n recent months, sponsors of defined contribution or capital accumulation plans (CAPs) have faced increasing member and regulatory scrutiny.
The increased concerns stem from a “perfect storm” of converging global pension issues: negative fund returns, falling interest rates, questions about mutual fund trading practices, corporate scandals, an aging population and an uncertain regulatory environment for both CAPs and for pension governance practices.
Regulatory concern arises in part from the recognition that pension legislation was essentially written for defined benefit plans, with little regulation or clear standards for DC plans.
As well, there was some concern by securities law regulators that the value in securities law principles and prospectus-type disclosure was not being applied to some CAP members.
Sponsors should be aware of the following pending changes to the regulatory environment for CAPs and the practical implications they may have.
It would be helpful, however, to remember what helped spur the explosion of CAPs in the late ’80s and ’90s. In part, plan sponsors were deliberately transferring investment risk and decision-making to plan members.
The change was welcomed by many plan members. What was not expected, by either party, was the increasing expectation, at least by regulators, that plan sponsors continue to have an obligation to educate and inform plan members about investment risk and fund selection, perhaps even provide access to educational tools and financial advisors.
There are legitimate concerns by sponsors that CAPs could become over-regulated, too costly or face new legal liability. The proposed regulatory changes should be viewed in light of these increased burdens on plan sponsors.
Joint Forum Guidelines for capital accumulation plans
The Joint Forum of Financial Market Regulators released proposed “Guidelines for Capital Accumulation Plans (CAPs)” in April 2003. CAPs in this context include DC registered pension plans, group RRSPs and deferred profit sharing plans where the member controls the investments. By and large, the guidelines recognize current industry practices and support continuous improvement in best practices, help clarify the responsibilities of CAP members, sponsors and service providers, and try to ensure that plan members have access to appropriate educational tools to assist with investment decisions.
More specifically, the guidelines call for:
•prudent selection of investment options, taking into account the purpose of the plan, the potential for investment diversification and the financial sophistication of plan members;
•monitoring of all investment options, relative to established benchmarks and, where appropriate, other funds with the same objectives and styles;
•monitoring of investment managers by the sponsor;
•hiring, firing and remedial policies related to fund managers and options;
•provision of “appropriate” investment information and decision-making tools;
•provision of an investment advisor, or advice to members about obtaining their own independent investment advisor;
•self-assessment by a CAP sponsor about its ability to carry out its responsibilities under the plan, law and the guidelines, or the need to obtain external advisors.
Critical concerns for CAP sponsors
•Uniformity of regulation: While the guidelines are not regulation or legislation, ideally individual regulators won’t go down a different path (as they have for DB plans) that will increase compliance costs. It’s worth noting that both Quebec and Alberta have issued discussion papers on governance-related issues which may further affect CAPs.
•Purpose of CAPs: The guidelines fail to sufficiently address the fact that CAPs may have different purposes, form and design, reflecting the plan sponsor’s total rewards program. Some question why regulatory focus is given to CAPs that is not given to other forms of compensation, such as salary, bonus, stock plans or taxable benefits. Greater attention will need to be paid to ensure that members clearly understand their responsibilities under CAPs.
•Cost: CAPs form only a portion of total compensation, and if their valuable status is to continue, these plans cannot become too burdensome or costly to administer. For example, as a practical matter, there is no clear indication that education costs can be transferred to members.
As well, small- and medium-size plan sponsors may have difficulty in obtaining internal resources to deal with the selection and monitoring of plan providers.
•Member education: The guidelines currently imply that CAP sponsors will need to establish disclosure of information and educational policies for members.
But adult education is difficult, and proving members are being educated implies testing of members’ knowledge.
There is currently no direction given under the guidelines as to how this will be accomplished. It certainly will have a cost. How will sponsors do it? Who will pay? Who will deliver the program? How will member diversity (language, numeracy, literacy) be handled? What will be provider selection criteria? If investment advice is made available to members, how will sponsors monitor the performance of the advisor and limit liability? How will the policy differ between plan types (pension, savings or DPSP)? Can sponsors provide the detailed expense information called for in the guidelines? Or, most importantly, can the service provider do this for sponsors?
This is one area in particular where regulators need to re-think.
•Investment performance reports: The guidelines suggest that a CAP member should be provided with reports that show the historical performance for each investment fund and its benchmark, with disclosure of any significant non-adherence to the investment process where available.
Although this type of information should be accessible to members, providing these types of formal reports will simply encourage CAP members to make changes in their investment accounts based on historical performance.
It is also not clear from the phrase “where available” what is expected of the CAP sponsor for monitoring an investment manager for non-adherence to the investment process. Does this mean relaying information it has received on a casual basis? Does it mean requiring formal letters of compliance with the investment process from each manager on a proactive basis?
In addition to the investment performance reports to be provided to CAP members, there is fund manager monitoring which must be done by the plan sponsor, where the sponsor selects the managers and available funds, as is usually the case.
This will result in considerably more monitoring and member disclosure on funds which members may not even participate in.
Other regulatory initiatives in the works
These guidelines overlap with the Canadian Association of Pension Supervisory Authorities’ proposed revised Pension Governance Guidelines, released in July 2003, with respect to such items as:
•the knowledge and skills of plan fiduciaries;
•member communication and advice;
•the selection and monitoring process for investment options and mergers; and
While space does not permit an examination of the CAPSA Pension Governance Guidelines, CAPs plan sponsors will need to become familiar with and review practices and policies against both regulatory initiatives.
(For more information visit the CAPSA Web site at www.capsa-acor.org.)
With respect to the governance guidelines, the key areas for attention relate to: risk identification and management, fiduciary reporting, selection and retention criteria for providers and monitoring processes for all fiduciaries, delegates and agents.
Both guidelines are expected to be finalized in the spring of 2004, but plan sponsors are asked to consider the application to plans now. This will be a critical year for examining capital accumulation plans and making sure they work for both sponsors and members.
Florence Holden and Stephen Lewis are senior consultants with Towers Perrin in Toronto. Florence specializes in retirement services and leads the Canadian governance practice. She can be reached at (416) 960-4473 or firstname.lastname@example.org. Stephen specializes in asset consulting services for all retirement plans including CAPs. He can be reached at (416) 960-2755 or email@example.com.