The holiday season is a time to reflect on the events of 2019 and how they may affect trends in the year to come.
I predict a couple of trends on the pension landscape in 2020: much needed progress on the expansion of decumulation options and the outsourcing of the chief investment officer function.
Expansion of decumulation options:
People whose retirement savings are primarily in capital accumulation plans, such as defined contribution pension plans or registered retirement savings plans, face a number of risks during their retirement years. These include longevity risk — the risk that retirees live beyond their savings — and the risk that the investment returns on their savings will be lower than expected. These risks could lead to people’s savings running out during their retirement years.
During 2019, federal and provincial governments proposed legislative changes aimed at providing retirees with more options to help manage these risks as they decumulate their retirement savings:
Variable benefits. Historically, DC plan members were required to transfer their entire DC account balance out of the plan, either purchasing an annuity or depositing their savings in a personal locked-in vehicle, such as a life income fund, in order to draw periodic retirement income from the account.
In recent years, provincial governments have amended pension legislation to permit employers to offer variable benefits within their DC plans. As the change takes effect in Ontario on Jan. 1, 2020, variable benefits will be permitted in all Canadian jurisdictions, except for New Brunswick and Newfoundland.
Variable benefits allow pension plan members to keep their DC account balance in their employer plan and draw periodic retirement income, subject to minimum and maximum limits on annual withdrawals. This enables members to increase their retirement income by benefiting from the lower fees negotiated by employers compared to the fees payable in typical retail products and from their employer’s oversight of the investment options offered in the DC plan.
Advanced life deferred annuities. Current tax rules allow a DC plan or RRSP member to purchase an annuity from an insurance company with the assets in their account, but annuity payments must begin no later than age 71. In order to help protect individuals against longevity risk, the 2019 federal budget proposed new rules to allow members to use a portion of their savings to purchase an advanced life deferred annuity, which will defer the commencement of annuity payments to as late as age 85. These new rules are expected to take effect on Jan. 1, 2020.
Variable payment life annuities. The 2019 federal budget also announced that tax rules will be amended to allow a new option for DC plans called variable payment life annuities. Under this option, DC plan members can allocate their account balances to a separate annuities fund within the plan.
The fund would then pool all individual members’ account balances and convert them to a regular monthly pension payable for each member’s lifetime. The monthly pension amounts will be adjusted periodically to reflect the pooled mortality and investment experience of the fund. This option enables DC plan members to pool their longevity and investment risk with the other retirees who elect this option. While the new tax rules are expected to be effective on Jan. 1, 2020, provincial and federal pension legislation will also need to be amended to accommodate the option.
These legislative changes are good news for Canadians, and I expect the options will be developed further in 2020. Hopefully, more employers will add variable benefits to their DC pension plans, insurance companies will begin offering ALDA products and the provincial and federal governments will begin working on the legislative changes required to implement VPLAs.
Outsourced chief investment officers:
One of the trends that’s emerged over the past few years is the outsourcing of the chief investment officer function for pension plans. Under this governance structure, the plan administrator maintains overall responsibility for the investment of the plan’s assets and continues to set the high-level investment strategy (i.e., asset allocation) for the plan.
However, the implementation of the investment strategy, such as the choice of specific funds and the hiring and firing of investment managers, is delegated to a third party.
The potential benefits of the OCIO model include allowing the employer to focus on their core business by spending less time managing their pension plan. As well, when there’s a need to replace underperforming investment managers, the third party can quickly execute this change. If the employer has a journey plan in place for de-risking the plan’s investments as its funded status improves, the third party can more closely monitor the triggers and quickly adjust the asset mix so the de-risking opportunities aren’t missed as a result of management delays. And the third party also has the ability to negotiate lower investment management and custodial fees for the plan, due to the economies of scale achieved through its role in the investment manager of many pension plans.
Because of its advantages, I expect the trend towards the OCIO model will continue, and likely increase, in 2020.