The Brutal Truth on DC Plans?

Janet McFarland of the Globe and Mail reports, Defined contribution pension plans more costly, study finds:
Converting large public sector pension plans into defined contribution savings accounts for employees could cost governments up to 77 per cent more to provide the same retirement benefit for workers, a report argues.

A study sponsored by the Canadian Public Pension Leadership Council, an association of large public pension funds, says governments considering converting their traditional defined benefit (DB) pension plans would face higher administration costs because defined contribution (DC) plans cannot be run as efficiently.

DB pension plans pay workers a guaranteed level of income in retirement, while DC pension plans operate like individual savings accounts, paying out a retirement benefit that varies depending on the investment performance of the funds.

The pension council said it commissioned the study because there have been increasing calls by some provincial opposition parties and pension advocates for governments to shut down their larege employee pension plans and convert workers to DC savings plans. Former Ontario Conservative leader Tim Hudak, for example, said in 2013 that the province should negotiate a transition to DC pension plans to reduce funding requirements, while the Saskatchewan New Democratic Party advocated in a 2013 study that more governments should shift public sector pensions to a DC model to cut costs for taxpayers.

“There’s an attack on public sector defined benefit plans, and we wanted to substitute facts for impressions,” study author Robert Brown, a pension researcher and actuary, said Tuesday. “We think it’s a fairly overpowering argument.”

Mr. Brown, a retired University of Waterloo professor, said DC plans are less efficient than DB plans because members must pay more for asset management and do not pool their risk of living longer than average; so they must each save enough to cover longer lives.

The result is that a hypothetical $10-billion DB plan would see the cost of providing the same retirement benefit rise by 77 per cent if it converted into individual-account DC plans.

Mr. Brown said DB pension benefits paid to workers are typically composed of 75 per cent from investment income and 25 per cent from contributions, which are typically split equally by employees and the employers. To achieve the same income from individual DC accounts, the study said investment returns would provide just 55 per cent of the final benefit, requiring workers and employers to cover 45 per cent of the cost.

The report said governments must also continue to manage the remaining DB plan that continues to exist after workers are shifted to DC, and have often found their liability soars because workers are not making any new contributions while the funding obligation remains and can grow.

Saskatchewan, which converted employees to DC plans in 1977, saw costs for its legacy DB plan climb in the first decades after it was closed, and will continue paying benefits under the plan for 90 years, the report said.

Two U.S. states – Nebraska and West Virginia – that converted employees into DC plans ended up partly converting back to DB because of a backlash about how low retirement income was for employees, the study adds.

The study also argues that governments do not enjoy the same savings as a private sector companies when they shift workers to DC plans because workers who end up with less retirement income can qualify for higher payments from Old Age Security or the Guaranteed Income Supplement for low-income retirees, so governments have to fund their pension costs through another route.

Mr. Brown said that if the motivation to convert to DC plans is to cut pension funding costs for governments, the outcome would be achieved more efficiently by modifying features of the DB plan – such as eliminating guaranteed inflation indexation – than by eliminating the plan entirely.

“If you’re concerned about the level of costs, then let’s talk about the level of benefits,” he said. “But don’t try to achieve cost reductions just by moving out of the DB delivery model, because it’s the most efficient and effective model there is.”
Take the time to read the research report by the Canadian Public Pension Leadership Council. The research paper, Shifting Public Sector DB Plans to DC – The Experience so far and Implications for Canada, examines the claim that converting public sector DB plans to DC is in the best interests of taxpayers and other stakeholders by studying the experience of other jurisdictions, including Australia, Michigan, Nebraska, New York City, Saskatchewan and Texas and applying those lessons here in Canada. I thank Brad Underwood for bringing this paper to my attention.

I'm glad Canada's large public pension funds got together to fund this new initiative to properly inform the public on why converting public sector defined-benefit plans to private sector defined-contribution plans is a more costly option.

Skeptics will claim that this new association is biased and the findings of this paper support the continuing activities of their organizations. But if you ask me, it's high time we put a nail in the coffin of defined-contribution plans once and for all. The overwhelming evidence on the benefits of defined-benefit plans is irrefutable, which is why I keep harping on enhancing the CPP for all Canadians regardless of whether they work in the public or private sector.

And while shifting to defined-contribution plans might make perfect rational sense for a private company, the state ends up paying the higher social costs of such a shift. As I recently discussed, trouble is brewing at Canada's private DB plans, and with the U.S. 10-year Treasury yield sinking to a 16-month low today, I expect public and private pension deficits to swell (if the market crashes, it will be a disaster for all pensions!).

Folks, the next ten years will be very rough. Historic low rates, record inflows into hedge funds, the real possibility of global deflation emanating from Europe, will all impact the returns of public and private assets. In this environment, I can't underscore how important it will be to be properly diversified and to manage assets and liabilities much more closely.

And if you think defined-contribution plans are the solution, think again. Why? Apart from the fact that they're more costly because they don't pool resources and lower fees --  or pool investment risk and longevity risk -- they are also subject to the vagaries of public markets, which will be very volatile in the decade(s) ahead and won't offer anything close to the returns of the last 30 years. That much I can guarantee you (just look at the starting point with 10-year U.S. treasury yield at 2.3%, pensions will be lucky to achieve 5 or 6% rate of return objective).

Public pension funds are far from perfect, especially in the United States where the governance is awful and constrains states from properly compensating their public pension fund managers. But if countries are going to get serious about tackling pension poverty once and for all, they will bolster public pensions for all their citizens and introduce proper reforms to ensure the long-term sustainability of these plans.

Finally, if you think shifting public sector DB plans into DC plans will help lower public debt, think again. The social welfare costs of such a shift will completely swamp the short-term reduction in public debt. Only economic imbeciles at right-wing "think tanks" will argue against this but they're completely and utterly clueless on what we need to improve pension policy for all our citizens.

The brutal truth on defined-contribution plans is they're more costly and not properly diversified across public and private assets. More importantly, they will exacerbate pension poverty which is why we have to enhance the Canada Pension Plan (CPP) for all Canadians allowing more people to retire in dignity and security. These people will have a guaranteed income during their golden years and thus contribute more to sales taxes, reducing public debt.  

In my ideal world, you won't have the bcIMC, Caisse, OTPP, PSP, AIMCo, HOOPP or Bombardier, CN, Bell, Air Canada pension plans. You will only have large, well-governed public defined-benefit plans managing the assets and liabilities of all Canadians regardless of whether they work in the public or private sector. If we achieve such a monumental undertaking, we will significantly lower investment and administrative costs and do away with the issue of pension portability once and for all because people will move across public and private sector jobs knowing their pensions are safe and secure, backed by the full faith and credit of the federal government.

Below, the shift from defined-benefit to defined-contribution plans, American workers and employers have lost predictability in retirement planning. Prudential is leading the way in bringing it back, with innovative lifetime income solutions for DC plans that can help workers retire on time with a guaranteed income stream -- without the actual cost of a pension to employers. And employers can manage costs and workforce mobility more effectively.

Forgive my skepticism but there is no way Prudential or any other large insurance company can effectively compete with large, well-governed public DB plans. These insurance companies are salivating at the prospect of underfunded private DB plans, seeking to profit off their misfortune.

Second, David Knox of Mercer's Melbourne Office discusses the findings from their global survey on pensions and the lessons we can take from Australia. Unfortunately, I'm also highly skeptical of lessons from Down Under and think Canada has the potential to surpass Australia if we bolster our public plans for all Canadians (ie. enhance the CPP!!).

Finally, I embedded an older clip from when I discussed America's 401(k) nightmare. As the default retirement plan of the United States, the 401(k) falls short, argues CBS editor-in-chief Eric Schurenberg. He tells Jill Schlesinger why the plans don't work.

That last clip goes over the problems with 401(k)s, RRSPs, PRPPs, or anything that claims defined-contribution plans are fair and will properly cover the pension needs of all citizens.