forestell, with Mercer, says what the budget allows is a win for employees and essentially allows them to double-dip when it comes to saving for retirement.

It’s not as obvious to me how this is good for employers,” he states. He goes on to say that in a non-unionized private sector pension plan, a member has to be well into their 60s to collect an unreduced pension. Therefore, Forestell notes, “government employees will benefit from this but it will be of less benefit to private sector plans because of this unreduced retirement criteria where you have to be already unreduced.”

He says the real benefit would come for employees who want to retain workers who are two or so years away from retirement. The phased-in provision would allow them to work part-time towards the end of their career but still retire with a full pension later on.

Still, says Forestell, “while welcome, I’m not sure [the government] has gotten it right on phased-in retirement.”

Joel Kranc is managing editor of BENEFITS CANADA.

For a PDF version of this article, which includes the Top 100 pension plans, click here.

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