So, what have pension plan sponsors learned from the financial crisis?
Prepare to pay – Although DB plans can arguably deliver retirement benefits more efficiently than DC plans, there is no free lunch. A generous DB plan is likely to be expensive over time. And while the longterm cost can be lowered if a plan sponsor’s risk budget is higher, DB costs are likely to be considerable over the next few years, barring a significant market rebound.
Communicate plan value – Most plan members don’t understand or appreciate the value of their DB plans. However, in times of uncertainty, most older members draw comfort from the knowledge that their annual pension income is more predictable than the annual income that they will draw from their RRSPs. Today, plan sponsors have a perfect opportunity to emphasize that value. But they also need to communicate the risk, reminding members that there is no such thing as a “guaranteed” pension.
Provide adequate benefits – Studies show that if DB plans disappear, workers will be more likely to retire with inadequate pensions or, worse, won’t be able to retire at all and will “retire on the job” instead. Before the financial crisis, this concern was somewhat theoretical—most DC plans are not mature and investment returns in the last few years have been strong. This concern has now become real as many Canadians have seen the value of their retirement savings drop 10% to 20% or more.
Assess affordability – Plan sponsors should realistically assess how much they can afford and how much volatility they can handle, then design their plans accordingly. Many plan sponsors have been burned by taking on significant risk to reduce long-term costs. This may not be something they’re prepared to live with in the future, particularly if the plan is mature and contribution or pension expense swings greatly affect cash flow or earnings per share.
Think market to market – Both cash contributions and income statement pension expense are becoming more and more market to market as a result of evolving solvency and accounting standards. This means that many return-seeking investment strategies take on potentially more risk relative to the liabilities. Although this may result in lower costs in the long term, it may increase volatility in the short term from a solvency or accounting perspective.
Will DB Plans Survive?
What does all of this mean for the future of DB plans? Many plan sponsors have already moved to some combination of DB and DC. Based on the Survey on Pension Risk, more participants offer a combination of DB and DC than either DB alone or DC alone.
The pension plan of the future will likely have some element of DC, which makes sense from a risk-sharing and a flexibility perspective. As to whether or not there will be a DB component, I believe this does provide significant value and will continue to be useful to many organizations. Here are some factors that could enhance the DB proposition.
• Plan sponsors need to understand mismatch risk and take steps to manage this risk by adopting more liability driven investing strategies—and stick with these strategies even if the markets come back strongly. This means developing a plan design that appropriately reduces risk going forward and an investment risk budget that reflects an appropriate level of risk relative to the liabilities. Given the market changes in the last few months, this risk budget will likely look significantly different than it would have a few months ago.
• Governments across Canada should take steps to simplify legislation, allow for the creation of more flexible plan designs, and allow plan sponsors and plan members to choose a plan design that best meets their collective needs.
• Older workers will begin pushing for more stable sources of retirement income. We have lived through the perfect storm in the early 2000s and now, according to many, the worst financial crisis in the last 50 years. Both of these events have occurred within a short period. At the same time, the workforce is aging quickly and demand for talent is likely to outstrip supply. All this adds up to the likelihood that the relative stability of DB plans will make them more attractive.
• Companies need to realize the importance of workforce planning and align their reward systems, including pension plans, accordingly. DB pension plans play a part in the attraction, retention and orderly exit of workers, and they can help organizations to manage future workforce challenges. DB plans are good for employees and good for society as a whole. They can also be good for employers in many circumstances. While times are tough for DB plan sponsors at the moment, they are arguably even tougher for DC plan members.
To some degree, the fate of DB plans lies in the hands of the various regulators, which are considering both temporary and long-term changes. But if employers can find an appropriate balance between cost and risk—and if the regulatory environment can find a fair balance between protecting the benefits of members and burdening plan sponsors—then DB plans can survive and even prosper
David Burke is retirement practice director, Canada, with Watson Wyatt Worldwide.
> click here for a PDF version of this article
© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the February 2009 edition of BENEFITS CANADA magazine.