Tuesday, December 21, 2010
The choice does very little for existing pension plans. Despite years of study, reports, hearings and consultations, and a clear need for change, the governments have once again postponed addressing the fundamental problems affecting employer pension plans. There is no harmonization between regulatory jurisdictions, nor any effort made to solve security issues for members.
Saving rates are low, and not getting better. But the Ministers did not want to deal with this head on. The excuse is the economy and a fragile recovery. But as they wait for better times, the governments have failed to notice that the business of rewarding employees has changed. Companies no longer support the expansion and creation of employer-sponsored pension plans. Companies that weren't involved before are not going to start now. And, on cue, the government has made plan participation optional.
Flaherty's Pooled Registered Pension Plans (PRPPs) are false promises. They are supported only by the financial industry, who see a new money making scheme, and by businesses, who know they wont have to pay. Polls conducted on line by the CBC, CTV(Calgary) and the Globe & Mail all indicate that Flaherty has made the wrong choice. The Globe & Mail poll has 83% favoring the CPP choice. Numerous other polls say the same. People simply do not believe that the financial industry has their interests at heart and are not willing to trust them with their money. This lack of trust will not easily be overcome.
PRPPs wont resolve the country’s retirement income issues. Flaherty has done nothing to curb the financial industry's fees and administrative costs - among the highest in the developed world. He has not tackled the insurance industry's distribution problems and lack of control over its sales force. Nor has he signaled an equalization of saving rates between private and public employers' pension plans.
So we are left waiting for the next round of study, reports, hearings and consultations.
Wednesday, November 24, 2010
"Defined Contribution pension plan sponsors who realize their members do not have enough to retire – and who don't understand that they don't have enough – may want to move to target benefit plans, says Jill Wagman, a principal at Eckler Ltd. In the ‘Target Benefit Plans – An Option for Single Employers’ session at the ACPM’s 'impACT 2010,' she said while they don’t really exist yet, the multi-employer plan concept uses a target benefit plan approach and they have been around for years. The advantage of these plans for employees is that they provide certainty over surplus ownership and give employees a say in the governance of the plan. For employers, they promise cost certainty and do away with solvency funding concerns because when there is a shortfall, the benefit can be reduced. The Ontario Pension Reform Commission has recommended they be set up. However, she said there are still some obstacles including an Ontario requirement which says an agreement with employees needs to be in place. At this time, that would seem to suggest that they would only be available in union environments where the terms of the plan could be set by collective bargaining."
A key point in the above report is the analogy to multi-employer pension plans (MEPPs). If the plan design works for MEPPs, it must be OK for non-unionized employee groups. What is not mentioned is that the reason MEPPs have some success is that the members of MEPPs actually retire from these plans. When they reach retirement age they tend not to terminate and cash in the pension to receive its commuted value.
If members decided not to take a pension from the plan but take the commuted value instead, the MEPP would collapse. This is due to plan benefit levels being based on the assumption that the MEPP will earn a high long term rate of return, which keeps the benefit high and the cost and value within the plan low. Commuted values, on the other hand, are based on a small margin over government bond returns, which produces higher values. The difference is significant. A plan that is financed on the first basis can't afford to deliver on the second.
The reason MEPP members chose retirement and a pension, rather than termination and a commuted value, often has nothing to do with the pension plan. Members who retire generally then quality for benefits such as medical, dental, life insurance and a variety of other benefits that their union decided are important for retirees. If the member terminates, these benefits are forfeited. In the absence of these benefits - non-unionized employers are not so generous - the member's financial advantage tilts towards termination and a commuted value. And, this advantage remains even if the commuted value is used to buy an annuity from an insurance company.
If employees are thinking about buying into the target benefit promise they really need to look at the whole picture. Without a union and promises of post retirement benefits, the plan may not be able to deliver anything close to a favorable long term outlook. Instead, the plan will be left financing the delivery of commuted values. The result - a very complicated DC plan.
Tuesday, October 12, 2010
Bill C-574,It was first read on October 1st; 2nd reading is expected to take place on November 23.
Here's an abridged version of the Bill:
Every individual has the right to accumulate sufficient pension income in a retirement income plan to provide for a lifestyle in retirement that the individual considers adequate, subject to any reasonable restrictions imposed by a federal law…. reasonable restrictions do not include a restriction based on age.
Every individual shall have the right to determine how and when to accumulate pension income, except that an individual who participates in a workplace plan may be required by that plan to save for retirement.
Every individual shall have the same opportunity to accumulate pension income as any other individual, without regard to age, sex, national origin or occupation.
Every individual who participates in, contributes to or receives benefits from a retirement income plan should be entitled to receive full disclosure of any material risks to the individual under the plan, including non-payment or reduction of benefits, and of the options available in the event of the non-payment or reduction of benefits.
Every individual shall be entitled to receive investment advice from an advisor who has no conflict of interest in terms of providing advice.
Every individual who participates in a retirement income plan shall be entitled to receive, in clear and concise language, all the information the individual requires to understand his or her rights, obligations and choices, including regular disclosure of all costs, regular disclosure of investment gains or losses pertaining to the individual’s entitlement, timely information regarding investment options and timely disclosure of any options or elections available to the individual.
Every person that administers a retirement income plan shall exercise the standard of care a prudent professional would exercise; may retain professionals to assist in the administration; and shall appropriately supervise the work performed by such professionals.
Every federal law that governs the establishment or operation of a retirement income plan shall promote individuals’ access to training in financial literacy and retirement planning.
Every federal law that directly or indirectly applies to a retirement income plan shall be interpreted, construed and applied so as to promote and give effect to the principles and rights set out in this Act.
The Bill is interesting for a number of reasons, but principally as is may present a preview of the Liberal Party's pension policy should they have the opportunity to form the next government.
Here's a few thoughts on the Bill and its implications:
- pension legislation is generally within the purview of the provinces, except for industries falling under OSFI and tax rules under the CRA. The Bill is limited to matters falling under the Parliament of Canada, so it is likely limited to tax issues, pension plans of federally regulated industries and RRSPs.
- the Act gives the right to accumulate sufficient pension income subject to any reasonable restriction imposed by federal law that is not based on a personal characteristic, such as age. This could be achieved by setting a lifetime contribution limit for tax deferred retirement savings. The person could then use this limit up as funds are available. The CRA could impose annual maximums on contributions, however it would have to prove that doing so would not unreasonably limit an individual's plan to achieve an adequate retirement income. Given that age must be taken out of the equation, this may be hard for them to do. This would be a major change in our system.
- the individual is entitled to disclosure regarding the material risks to the individual under the retirement plan. This sounds good but in practice may be challenging. Material risks could include all the various investment risks, mortality risks, inflation, variations in expense levels, value splitting on marriage breakdown, corporate bankruptcy, membership declines within negotiated plans, target benefit valuation failures, fraud, and on and on. Lawyers will love this one.
- there are a variety of disclosure requirements. These would generally reset pension plan regulation under a financial instrument model. The disclosures sound similar to those required of insurance companies or of other financial instruments. This could be good for the consumer but, this type of model has not been adopted by any provincial or federal jurisdiction.
- the Bill requires any federal law connected to retirement income plans to promote training in financial literacy and retirement planning. This would force the CRA take on a training role that it doesn't assume in any other circumstance.
- the requirements for risk disclosure, investment advice, broad financial information and training will complicate pension plan administration and may significantly increase trustee liability. These could be handled by safe harbour rules, but the changes would be a significant jolt to the system. Sponsors may bail out and close plans.
Saturday, August 28, 2010
- how should we measure the effectiveness of ‘innovation’ or what would be a minimum requirement for a credible innovation - increased benefit, lower cost, improved security, clearer communication/understanding/transparency?
- what might constitute an acceptable expense level? A minimum requirement for such a plan might be an annual cost of less than 0.5% of assets for a balanced portfolio (the CPP cost is of the order of 0.3%). A slightly higher cost might be justified due to smaller scale and some additional administrative costs - but the total has to be way lower the expenses typically charged today . Should the cost be federally or provincially regulated - say, by something similar to a rate board?
- what are reasonable income drawdown strategies during retirement? Does the innovative design allow for the construction of portfolios to achieve this? What are the trade-offs between investment risks and return? Can these be easily explained? When or should annuitization occur? Is the approach supported by the annuity marketplace?
- what tools could be made available to specify on an ongoing basis the required contributions to achieve some level of retirement income, as well as the expected retirement income given current level of contribution? Is guidance and feedback continuously available? Do the tools explain what are the risks and what can be done about them?
- is a longevity insurance option available to protect against exhausting assets if one lives too long? Should a new retiree purchase a life-contingent lifetime income stream starting at, say, age 85? Does the new design provide such an option or does it offer a better alternative?
- would TFSAs be a better choice than RRSPs (or RPPs) as a saving vehicle? Does the new design allow for such funding choices?
The intent of the above is to push the discussion from generalities to specifics. I hope others will take up the challenge.
Tuesday, August 3, 2010
Surveys are much more than a statistical exercise. And, an important starting point is to note that all responses are voluntary regardless of whether the completion of the questionnaire is mandatory or not - if the survey is not user friendly it will, by its nature, introduce biases.
A fundamental question is whether the data collected is actually useful relative to an information need. Census information should focus solely on information to enable efficient and effective government. More than this is an abuse of the public. Just because a religious group would like certain information, to be able to better target its missions, does not create a need. The group can find other ways to get the information. It should have no say in the matter.
Canada's long-form has been around for some time. Some of the questions now sound dated and are open to interpretation. The survey perpetuates ethnic and social profiling and connects it to housing and incomes. Does this really measure social progress? The survey fails to deal with many important emerging issues including the financial, social and activity issues of pensioners, volunteer activities, early childhood development, adult educational, and so on. These issues could give a better indication of life in Canada than questions on commuting times or number of rooms in a house.
Is a mandatory survey the best way to get information or would special studies provide more? Many commentators support a mandatory survey because they feel we will lose coverage of low income earners, new immigrants, aboriginal peoples, people not fluent in English or French, and the elderly. However, one has to question coverage quality when all of these groups are faced with completing a very technical 40 page survey. I suspect that a large proportion of the surveys returned on behalf of these people were not completed by those targeted.
The survey is simply too complex. It assumes that all members of a household share freely information. It assumes that people keep detailed records of expenditures. It requires too much effort to complete. Unlike members of the Statistical Society, we perhaps don't get quite the enjoyment out of all this. I think that it is fair to ask why the information is so important.
Other countries have given up on long-form surveys. They are collecting data through special studies that focus on specific issues. Canada should do the same.
Friday, July 23, 2010
Perhaps it is time for a change. A voluntary system has been proposed with a larger sampling base. The larger sampling base might compensate for the move away from a mandatory system, but it's hard to judge. The mandatory system undoubtedly contains errors as some filers emphasis speed of completion and guess work over accuracy. Presumably the voluntary system will mean those forms that are filed will at least be accurate. But who will be missed? The issue is which approach gives a better representation of the underlying population.
Another approach is to segment the form. All of the population completing a 20% segment may be more acceptable than 20% of the population completing the entire form. This approach could be coupled with a thorough review of the long form census to make sure each question contributes to some purpose. Statistics Canada should clearly explain why each data point is needed.
Thursday, April 15, 2010
A number of organizations have suggested that pension regulations change to create a better environment for the creation of defined benefit plans. These organizations include plan sponsors, insurance companies and various consulting and law firms.
These proposals include:
· Creating different rules for different types of plans in regulation or administrative policy (DB, DC, target benefit, etc.);
· Broadening the definition of plan administrator to permit an entity that is not an employer or a board of trustees to sponsor a plan (e.g. unrelated employers, professional associations, trade associations);
· Broadening the definition of member to permit a worker who is not an employee to become a member (e.g., self-employed);
· Permitting the creation of commingled asset pools for the participants in these plans; and
· Ensuring that there are no legislative barriers to features such as assigning default investment portfolios, escalating contributions to meet target benefit requirements, and scaling contributions by the age of the participant.
My concerns focus on three aspects of these proposals:
· The expansion of pension plans to include unrelated employer participation where there is no union or other bargaining connection between employees;
· The inclusion of target benefit plans as a permissible plan design in the above; and
· The establishment of commingled asset pools for the participants in these plans.
Plans with these aspects are analogous to plans that might be offered to the public by an insurance company or bank. However, insurance companies and banks are subject to sufficient regulatory backup to ensure that promises made are promises kept. The standards of oversight are well defined and enforced. Pension regulation by comparison is totally inadequate, as can be seen recently by the number of pension plan failures. There is nothing in any of the federal or provincial governments' pension consultation papers that suggests that pension plan regulation will be brought up to financial institution standards, despite the fact that pension plan assets are the largest financial assets of individuals.
In concept, target benefit plans are relatively straightforward. Each participant has a target benefit the plan is meant to achieve. Starting with the target benefit and working backwards to the contribution level needed to achieve the target benefit determines required contributions. If things go better than assumed in this calculation, benefits can be increased. If the results are worse then benefits are decreased.
This concept builds on what occurs in many MEPPs today. In times of poor investment returns, accrued pension benefits have to decrease. In good times, excess benefits can be granted.
Proponents suggest that target benefit plans share pension risks more evenly between plan sponsors and workers. Classical DB plans (as long as they don’t terminate) leave all of the risks with the plan sponsor, while classical DC plans leave all of the risks with the worker. Target benefit plans are supposed to change this. However, they don’t work this way; risks are shared not with the plans sponsor but with the retirees.
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.
Wednesday, March 24, 2010
Stocks as a hedge against inflation. While many have argued that investors with long time horizons should own stocks as a means of hedging against inflation, there is no evidence that stocks offer an effective hedge, even in the long run. In fact, empirical studies show that stock returns are largely uncorrelated with inflation. Not only that, but stocks have often performed very poorly during periods of high inflation, such as experienced in the 1970s. The idea that stocks should be included in a glide path as an effective hedge against inflation is not justified by the facts.
The fallacy of time diversification. The idea that the risk of holding risky assets somehow decreases with the length of the holding period has perhaps been around as long as investing itself. That this is a fallacy is well documented. A simple way to understand this is to consider the riskiness of an asset, or portfolio of assets, in terms of the cost to insure that it will earn at least the risk-free rate of return over time. Bodie (1995) shows that the cost of this insurance increases with the time horizon, and the empirical evidence supports this conclusion. Such insurance can be replicated by purchasing a put option, and the actual prices of put options traded in the capital markets do in fact increase with the length of their horizons.
Reliance on probability statistics as a measure of risk. Probability theory has strongly influenced modern economics, including the area of lifecycle finance. In fact, we can learn much about its application—and limitations—from its 17th century founders, Blaise Pascal and Pierre de Fermat. It was Pascal who so famously reasoned that knowing the probability of an event was not enough. The consequences of the event matter, too. Thus, risk has two dimensions. One involves the probabilities of certain events. The other involves the consequences of those events. In terms of the defined contribution plan objective, we can think of this decomposition of risk in terms of (1) the probability that a given funding level objective will be met and, if not, then (2) the magnitude by which it could fall short of its objective. Any risk measure that does not address both dimensions is flawed. Risk measurement is not the same thing as probability measurement.
Thursday, March 4, 2010
"In May 2009, the Minister of Finance, along with provincial and territorial Finance Ministers, launched a process to expand understanding of the issues. They received a report in December and are continuing their collaborative work, leading to a review of policy options at the next meeting of Finance Ministers in May 2010." - the report said there were no problems, why are they still talking? Was the report wrong?
"In preparation for the May meeting, the Government will undertake consultations with the public on the government-supported retirement income system, including the main issues in saving for retirement and approaches to ensuring the ongoing strength of the system. This process will be launched in March." - but, will they talk to real people?
Friday, January 22, 2010
Recently, there has been a significant amount of press concerning whether or not a changes are needed in Canada’s retirement system. What follows are a number of precepts and why they shouldn’t be taken at face value.
1) Canada has one of the best retirement systems in the world
Canada currently spends around 4.5% of national income on pensioners. This is significantly below the OECD average of 7.4%. Canada depends on voluntary, private pension saving to lift overall replacement ratios.
For most Canadians, adequate retirement income depends primarily on personal or occupational saving schemes and sufficient economic stability to ensure that the expected benefits are actually delivered.
While Canada ranks thirteenth in the OECD in income replacement for people earning half the national average wage, it ranks 20th out of 30 OECD countries for those earning the national average wage before retirement, and 26th for those earning 1.5 times the average wage before retirement.
2) Mercer's Global Pension Index gives Canada a high score.
Mercer ranks Canada fourth, behind the Netherlands, Australia and Sweden. Canada scored second highest in their pension adequacy sub-index that looks at how much income is available to a retiree. This high rank is due to the level of minimum public pension and a relatively high net replacement rate of income for median income earners.
However, OECD studies show a somewhat different result. Canada has a strongly progressive mandatory retirement-income system. For low earners, the replacement rate exceeds the OECD average, but then the gap between Canada and the OECD average grows larger as earnings increase. At average earnings, the replacement rate from the mandatory schemes in Canada is 45%, compared to the OECD average of 59%. At twice average earning the replacement rate falls to 20%, compared to an OECD average of 50%. An adequate replacement rate can only be achieved by taking full advantage of tax-deferred saving opportunities over an entire career.
3) Canada’s retirement system has almost eliminated poverty among senior citizens.
Over the last 20 years, retirees’ incomes have tripled. This is due to the impacts of CPP benefits and the number of women working, who have contributed to the CPP. But following retirement, the proportion of income from the CPP has increased as inflation has taken its toll on other sources of income.
Poverty measures are both absolute and relative. In the1990s, despite the gains noted above, workers’ incomes increased faster than those of retirees. At present, approximately 35% of retirees are receiving the GIS – a good indication of the level of poverty or near-poverty found among retirees.
4) A 50% income replacement rate is a reasonable target for middle- income earners.
A good starting point to answer this question might be to look at current income replacement rates and the standards of living these provide. Unfortunately, Statistics Canada has not had sufficient data to conduct the needed longitudinal study. At a recent Standing Committee on the Status of Women meeting, Statistics Canada offered that they hope to do such a study in the future.
A UK survey indicated that desired replacement rates are around 70% for middle to high earners and nearly 60% for the highest income group. These rates have also been the targets of many defined benefit pension plan designs in Canada. However, these are well above the replacement rates that recent retirees have achieved.
The OECD takes as its benchmark the average replacement rate of its 30 member countries' replacement rates from mandatory schemes. This benchmark is about 60% for average earners and 50% for those earning twice the average. While the benchmark is based on mandatory schemes, the OECD extends its use to include voluntary private provision. As noted above, mandatory schemes in Canada replace only 20% of earnings at this level, which highlights the importance of private savings or plans in Canada.
Financial planners frequently use a target replacement rate of 50% when preparing financial work-ups for clients. For higher income clients, this will typically exclude pensions from mandatory schemes. Once the pensions from the mandatory schemes are added back in, the replacement target becomes 70% at twice the average earnings level, with a gradually decreasing overall target for higher earnings levels.
However, any target should come with a few cautions:
· Deciding when to retire is one of the most important decisions most people make. Standard economic analysis says that they can be depended on to plan with foresight and make sound decisions. But studies by psychologists, sociologists, and behavioral economists raise doubts.
· Recommendations from financial planners often tie into what people feel they can afford – many, if not most, underestimate their long term needs.
· As Andrew Allentuck reports, the odds of living to a very old age are increasing. Data from Manulife Financial actuaries show that one member in a couple, each of whom is 65, has a 99% chance of living to age 70, a 94% chance of living to 80, a 63% chance of living to 90 and a 36% chance of living to age 95.
· A person who retires with debt should add the amortization of the debt to the target replacement rate
· Income needs to be indexed or it will quickly lose value. If income is not indexed, a higher replacement rate is needed to enable saving to finance the impact of future inflation.
5) An expansion of the CPP will result in intergenerational transfers.
An expansion of the CPP can not be funded by intergenerational transfers. Bill C-36 (2007) requires that any amendment to CPP be financed on a fully funded basis, whereby each generation pays in advance for the additional benefits accruing to it. As a result any proposed expansion or doubling of the CPP would fully benefit only to those retiring after at least 40 years, not 7 seven years as has been reported.
6) There is no need to improve Canada’s current retirement system.
Edward Whitehouse’s report, prepared for the Research Working Group on Retirement Income Adequacy, set out a number of areas of concern about retirement-income provision for people of working age today.
· Coverage of private pensions, particularly among low-to-middle earners and, to a lesser extent, younger workers, is less-than-complete. While the lowest earners will be able to get by on public pensions, projected replacement rates for middle earners from public benefits are below the OECD average. The analysis here suggests that most workers with a full contribution history will fill this pension gap through voluntary retirement savings. Nevertheless, there are concerns that interrupted contribution histories will leave a retirement-savings gap.
· Contribution rates for people with personal plans (RRSPs) are often relatively small. For example, calculations carried out by Human Resources and Skills Development Canada show that balances in RRSPs for people late in their careers (and so nearing retirement) are significantly smaller than those of people with occupational plans (RPPs).
· Although the public pension scheme provides incentives to remain in work, labor-market participation rates for people in the years up to the normal retirement age of 65 are relatively low.
· Administrative charges for personal pensions (RRSPs) are high for people with individual plans, especially those invested through actively managed funds. Such charges can take a substantial proportion of people's retirement savings.
Mercer's report on their Global Pension Index adds a number of suggestions to improve Canada’s position in their index:
· Increase the level of coverage of employees in occupational pension schemes, possibly through a more efficient system
· Introduce a mechanism for ensuring that voluntary retirement savings are preserved for retirement purposes
· Introduce a mechanism to increase the pension age as life expectancy continues to increase
· Increase the level of household savings.
I believe pension reform should be focused on two key goals - improve the adequacy of retirement income and ensure that whatever retirement income is promised is secure. While most people are financially prepared for retirement, there remains a significant minority who are not. These people need help. Solutions include expanding the CPP, purchasing a CPP supplement, expanding the OAS or allowing retroactive TFSA savings. For others, people are willing to save more on their own. But, surveys indicate that they do not trust private enterprise to do the job and look to government to offer both the facilities and the security for savings. They want a safe affordable retirement option without the high fees and self-serving, questionable advice.