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.