Pensions as financial instruments

Imagine walking into a bank and being told that your $10,000 savings account was only worth $8,800 because they made some bad investments. Or, imagine your heirs being told by your insurance company that it will take 5 years to pay out the proceeds because some of their mortgage investments defaulted. Unthinkable? Then why does it happen in some pension plans?

For many people, a pension plan is their largest financial asset. Employees and retirees view the pension promise as a financial commitment made by the plan sponsor – something they can rely upon. Yet pension legislation doesn’t treat the pension plan as a financial instrument, it treats it as a labor contract. And that’s where the problems start – the contracts are frequently incomplete and depend upon an external value assessment if the plan gets into trouble. Or they are run like a mutual association, where the security of the retiree is often dependent on the desire of active employees to keep the faith.

I think it’s time to start managing and regulating pension plans differently. Pension plans should offer a similar level of security to members as insurance companies and banks offer to their customers. Provincial authorities need to move from rule based regulation to principal based supervision. Supervision would avoid rule of thumb funding and instead focus on the risk characteristics of the plan, member demographics, investment selection and the sponsor’s ability to cover shortfalls.

Plans might have to change to simplify designs, to remove contingent benefits that don’t involve predictable risks and to permit sponsors to withdraw excess funds once solvency is assured. But the end result would be more secure benefits for plan members and plan sponsors knowing exactly what they are paying for.