Two ways to get employees to save as they should
Pension plan sponsors have been moving toward defined contribution plans and away from defined benefit plans. While in some circles the debate continues about the merits of one system over the other, the growth in defined contribution pension and other capital accumulation plans, like group RRSPs, has revealed fundamental flaws in the system that regulates the capital accumulation plan (CAP) market.
The problems are manifest in widespread anxiety and apathy among plan members, and concern about legal protections among plan sponsors.
Recently, the Canadian Association of Pension Supervisory Authorities (CAPSA) published best practice guidelines for plan sponsors, which, while helpful, overlooked two areas for potential reform.
Offering members advice and allowing automatic enrolment within capital accumulation plans would go along way to fighting the participant anxiety and apathy that plagues plan sponsors.
Whether to provide advice or not, that is the question
The shift to defined contribution from defined benefit has more advantages for employers than it does for employees.
A disadvantage for many employees within CAP plans is the requirement to select their own investment options. Financial investing is a daunting prospect and most employees feel uncomfortable managing their own retirement savings.
So why isn’t advice being put forward as an option to employees? Many sponsors are fearful of offering advice in the event that it may lead to litigation from employees who claim to have received bad advice.
Bemoaning the lack of “safe harbour” rules, a Canadian consulting firm has recommended to its clients (plan sponsors) that they not offer advice to employees. The reason was the recently released CAP guidelines from CAPSA do not offer any protection for the employer that wishes to do so.
Safe harbour rules, like those in the U.S., provide protection against employee litigation. These rules include direction to the sponsors on the minimum number of fund options to offer employees, disclosure requirements for funds, and allowances for participant trading throughout the year. While some people like the prescriptive guidelines set forth in U.S. law, others argue against them because explicit rules can be extremely difficult to meet for sponsors.
It should be noted that there are no explicit safe harbour rules for the provision of advice in the U.S., but a legal environment has been created that makes the risks of doing nothing greater than the risks of providing advice.
While the CAP guidelines have been criticized for not offering more explicit safe harbour protections, in the minds of others, the CAP guidelines have appropriately adopted a spirit of prudence and reasonableness instead of rigid rules, which is a benefit to sponsors.
For instance, the CAP guidelines do suggest that participants should seek advice. They also propose best practices to follow should a sponsor wish to offer advice to employees.
Advice can take the form of fee for service or asset-based compensation through advisors and planners. Sponsors will need to assess whether this advice is any more risky than letting participants either not select options at all or select investments based upon their limited knowledge of the markets.
Paul Litner, a partner of Osler Hoskin & Harcort’s pensions and benefits practice, notes, “I don’t see a greater legal risk to sponsors by making investment advice available to CAP participants than not making it available. It’s a bit of a ‘Catch-22’ for sponsors. If you don’t offer advice, some members might claim that they didn’t know how to invest, and the sponsor/administrator owed them a duty to provide them with investment advice (access to a qualified professional for such advice). If you do offer them advice, it must be by a qualified individual and the sponsor may have to do some due diligence on the firm/individual or it may be at risk. But as long as the sponsor has been prudent in selecting qualified advisors, in my view the risk of the sponsor being liable for advice given by that person is remote.”
Automatic enrolment blocked in Canada
Automatic enrolment for company matching plans is on the other hand not an option today. That’s because the Canadian Labour Code and provincial laws such as the Ontario Employment Standards Act do not allow an employer to deduct money without expressed consent from the employee.
However, given that the U.S. experience with automatic enrolment has been so favourable, Canada’s pension industry would benefit from investigating the changes necessary to implement this tool.
Some retirement plans in Canada are mandatory plans, where sponsors automatically direct money into the employees accounts; others are matching plans requiring a participant to enroll in the plan and defer their own money to attract the company match.
Plan participants left to make their own decisions in group plans often follow the path of least resistance, and that means not enrolling. Sponsors need to be concerned about apathy and should carefully document the steps taken to inform participants about the company plan and the action needed to attract the company match. A long-term risk for sponsors is that they are sued by these apathetic employees who, now retired, claim they have insufficient funds for retirement on account of poor education efforts by their employer.
Participant inertia was the subject of a 2002 study by a number of eminent American finance and economic professors entitled, Defined Contribution Pensions: Plan Rules, Participant Choices, and the Path of Least Resistance. The study showed a dramatic difference in enrolment rates for those companies that decided to implement automatic enrolment compared to less favourable enrolment increases for the companies that chose traditional means of encouraging employees.
“For better or for worse, plan administrators can manipulate the path of least resistance to powerfully influence the savings and investment choices of their employees,” wrote the authors. Before the automatic enrolment began, employees who had worked for six months at three of the companies surveyed, participated in plans at rates of 26 per cent to 43 per cent. But among employees hired after enrolment became automatic, participation after six months’ tenure ranged from 86 per cent to 96 per cent.
Other countries are exploring automatic enrolment.
This year in the United Kingdom, a pensions commission released a report devoting considerable discussion to participant behaviour and the ensuing issues around employee inertia. The paper says, “Many people will only save if some trusted institution, such as the government or their employer, instructs or encourages them to save, or facilitates saving via automatic enrolment. Or they will only save if a financial advisor persuades them to.”
It is disappointing that the CAP guidelines did not address participant inertia in Canada other than a mention of default funds which are both reactive and ineffective. While there are issues with automatic enrolment, including a dilemma about what fund options to provide automatically enrolled participants, the risks of doing nothing could be more significant.
Some professionals agree that using life cycle funds based upon a participants’ age would be a suitable solution for automatically enrolled participants. Federal and provincial laws would need to be amended to implement this type of solution in Canada. While the U.S. has made changes to its system at the federal level, it will take significant pressure from pension constituents to get the ball rolling in Canada.
Adam Neal is vice-president, sales and relationship management with Open Access, a record-keeper for capital accumulation plans. He can be reached at (416) 364-8434.
The problems are manifest in widespread anxiety and apathy among plan members, and concern about legal protections among plan sponsors.
Recently, the Canadian Association of Pension Supervisory Authorities (CAPSA) published best practice guidelines for plan sponsors, which, while helpful, overlooked two areas for potential reform.
Offering members advice and allowing automatic enrolment within capital accumulation plans would go along way to fighting the participant anxiety and apathy that plagues plan sponsors.
Whether to provide advice or not, that is the question
The shift to defined contribution from defined benefit has more advantages for employers than it does for employees.
A disadvantage for many employees within CAP plans is the requirement to select their own investment options. Financial investing is a daunting prospect and most employees feel uncomfortable managing their own retirement savings.
So why isn’t advice being put forward as an option to employees? Many sponsors are fearful of offering advice in the event that it may lead to litigation from employees who claim to have received bad advice.
Bemoaning the lack of “safe harbour” rules, a Canadian consulting firm has recommended to its clients (plan sponsors) that they not offer advice to employees. The reason was the recently released CAP guidelines from CAPSA do not offer any protection for the employer that wishes to do so.
Safe harbour rules, like those in the U.S., provide protection against employee litigation. These rules include direction to the sponsors on the minimum number of fund options to offer employees, disclosure requirements for funds, and allowances for participant trading throughout the year. While some people like the prescriptive guidelines set forth in U.S. law, others argue against them because explicit rules can be extremely difficult to meet for sponsors.
It should be noted that there are no explicit safe harbour rules for the provision of advice in the U.S., but a legal environment has been created that makes the risks of doing nothing greater than the risks of providing advice.
While the CAP guidelines have been criticized for not offering more explicit safe harbour protections, in the minds of others, the CAP guidelines have appropriately adopted a spirit of prudence and reasonableness instead of rigid rules, which is a benefit to sponsors.
For instance, the CAP guidelines do suggest that participants should seek advice. They also propose best practices to follow should a sponsor wish to offer advice to employees.
Advice can take the form of fee for service or asset-based compensation through advisors and planners. Sponsors will need to assess whether this advice is any more risky than letting participants either not select options at all or select investments based upon their limited knowledge of the markets.
Paul Litner, a partner of Osler Hoskin & Harcort’s pensions and benefits practice, notes, “I don’t see a greater legal risk to sponsors by making investment advice available to CAP participants than not making it available. It’s a bit of a ‘Catch-22’ for sponsors. If you don’t offer advice, some members might claim that they didn’t know how to invest, and the sponsor/administrator owed them a duty to provide them with investment advice (access to a qualified professional for such advice). If you do offer them advice, it must be by a qualified individual and the sponsor may have to do some due diligence on the firm/individual or it may be at risk. But as long as the sponsor has been prudent in selecting qualified advisors, in my view the risk of the sponsor being liable for advice given by that person is remote.”
Automatic enrolment blocked in Canada
Automatic enrolment for company matching plans is on the other hand not an option today. That’s because the Canadian Labour Code and provincial laws such as the Ontario Employment Standards Act do not allow an employer to deduct money without expressed consent from the employee.
However, given that the U.S. experience with automatic enrolment has been so favourable, Canada’s pension industry would benefit from investigating the changes necessary to implement this tool.
Some retirement plans in Canada are mandatory plans, where sponsors automatically direct money into the employees accounts; others are matching plans requiring a participant to enroll in the plan and defer their own money to attract the company match.
Plan participants left to make their own decisions in group plans often follow the path of least resistance, and that means not enrolling. Sponsors need to be concerned about apathy and should carefully document the steps taken to inform participants about the company plan and the action needed to attract the company match. A long-term risk for sponsors is that they are sued by these apathetic employees who, now retired, claim they have insufficient funds for retirement on account of poor education efforts by their employer.
Participant inertia was the subject of a 2002 study by a number of eminent American finance and economic professors entitled, Defined Contribution Pensions: Plan Rules, Participant Choices, and the Path of Least Resistance. The study showed a dramatic difference in enrolment rates for those companies that decided to implement automatic enrolment compared to less favourable enrolment increases for the companies that chose traditional means of encouraging employees.
“For better or for worse, plan administrators can manipulate the path of least resistance to powerfully influence the savings and investment choices of their employees,” wrote the authors. Before the automatic enrolment began, employees who had worked for six months at three of the companies surveyed, participated in plans at rates of 26 per cent to 43 per cent. But among employees hired after enrolment became automatic, participation after six months’ tenure ranged from 86 per cent to 96 per cent.
Other countries are exploring automatic enrolment.
This year in the United Kingdom, a pensions commission released a report devoting considerable discussion to participant behaviour and the ensuing issues around employee inertia. The paper says, “Many people will only save if some trusted institution, such as the government or their employer, instructs or encourages them to save, or facilitates saving via automatic enrolment. Or they will only save if a financial advisor persuades them to.”
It is disappointing that the CAP guidelines did not address participant inertia in Canada other than a mention of default funds which are both reactive and ineffective. While there are issues with automatic enrolment, including a dilemma about what fund options to provide automatically enrolled participants, the risks of doing nothing could be more significant.
Some professionals agree that using life cycle funds based upon a participants’ age would be a suitable solution for automatically enrolled participants. Federal and provincial laws would need to be amended to implement this type of solution in Canada. While the U.S. has made changes to its system at the federal level, it will take significant pressure from pension constituents to get the ball rolling in Canada.
Adam Neal is vice-president, sales and relationship management with Open Access, a record-keeper for capital accumulation plans. He can be reached at (416) 364-8434.
