Employers remain concerned about DB plans

Sears Canada the latest to make the switch from DB to DC

Defined benefit (DB) plans were better funded last year than in previous years, but plan sponsors are still concerned about the risks entailed in these plans and are mulling over alternatives to them.

The latest employer to opt for the alternative is Sears Canada, which announced last month that its DB pension plan will be replaced by a defined contribution (DC) plan as of July 1, 2008.

In a Mercer Human Resource Consulting survey of 300 financial executives around the world, half reported that their DB plans represent at least a moderate financial risk and 60 per cent have either closed DB plans to new hires, frozen or reduced DB benefits or intend to do so.

Half the respondents have already introduced a DC plan or intend to, according to Mercer’s Pension Outlook and Investment Fearless Forecast 2007, released last month.

Paul Forestell, leader of the retirement professional group at Mercer’s Toronto office, said Canadian plan sponsors share these general sentiments.

“The universal fact is DB plans are expensive. People live longer, interest rates are low, so the expected costs of the benefits have gone up,” said Forestell. For 80 per cent of employers, cost volatility is a factor behind plan design changes; for 32 per cent of employers, it’s the most important factor, he said.

Funded status improves

Ironically, the funded status of DB plans has improved despite such sombre reflections. In 2006, the number of plans that were less than 80-per-cent funded declined from about 41 per cent to about 33 per cent. The number of plans that were fully funded were up — from 18 per cent to 26 per cent, according to the Mercer Pension Database.

Much of this improvement could be attributed to the high level of contributions sponsors have been making, said Forestell. Due to the requirement to fund solvency deficits, employer contributions have gone up from $6 billion in 2000 to nearly $30 billion in 2006. Though investment managers surveyed by Mercer forecast 6.5-per-cent returns for plans with a 60-40 equity-bond asset mix — well below the double-digit per cent seen in the past four years — solvency positions will improve this year, said Forestell.

The improved funded position means employers now have some breathing space to step back and determine what their funding strategy should be in the next five years.

“For the first time in a long time sponsors are seeing better funded plans and some sponsors are actually back in a surplus position,” said Forestell. “What it means is plan sponsors will be able to make more informed decisions and strategic decisions about how much to fund their plans. In past years, funding the minimum was painful enough. Now they’ll have an opportunity to make more strategic calls on how much to fund their plans.”

Long-term decisions for sponsors

Among the long-term decisions plan sponsors should consider are what the objectives are in terms of how much to put into their plans, how quickly they’ll meet them, what they’ll do the moment they have a surplus and how they’ll respond if their funding strategies go off target, said Forestell.

“Historically most sponsors would have waited until something happens and then decide what they’ll do. It makes it difficult for committees responsible for making these decisions. They need the framework that says why they’re deciding to put in the minimum or more than the minimum.”

DC plans not a panacea

Janet Rabovsky, investment consulting practice leader for central Canada at Watson Wyatt Worldwide, agreed that being in a better funded position doesn’t mean plan sponsors have stopped asking whether they should get out of DB plans.

New “marked to market” accounting rules, which require the funded status of the plan to be reflected on the company’s balance sheet — hence, increasing the volatility of a company’s balance sheet — have only added to the list of reasons plan sponsors are thinking twice about the risks entailed.

“But defined contribution plans are not the panacea that everybody makes them out to be,” said Rabovsky. “There are a lot of risks and obligations conferred to the companies as well. People are realizing that no matter how much education you give to your members, they’re probably not going to make the right choices. You’re getting cost-certainty but you’re not necessarily getting less risk, and certainly the amount of time you need to monitor these things is certainly not less.”

What that means is DC plan sponsors have to regularly review the funds they offer to make sure there are enough choices and that the choices represent a good mix of investment strategies.

“The member has the obligation to actually read the material and get educated, but a lot of them are apathetic and they don’t. Which is why you’re seeing things like targeted retirement date funds, which are funds that migrate over time,” said Rabovsky. “You’re seeing auto-escalation programs, which means the more you earn the more you contribute. This is why these things are starting to come into Canada. You can’t just leave it up to the member.”

To read the full story, login below.

Not a subscriber?

Start your subscription today!