Mind the Governance Gap
In 2004, Canada’s financial regulators ignited interest in DC plan governance when they released the CAP Guidelines, a broad statement of best practices with respect to DC plan administration. Since then, even the highest levels of organizations have taken an interest in pension governance.
“Boards of directors are taking a keen interest in the company’s pension plans, and DC plans are no exception,” says Elizabeth Brown, head of Hicks Morley’s pension and benefits practice group. Decision- makers want a detailed checklist of DC plan administration tasks, including who is responsible for each task, to identify any gaps in the governance process.
By law, the buck stops with the employer, but external service providers often perform the day-to-day plan administration. Employers should review their contracts with service providers, keeping governance concerns in mind. “Employers are looking at their service-provider arrangements to ensure that the provider is contractually held to a fiduciary standard, that their liability is not unreasonably limited, and that fees are reasonable,” notes Terra Klinck, a partner and recent addition to the Hicks Morley group.
Financial advisors estimate that Canadians need roughly 60% to 70% of their pre-retirement incomes to live comfortably in retirement. As DC plans mature, plan sponsors are asking whether the investment education, benefits calculators and projection tools they’re providing are adequate to enable members to properly plan for retirement.
“Benefits adequacy education is an often neglected element of DC plan management,” says Susan Nickerson, a partner in the group. “If members don’t understand what they can expect from their DC benefits, this presents a legal risk to the employer.”
A commitment to clear, effective communication is one way to mitigate this risk. Another is to regularly encourage plan members to seek independent financial advisors who can help employees examine their retirement lifestyle expectations in light of their total savings. Because not all employees will seek expert advice, Nickerson stresses that “it’s important to document your communication efforts to show that employees understood the benefits of such advice, even if they never pursued it.”
Invest in Options
Many employers choose DC arrangements over traditional DB plans because the investment risk is transferred from the employer to the plan members. However, DC plan sponsors still have an ongoing duty to examine the performance of the investment options, and to ensure that members can select from a range of choices offering appropriate opportunities for diversification and liquidity.
“Members should have a varied menu of investment options to choose from and be able to understand the risks and expected returns of each option,” notes Stephanie Kalinowski, a partner in the group. “And, because investment products and investment managers are always changing, and the demographics of the plan members can shift over time, what’s best for your plan and its members today may not be best a few years from now. That’s why a regular review of your plan’s menu of investment options is so important.”
Don’t Lose by Default
Member indifference is a challenge that many DC plan sponsors face. In some cases, a large percentage of the plan members may be wholly invested in the default investment option because they failed to provide instructions on how they wanted their contributions invested.
“If a significant percentage of members are invested only in the default fund, this can be symptomatic of an ineffective investment education program,” observes Lisa Mills, a partner in the group.
The CAP Guidelines state that DC plan members should be made aware of the risks of failing to provide investment directions, and that they should be told about the characteristics and risks of the default investment option. However, industry standards continue to evolve. Simply providing this information at the time of enrollment may no longer be enough to mitigate the default risk.
“Employers are taking a fresh look at their DC plan’s default investment option and asking whether it is too risky or too conservative in light of the demographic characteristics, experience and investment horizon of the plan’s membership,” notes Mills.
More and more, DC plan members are asking their employers to add socially responsible investment (SRI) options— funds for which social, environmental and other non-financial criteria are used to select the underlying investments—to the menu of available funds. With the demand for SRI options gaining steam, boards of directors and pension committees are under pressure to meet that demand while still ensuring that the funds provide competitive returns.
“Fund providers offer a wide range of ‘ethical’ funds, and plan sponsors must keep their fiduciary duty to plan members top of mind when dealing with SRI issues,” says Jordan Fremont, an associate in the group.
The decision to “go green” should be made carefully. “It involves much more than just adding a couple of funds,” says Fremont. “You’ll want to understand the risk profile of each new fund and consider any SRI additions in the context of your current investment lineup.”
Change is a constant in the pension world. While DC plans are an effective way to deliver retirement benefits to employees, plan sponsors need to stay on top of evolving governance standards and best practices to properly mitigate the risks and maintain the health of their plans.
John Prezioso is a lawyer with Hicks Morley Hamilton Stewart Storie LLP. firstname.lastname@example.org
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