Monday, July 18, 2011

Pensions as financial instruments

Sadly, the Nortel pension plan is being wound up. Retirees will get 59% to 70% of their full entitlement – depending upon their province of residence and whether they had an indexed pension. They will have to adjust to living on much less than they planned, or find some other source of income. The later is hard to do if you’re in your 70’s.

What is clear from all this is that pension legislation has done a poor job of protecting today’s or future pensioners. Perhaps this is not as surprising as it should be.

If we look back 50 years, pensions were often seen as a gift from a generous employer (or union), in recognition of many years of faithful service. But employees could never be quite sure these promises would be kept, and many weren’t kept. What if the employee didn’t stay to retirement, or the service was not as faithful as the employer would have liked – all possible cause for default on the promise.

Pension legislations changed everything. The first rules covered such things as benefit determination, vesting, death benefits, pension payment and funding. Actuarial valuations were to be done every 3 years. The legislation was enacted as an employment standard. Each of the provinces had a slightly different view as to what these standards should include, like other employment standards.

The important point is that the provincial pension legislations focus primarily on social aspects – setting standards as to what and when an employee is entitled to receive something from a pension plan. Plan financing rules are included in the legislation, but these rules are far from most important and they occupy much less of the legislative text than the social aspects. As well, despite the fact that nearly all provinces have made a review of their legislation, with input from numerous experts, provinces have made very few changes in the financing provisions of the plans. And, it is clear that the changes that have been made are intended to avoid placing a “burden” of plan sponsors.

But the Nortel situation illustrates what happens when plan financing is not top of mind. People suffer the consequences. Running a pension plan is not like running an endowment fund, where best efforts can be made to deliver the intended result. A pension plan, viewed by a retiree or future retiree, is a financial promise. It is similar to the promise made by an insurance company to an annuitant. And, it should have similar financial oversight.

Viewing a pension plan as a financial instrument would mean changing and strengthening legislation. For example, actuarial valuations should be done annually (many plan sponsors are doing this now) and minimum surplus requirements should be established (these could vary depending on plan maturity and investment choices). The timing to do this couldn’t be better. New accounting legislation is forcing plan sponsors to change how they report costs and liabilities. Pension legislation could piggy-back on some of these new requirements.

Members need confidence that promised benefits will be paid. Pension legislation has corrected many past “social” ills – it is now time for “security” to take over as the major focus.

Sunday, April 3, 2011

Retirement Security

In a recent issue of The Actuary, an article titled "Retirement Security" tackles the risks of retirement and how those risks impact attaining a secure retirement in a defined contribution world. Although written from a US perspective, the issues highlighted are equally prevalent in Canada. I suggest the article should be required reading for all those trying to improve our retirement future.

The authors start by identifying a number of reasons why an individual's funds may not be adequate:

• Not saving enough money;
• Inadequate investment returns and poor investment strategy;
• Leakage—using funds too early, possibly as a result of cashing out savings as participants change employers, taking loans and not repaying them, or requesting hardship distributions;
• Premature death of the employee, leaving the family without adequate funds for retirement;
• Disability before retirement;
• Early retirement;
• Outliving retirement resources because they are used too quickly;
• Job changes, which disrupt the program of retirement savings; and
• Period of unemployment.

Some of these risks can be managed within the DC plan, but others require interventions or actions outside of the plan.

The authors conclude by highlighting some of the things individuals, employers and financial service providers should think about when helping individuals prepare for the future:

• More long-term planning;
• Encourage increased savings via communication and/or auto-escalation programs;
• Improve diversification and risk management in asset allocation defaults;
• Re-examining solutions for the payout period, and providing more options for structured solutions and a portfolio of options;
• Prepare people to work longer, and to keep skills up-to-date;
• More consistent focus on emergency funds so that retirement funds do not become emergency funds;
• Enhancing approaches to disability benefits so that when they work next to DC plans they support appropriate lifetime security. The disability benefit ideally should support continued saving for retirement until expected retirement age, but this is very rarely explicitly done when benefits are provided through DC plans; and
• Re-examining whether survivor and death benefits are adequate.

It's a good list - but, please read the article for more detail and background.