Wednesday, April 6, 2011

Canadian Companies Crossing ‘Pension Rubicon’?

Janet McFarland of the Globe and Mail reports in CTV, Companies cross ‘pension Rubicon’:

Canadian companies have crossed a “pension Rubicon” and are continuing to dismantle traditional defined benefit plans even as the economy improves, according to a review by Towers Watson.

A survey of 150 Canadian pension plan sponsors found 51 per cent have converted to defined contribution (DC) plans for current employees or new hires, up from 42 per cent in 2008. Defined contribution plans do not pay a guaranteed level of benefit at retirement like a traditional pension plan, but instead pay a return that varies based on the performance of the investments held by each member of the plan.

Companies surveyed are continuing to convert their plans to DC accounts, with 12 per cent of those surveyed in 2010 saying they would convert to a DC plan within 12 months – up from 5 per cent in 2008 – and a further 9 per cent reporting plans to convert in 2011.

“The study suggests that this trend shows no signs of relenting – the Rubicon has been crossed ,” the Towers Watson report said.

Employers have complained about the volatility and risk of maintaining a traditional defined benefit pension plan in recent years as low interest rates have reduced returns while simultaneously boosting the liability that must be funded.

“Those considering a conversion are generally intent on doing so regardless of improved economic conditions, a more sponsor-friendly legislative environment or changes in plan design or investment strategy,” the report said.

However, Towers Watson said the survey showed one glimmer of hope for employee pension plans. Employers acknowledged that workers in Canada’s aging population will find defined benefit pension plans more valuable in the future. Companies considering changing their plan design to reduce risk said the potentially negative impact on employee attraction and retention is a “major concern” for the company.

The survey found 59 per cent of employers believe workers will find defined benefit pension plans more valuable in the future, while only 9 per cent thought employees would find them less valuable and 32 per cent said their perceived value will not change.

Towers Watson said the findings are in line with a 2010 global work force study that found a better pension plan is considered one of the main factors that would influence Canadian workers to leave their current employers.

You can read the Towers Watson Canada press release below, Defined Benefit Pensions at a Tipping Point:

As retirement savings adequacy and security becomes an election issue, a new survey of more than 150 Canadian pension plan sponsors from global professional services firm Towers Watson (NYSE, NASDAQ: TW), indicates that just over half (51%) of the private sector Defined Benefit (DB) plan respondents have now converted their plans to Defined Contribution (DC) arrangements for current or future employees - up from 42% in 2008. The study suggests that this trend shows no sign of relenting.

The survey also reveals that recent improvements in economic conditions have had virtually no impact on executives’ perception of a DB funding crisis. The percentage of respondents who agree that there is a pension funding crisis has remained at historic highs since the financial downturn of 2008. The survey found that more than half of respondents (56%) believe that the funding crisis will persist for the long-term compared to 34% who held this view in 2008 before the onset of the recession. Just under one-third (32%) perceive funding challenges to be a cyclical phenomenon.

“The financial crisis has caused a shift in plan sponsor attitudes,” said Ian Markham, Canadian Retirement Innovation Leader at Towers Watson. “This year’s survey results show that employers planning a conversion to DC are intent on doing so regardless of whether economic conditions improve, or a more sponsor-friendly legislative environment appears, or even in lieu of less dramatic changes to plan design or investment strategy.”

While the economic conditions of 2009 and early 2010 prevented many plan sponsors from taking drastic action, the percentage of plan sponsors who are preparing to implement changes has significantly increased as the financial markets continue to improve. Of the private sector DB plan sponsors considering adjustments to their plan design, funding policy or investment strategy, more than half (52%) indicate that they have prepared a “journey plan” of measures to contain cost and volatility.

“The 2008 crisis may have been the final straw for senior finance officers,” said David Service, Director of Towers Watson Investment Services. “While plan sponsors may not be able to afford to make changes right now, many are working on strategies to de-risk or even exit when the financial position of their plans improve."

However, there may be some hope for traditional DB pension plans. With an aging population, a majority of survey respondents (59%) agree that employees will be showing a greater appreciation for DB pensions. The potential impact on attraction and retention is also a major concern for the majority (52%) of organizations that are considering plan design changes. “Canadian employees tell us that the prospect of a competitive pension is one of the top five factors that would influence them to leave their current employer, “ said Martine Ferland, Canadian Retirement Leader for Towers Watson. “As election rhetoric heats up the pension debate, we hope to see additional measures proposed that will increase the sustainability of private sector pensions.”

Companies are increasingly nervous about liabilities attached to traditional defined benefit (DB) plans so they're passing the buck to individuals by shifting their employees to defined contribution (DC) plans. This is a recurring theme throughout the developed world. In the UK, companies are transferring pension risk over to banks and insurance companies who are probably going to make a killing in the process.

But the survey showed a glimmer of hope for employee pension plans as employers acknowledged that workers in Canada’s aging population will find defined benefit pension plans more valuable in the future. I happen to think that smart companies will figure out a way to shore up their defined benefit plans to attract and retain good employees who are not just looking at base salary and bonus. They're also thinking long term.

My honest opinion, however, is that most companies shouldn't be in the defined benefit pension business at all. Instead, companies should transfer this risk to existing and new public sector pension plans and have professional pension fund managers manage these retirement monies. I'm the first person to acknowledge that Canadian public DB plans are far from perfect, but they're way better than DC plans and the truth is that it makes better economic sense for companies to worry about their business and let public pension plans worry about pension risk. Just make sure you get the governance right, aligning interests with the workers, not the pension fund managers' pockets.

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