Thursday, April 7, 2011

More on Companies Fleeing DB Pensions

A follow-up to my previous comment on Canadian companies crossing the "pension Rubicon". Cynthia Vukets of the Toronto Star reports, Companies flee defined-benefit pensions:

Financial officers are increasingly switching private sector pensions from defined-benefit to defined-contribution plans, even with the economy on the upswing, according to a study released Wednesday.

“The 2008 crisis may have been the final straw for senior finance officers” said David Service, director of investment services at Towers Watson.

“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.”

Tower Watson’s 2011 Pension Risk Survey, which collected information from 150 defined-benefit plan sponsors, indicates that 51 per cent of private sector defined-benefit plan respondents have now converted their plans to defined-contribution arrangements — up from 42 per cent in 2008.

“The defined-benefit plan has come under considerable attack because there’s been tremendous pressure to shift to defined contribution plans, which are seen by employers to be more predictable,” said Toronto Centre Liberal MP Bob Rae.

Rae was addressing the Conference Board of Canada’s Summit on the Future of Pensions on Wednesday.

Defined-contribution plans pay out on retirement according to the investment’s performance, while defined-benefit plans promise a set monthly amount calculated according to a retiree’s average salary and years of work. Defined-contribution plans tend to be less risky for employers, but depend on the worker’s ability to manage his or her own investment portfolio.

Although the economy is improving, the Towers Watson study showed senior executives are more pessimistic about pension funding. According to the survey, 56 per cent believe the funding crisis will persist for the long term, compared with 34 per cent polled in 2008, before the onset of the recession.

“We have our work cut out for us to try to deliver a better return on assets than market value,” said Leo J. de Bever, CEO and CIO of the Alberta Investment Management Corporation.

He said pension fund returns have been “barely positive” over the past 10 years and doesn’t expect much better over the next five, adding Canadian pensions will be more difficult to fund as they come to maturity in the near future.

Rae said pension reform is now critical for Canadians.

“People talk about something when they have to . . . On the pension issue, we’re getting up to that point,” he said, adding 75 per cent of Canadians eligible for an RRSP don’t have one.

“Those who can save, do; those who can’t save, don’t,” he said.

Rae, 62, joked that “60 is the new 40,” but was serious when he urged a discussion of public policy to address the fact that Canadians no longer follow the traditional path of graduating from school, getting a job, contributing to a pension and retiring at age 65.

Contract work, career changes and a longer, more active retirement have changed what Canadians need from a pension. In addition, two out of every three Canadians have no workplace pensions and 1.6 million seniors are living on less than $15,000 a year in government support, says seniors advocacy group CARP.

“There is, I think, a very strong consensus that we need to continue to focus on the needs of people who are poor and people who are struggling,” Rae said. “We have a gap in our coverage for people.”

The Liberals and NDP have promised to add $700 million to the Guaranteed Income Supplement, with the Conservatives proposing a $300 million annual increase. On the Canada Pension Plan, the NDP would double the CPP and QPP, while the Liberals would gradually increase defined CPP benefits and allow for a new, voluntary supplement to the CPP, called the Secure Retirement Option. The Conservatives have proposed defined-contribution, pooled, registered pension plans that would be privately run.

I thought Leo de Bever's comments were interesting. Pension fund returns have been “barely positive” over the past 10 years and he doesn’t expect much better over the next five, adding Canadian pensions will be more difficult to fund as they come to maturity in the near future.

Leo de Bever is also worried about what happens when the music stops. In a recent FT article, Canadians get creative with infrastructure acquisitions, de Bever said that AIMCo's 50 per cent stake in Autopista central, a motorway in Santiago, Chile, made sound sense because some infrastructure funds still carry 2-and-20 style fees (2 per cent of assets and 20 per cent of profits) but are not throwing up the returns of private equity funds. He's very fussy with infrastructure deals, picking his spots carefully.

Now, getting back to the topic of Canadian companies fleeing DB plans. As I wrote in my last comment, I believe that most Canadian 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 funds.

I want to clarify something. I know of private companies with excellent DB plans. Right here in Montreal, CN Investment Division, which for many years was run by Tullio Cedrashi (now run by Russell Hiscock), is an example of a top-performing private DB plan managing billions in assets. It's arguably one of the best DB plans in Canada with a long, stellar track record. The people at CN Investment Division are excellent pension fund managers who consistently deliver top decile performance.

But there is only one CN Investment Division. Most Canadian companies have terrible DB plans which are severely underfunded. It's hardly surprising to see them opt out of DB plans and switch over to DC plans, placing the retirement onus entirely on employees. This is why I believe we should scrap private DB plans altogether, and create new public DB plans to manage these assets. Instead of transferring over the risk to banks and insurance companies, getting raped on fees in the process, companies would transfer the risk to Crown corporations with world class pension governance standards. You have to compensate these pension fund managers properly and even hire the people at CN Investment Division to manage these entities (why not?).

Again, I believe companies should worry about their business, not pensions. We have some of the world's best pension fund managers in Canada who can worry about pensions. Employees need to have the peace of mind that comes with a well managed DB plan. Period, end of story.

Listen to Leo de Bever, he knows the challenges that lie ahead for pension funds. Let me end by repeating something I've stated many times before: switching over to a DC plan is a cop-out, a defeatist approach which is not in the best interest of employees. The trend of switching over to a DC plan will only ensure more pension poverty down the road. It's high time Canada takes the lead in crafting better pension policies, ensuring more people retire with dignity.

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