Workers won’t like it, but DB plans are too risky to maintain, expert says
Canada’s pension system has become a dangerous place for plan sponsors, and rather than waiting for governments to reduce that danger, employers should act immediately to protect their organizations, said a leading Canadian pension expert in a headline-grabbing speech last month.
The double-digit market returns enjoyed during last decade’s stock market boom are likely gone for good. On top of that, the pension system has matured, which means there are more pensioners than ever. Further, benefits have been improved and assets and liabilities in some cases have outgrown the enterprise supporting them, said Malcolm Hamilton, a principal of Mercer Human Resource Consulting.
In a difficult business environment, pension risks can threaten the survival of an organization. “For some, unfortunately, there is only one warning — the first wave capsizes the boat. For most there will be many warnings and many opportunities to act before it is too late,” he said.
Ideally, governments should improve the pension system, but plan sponsors cannot wait for that to happen. Recent government behaviour suggests the political willpower to make unpopular but necessary changes may be lacking. The Ontario government proposed positive changes to clear up the sticky issue of surplus ownership last year, but it beat a hasty retreat at the first sign of public criticism, he said.
If there is no plan, don’t start one
If an organization is just starting out it shouldn’t even create a pension plan, he said. If that isn’t feasible, the sponsor should start a defined contribution (DC) plan.
The flaws in the system are greatest with defined benefit (DB) plans, still the most common model.
For those already with a plan, it is important to look closely at the costs of the plan and make sure the accounting is right. “The long and the short of it is that companies have probably been underestimating the cost of the plans,” said Hamilton, in an interview with Canadian HR Reporter.
Once the true cost is established, sponsors can consider cost containment strategies.
“Most sponsors, if they could get out of their (DB) plan, they would,” he said. The most common way to do this is create a DC plan, direct all new members into that plan as well as offering it to existing DB plan members. “And then, let (the defined benefit plan) run out,” he says.
Even by going the defined contribution route, sponsors need to be aware of the inherent risks, most notably, the recent proliferation of class action suits which will likely increase in the future.
“Every class action lawyer in the country is just itching to second guess any investment information, suggestion or advice that turns out poorly,” he told his audience of pension plan managers in Toronto last month.
In his address, Hamilton said the significant changes that are in order will upset a lot of plan members. “From an employee’s perspective none of this is good news. There is no opportunity here for the HR department to be the bearer of good news because there is no good news to bear,” he said.
But it is time to dispel the myth that employers have an obligation to protect employees for life. “You pay them and you tell them to behave like adults and when the time comes you tell them to save for retirement and invest wisely,” he said.
In the past, it was assumed employees didn’t have the investment knowledge or experience to save for retirement. That is not the case, he said. Employers can take the money put into a pension plan and give it directly to the employees and let them invest it themselves. “There is no reason to think they will be dismal failures at saving for their own retirement,” he said.
Change must be holistic
Steve Bonnar, a pension specialist with Towers Perrin, agreed with much of what Hamilton said in his speech. “I think we do have big problems with the private pension system in Canada,” he said. But he is confident improvements to the system may be on the way.
“I think we are at an opportune time where we can start to make some fundamental changes to the system.”
It won’t be easy, but there is emerging consensus and agreement among professionals in the pension industry that there are fundamental problems. Organizations like Towers Perrin and other consulting firms have just begun to look for answers, but ultimately it is going to take involvement from all the principals in the pension system, including sponsors and members, he said.
“My personal view is that we need to rethink the overall framework of how pension plans are delivered,” he said.
“It’s tempting to try to fix each of the problems individually but I fundamentally don’t believe that is the right approach. There needs to be a holistic solution,” he said.
“Just trying to put scotch tape in one place and stick a finger in the dike somewhere else might work, but it has the potential to cause problem somewhere else.”
He cites as an example the long-lasting Monsanto case which deals with the issue of surplus ownership and is now before the Supreme Court. The issues in the Monsanto case arose from an effort to protect members, but that protection has been extended too far to the detriment of sponsors.
DBs aren’t all bad
Some of what Hamilton said in his speech may have been intended to shock, but there are people who need to be shocked, said Ian Markham, a pension expert with Watson Wyatt.
“To the extent that some politicians might finally sit up and say, ‘Oh, it is that bad?’, if it could make some people listen, that is good.”
Improvements to the system definitely are in order, but he does not agree defined benefits plans are all bad.
Defined pension benefits plans serve an important purpose. Considering only the impact on shareholders, ignores the HR value of a DB plan, he said. Human resources leaders still need to attract and retain key people and DB plans are important tools to that end, he said.
While it is true organizations need to reduce the risk inherent in sponsoring a DB pension plan, there is also a risk that an organization will not be able to attract the key people it needs to produce its goods and services if it makes the wrong changes to its pension plan.
The double-digit market returns enjoyed during last decade’s stock market boom are likely gone for good. On top of that, the pension system has matured, which means there are more pensioners than ever. Further, benefits have been improved and assets and liabilities in some cases have outgrown the enterprise supporting them, said Malcolm Hamilton, a principal of Mercer Human Resource Consulting.
In a difficult business environment, pension risks can threaten the survival of an organization. “For some, unfortunately, there is only one warning — the first wave capsizes the boat. For most there will be many warnings and many opportunities to act before it is too late,” he said.
Ideally, governments should improve the pension system, but plan sponsors cannot wait for that to happen. Recent government behaviour suggests the political willpower to make unpopular but necessary changes may be lacking. The Ontario government proposed positive changes to clear up the sticky issue of surplus ownership last year, but it beat a hasty retreat at the first sign of public criticism, he said.
If there is no plan, don’t start one
If an organization is just starting out it shouldn’t even create a pension plan, he said. If that isn’t feasible, the sponsor should start a defined contribution (DC) plan.
The flaws in the system are greatest with defined benefit (DB) plans, still the most common model.
For those already with a plan, it is important to look closely at the costs of the plan and make sure the accounting is right. “The long and the short of it is that companies have probably been underestimating the cost of the plans,” said Hamilton, in an interview with Canadian HR Reporter.
Once the true cost is established, sponsors can consider cost containment strategies.
“Most sponsors, if they could get out of their (DB) plan, they would,” he said. The most common way to do this is create a DC plan, direct all new members into that plan as well as offering it to existing DB plan members. “And then, let (the defined benefit plan) run out,” he says.
Even by going the defined contribution route, sponsors need to be aware of the inherent risks, most notably, the recent proliferation of class action suits which will likely increase in the future.
“Every class action lawyer in the country is just itching to second guess any investment information, suggestion or advice that turns out poorly,” he told his audience of pension plan managers in Toronto last month.
In his address, Hamilton said the significant changes that are in order will upset a lot of plan members. “From an employee’s perspective none of this is good news. There is no opportunity here for the HR department to be the bearer of good news because there is no good news to bear,” he said.
But it is time to dispel the myth that employers have an obligation to protect employees for life. “You pay them and you tell them to behave like adults and when the time comes you tell them to save for retirement and invest wisely,” he said.
In the past, it was assumed employees didn’t have the investment knowledge or experience to save for retirement. That is not the case, he said. Employers can take the money put into a pension plan and give it directly to the employees and let them invest it themselves. “There is no reason to think they will be dismal failures at saving for their own retirement,” he said.
Change must be holistic
Steve Bonnar, a pension specialist with Towers Perrin, agreed with much of what Hamilton said in his speech. “I think we do have big problems with the private pension system in Canada,” he said. But he is confident improvements to the system may be on the way.
“I think we are at an opportune time where we can start to make some fundamental changes to the system.”
It won’t be easy, but there is emerging consensus and agreement among professionals in the pension industry that there are fundamental problems. Organizations like Towers Perrin and other consulting firms have just begun to look for answers, but ultimately it is going to take involvement from all the principals in the pension system, including sponsors and members, he said.
“My personal view is that we need to rethink the overall framework of how pension plans are delivered,” he said.
“It’s tempting to try to fix each of the problems individually but I fundamentally don’t believe that is the right approach. There needs to be a holistic solution,” he said.
“Just trying to put scotch tape in one place and stick a finger in the dike somewhere else might work, but it has the potential to cause problem somewhere else.”
He cites as an example the long-lasting Monsanto case which deals with the issue of surplus ownership and is now before the Supreme Court. The issues in the Monsanto case arose from an effort to protect members, but that protection has been extended too far to the detriment of sponsors.
DBs aren’t all bad
Some of what Hamilton said in his speech may have been intended to shock, but there are people who need to be shocked, said Ian Markham, a pension expert with Watson Wyatt.
“To the extent that some politicians might finally sit up and say, ‘Oh, it is that bad?’, if it could make some people listen, that is good.”
Improvements to the system definitely are in order, but he does not agree defined benefits plans are all bad.
Defined pension benefits plans serve an important purpose. Considering only the impact on shareholders, ignores the HR value of a DB plan, he said. Human resources leaders still need to attract and retain key people and DB plans are important tools to that end, he said.
While it is true organizations need to reduce the risk inherent in sponsoring a DB pension plan, there is also a risk that an organization will not be able to attract the key people it needs to produce its goods and services if it makes the wrong changes to its pension plan.
