Thursday, April 15, 2010

Consensus Slowly Building on Pension Reform?

Karen Mazurkewich of the National Post reports, Consensus slowly building on pension reform:

There is a concensus slowly building on the issue of pension reform. Some of the heavy-weights in the industry are weighing in again on the issue after putting it on the back-burner for months.

While the federal government continues to drag its feet and concern itself with another round of pension talks across the country, industry players met Tuesday in Toronto for the Conference Board of Canada/Towers Watson Future of Pensions Summit to talk specifics.

The issue of pension fund reform has blown hot and cold in political circles since the economic crisis. At first, when people saw their retirement savings plummet, they worried that the sky was falling. "But then, as markets rebounded, "they said, well, maybe it's not so bad we aren't falling into an abyss compared to other countries," Jim Leech, president and chief executive of Ontario Teachers' Pension Plan told reporters following his speech at the conference.

The debate appeared to have stalled.

But Mr. Leech believes that while lots of people need to "wake up" to the pension issue, he is optimistic that time has brought perspective and the reform proposals now being put forth are "becoming more refined."

Mr. Leech said the provinces won't venture into reform on their own and there will, in the end, be a federal solution: "We need to innovate. We need to save. Industry, academia and elected officials must agree on this and the path to get us there."

He added: "There will never be a better time than right now for Canada to undertake similarly visonary pension reform."

What has also emerged is a united front among the big multi-employer pension funds. In the wake of strong returns-on-investment for 2009, pension fund managers are flexing their muscles again and taking on mutual fund managers. The heads of OTPP, the Healthcare of Ontario Pension Plan (HOOPP) and Canada Pension Fund Investment Board are challenging notions that defined benefit pension plans are unaffordable. Mr. Leech, in particular, pointed out that RRSPs are not the solution because people don't save enough, and they also carry large administrative fees.

"Defined benefit plans were made unaffordable by short-sighted tax rules and court decisions that have effectively prevented sponsors from saving enough in good times to offset losses in bad times," said Mr. Leech. In fact, they are "far better vehicles for pension saving from both a security and a cost basis for employees and sponsors," he added.

Mr. Leech is calling for a new hybrid pension model that everyone can participate in, can be transferred across provincial lines, and offers some degree of guarantee.

David Denison, president and chief executive of the CPPIB, is also singing from the same song book. He talked to the industry about the advantages of the long-term risk model, and pointed to the weaknesses inherent in the mutual fund industry.

"If you are a mutual fund or institutional manager facing a redemption notice, you have to sell," said Mr. Denison. "By its very design, at CPPIB "not only do we have a stable asset base to work with, but we also have relative certainty of the timing and amounts of excess contributions into the fund over the next ten years," he added.

While Mr. Denison, in his role, cannot advocate an expanded CPP as a solution to Canadians pension worries -- in fact he got his wrists slapped last September when he hinted at it in a speech at the Annual International Conference of Social Security Actuaries and Statisticians -- but his speech Tuesday underscored the new tone of the reform debate: that some kind of pension guarantee for all Canadians is important, and the CPPIB has some important characteristics that enable it to act as a true long-term investor that can capture advantages for the benefit of the 17-million Canadians whose money it manages.

As I stated in yesterday's comment on pension reform, I am all for providing a DB plan to as many Canadians as possible, not just public sector workers. If we do it right, Canada will be leagues ahead of other countries.

But I recommend we start anew, cutting the CPPIB in half and creating new DB plans spread throughout the country. Why? Because the idea of concentrating power in the hands of one big fund worries me, and we should have a few large DB plans - like they have in Sweden - with world class governance standards.

And my standards for pension governance go way beyond what we currently have implemented. We need more transparency, more accountability and less smoke and mirrors.

For example, on Thursday, the Caisse published its 2009 annual report where accountability reporting was greatly improved and it said it was chopping executive bonuses:

The Caisse de dépôt et placement du Québec slashed senior executive bonuses in 2009, a year in which the institution posted a modest 10 per cent return on its investments.

Canada's largest pension fund manager said Thursday that the total amount of incentive pay to senior management last year was $1.1-million, compared with $4.6-million for 2007. No incentive compensation was paid to employees in 2008, a disastrous year in which the Caisse posted a record 25 per cent loss – $40-billion – on its investments.

The fund said in a news release Thursday that the 2009 bonuses were “commensurate with the Caisse's results,” that is, below the industry median.

The Caisse is also moving to further cut costs, with a series of measures aimed at reducing its operating expenses by more than $20-million in 2010. This latest round of cuts follows last year's $43-million reduction in costs, the fund said.

Kudos to Michael Sabia because I know this isn't a popular decision within the Caisse, but that's what accountability is all about. I hear so many pension fund managers whining but I just look at them and say: "Count you're lucky stars that you have a job and just focus on delivering results. You don't deliver, you don't get a bonus. It's that simple. And if you don't like it, take a hike. Stop whining, roll up your sleeves, and just deliver the results."

Meanwhile, the push for pension reform is proceeding:

Canadians shouldn’t let “pension envy” enter in the debate over pension reform, the head of the Ontario Teachers’ Pension Plan said Tuesday.

This is a danger as the private sector increasing moves towards defined contribution pension plans and away from defined benefit plans, Jim Leech said during a keynote address.

Canadians are being told that defined benefit plans are unaffordable, but that is largely because of “short-sighted tax rules and court decisions that have effectively prevented sponsors from saving enough in good times to offset losses in bad times,” Leech said.

“Weak-kneed managements [have], out of expediency, promised unrealistic levels of future benefits in order to dampen salary demands. Their strategy was to show good results today by pushing costs off to the next generation of managers – but the future has now arrived and pensioners are lined up for those promised benefits.”

He made the remarks at the 2010 Summit on the Future of Pensions, a two-day conference that brings together money managers, industry experts, and regulators. It is being held in Toronto by the Conference Board of Canada.

The debate over pension plan reform has heated up in recent months as the stock market decline and the recession have more companies talking about the cost of pension plans and Canadians wondering if they afford to retire.

Federal Finance Minister Jim Flaherty has launched cross-country consultations into pension reform, and many provinces have begun their own discussions.

The private sector is moving away from defined benefit plans, which provide set payments upon retirement that are based on age and years of service. The benefits are pre-determined and the employer is responsible for investment performance.

They are being replaced by defined contribution plans, where the amount paid in retirement depends on the market value of the investments at the time of retirement.

“The truth is that DB plans are far better vehicles for pension saving from both a security and a cost basis for both employees and sponsors,” Leech said.

Researchers have found that defined benefit plans can deliver the same level of retirement income at almost half the cost of a defined contribution scheme.

In part, that’s because professionally-managed defined benefit plans benefit from lower costs and a more balanced mix of assets over a longer time horizon.

“We as a society are in a pickle. Defined benefit pans are being terminated and replaced by defined contribution plans which are inadequate,” Leech said.

Glen Hodgson, chief economist for the Conference Board, discussed the challenges that pension plans will face as economic growth slows down in Canada and other developed nations over the coming decade.

A higher currency and aging workforce will contribute to slower growth, he said. “We now have to think about Canada as the new Norway or new Switzerland where we have a chronically strong currency. We think oil prices are only to rise.”

These factors will put added pressure on pension funds as they also try to manage with a shrinking base of contributions. “That’s going to be the new reality for pension plans across the country,” Hodgson said.

An estimated 75 per cent of Canadians in the private sector workforce have no company-sponsored pension plan.

Finally, please take the time to read Jim Murta's excellent comment on target benefit plans for unrelated employers. I quote the following:

Under a target benefit plan the plan sponsor has no commitment to plan funding beyond a DC-styled contribution. The risks - poor investment returns, increasing longevity, unexpected member terminations, cost overruns, etc. - are shared between workers and retirees. For example, in times of poor investment returns, both pensions being paid to retirees and workers’ accrued benefits are reduced until liabilities match assets. In this case, the biggest hit is to the retirees, who individually have the largest liabilities and whose benefit reduction makes the biggest impact on the financial structure of the plan.

These risks are further exacerbated as pension regulation does not require plans to invest in assets that match the liabilities of retirees nor does it allow the separation of retiree liabilities from other liabilities. The practice of MEPPs has often been to optimize returns to support workers’ benefits. This risk has been compounded by poor governance, which is pretty much universal among the MEPPs that are in trouble. Granting benefits out of temporary surpluses, making or acquiescing in very poor and non-professional investment decisions, unbelievable incompetence and fiduciary duty failures manifest the poor governance. There is no reason to think that target benefit plans will do things differently.

This return optimization will become even more important once the connection between workers and retirees, as exists with current MEPPs, is broken. For new target benefit plans to grow, they will have to promise very competitive benefits to workers. High rates of investment return are needed in order to maximize target benefits or minimize contributions. And, without regulatory constraint management will sacrifice security for growth.

The proposed way to achieve the highest return for plan participants is through a commingled asset pool. The view is that such a pool would have lower administration and investment expenses than anything available today. And, it could invest in assets that are beyond what mutual funds for individual accounts are capable of today. These could include private equity investments, e.g. golf courses, casinos, commercial mortgages, and so on, that offer high rates of return and are not subject to mark to market annual valuations. The room for abuse is obvious, particularly when very large amounts of money are involved, the knowledge to manage such schemes is limited and there is inadequate regulatory oversight.

In the face of this, the expansion of acceptable pension designs to include target benefit pension plans, with unrelated employer participation, is simply asking for trouble. Such plans will be subject to aggressive marketing by entrepreneurs seeking to expand the financial base of their offering. An aggressive investment posture, particularly involving private equities, will be used to justify high salaries for those running the plan. We have seen this before in other financial sectors. It is not in the public interest. It is akin to legalizing Ponzi schemes.

The problems identified above can only be corrected by treating target benefit plans, and any other plans being marketed to non-related employers, as if such were insurance companies and subject to the same standards. Given that regulations are unlikely to change to this extent, the better course is to not allow such plans.

I couldn't agree more. Just look at the dominos falling in the pension probe involving President Obama's former "auto czar"and you get a sense of what abuses can take place in these target benefit plans for unrelated employers. They are fraught with potential conflicts of interest and vulnerable to outright fraud.

Let's quit mucking around and improve on our existing DB plans to provide a solution to the retirement needs of millions of Canadians. If we don't, we are only going to face a much tougher challenge ahead - and by then, it will likely be too late.

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