Post on 01-Jan-2016
Michel St-GermainMontréal
Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan the answer?
Presentation to the Canadian Association of University Business Officers
June 19, 2006
Mercer Human Resource Consulting 2
Agenda
Are DB pension plans too risky?
How many employers are moving away from DB?
Why replace a DB by a DC?
Are Universities different?
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Most pension plans are significantly underfunded
0%
10%
20%
30%
40%
50%
% of plans
<80% 80%-90% 90%-100% 100%-110% 110%-120% >120%
Solvency ratios
Déc . 31, 2003 Déc . 31, 2005
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Because interest rates have decreased by more than 2% since 2000. But are they going up?
3%
4%
5%
6%
7%
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Bond Yields
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Return on Canadian equities
-20%
-10%
0%
10%
20%
30%
40%
1997 1998 1999 2000 2001 2002 2003 2004 2005
And return on equities have gone up and down
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Total returns on pension funds have not been bad
-10%
-5%
0%
5%
10%
15%
20%
1997 1998 1999 2000 2001 2002 2003 2004 2005
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But pension liabilities are growing faster than pension assets because of the decrease in interest rate
Source: Mercer Pension Health Index
0.90
1.10
1.30
1.50
1.70
1.90
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Asset Performance
Liability Performance
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And pension solvency has lost 40% since 2000. But is it going up?
Source: Mercer Pension Health Index
0.70
0.80
0.90
1.00
1.10
1.20
1.30
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Solvency Index
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Solvency ratio
70%
80%
90%
100%
110%
120%
2006 2007 2008 2009 2010 2011
Base Interest + 1% Int. + 1%, eq. 20%
Employer contribution
0%
10%
20%
30%
40%
2006 2007 2008 2009 2010 2011
Base Interest + 1% Int. + 1%, eq. 20%
What would make the problem disappear? A 1% increase in interest rate and20% stock return
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Pension plans are in the news
GM to freeze salaried
pension plan.
Alcoa to close its pension plan to new
workers.
IBM to freeze pension plan.
Dodge calls for reform of pension
rules; overhaul needed to ensure system’s viability.
When the spinning stops – Actuaries and the pension
crunch.The Economist,28 January 2006
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What can be done to manage pension costs?
Reduce investment risk
Stop plan improvements
Increase employee contributions
Convert from DB to DC
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Key difference between DB and DCWho supports the pension risk?
Defined DefinedBenefit
Contribution
Employer Contributions Volatile Fixed
Employees Pensions Fixed Volatile
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In the U.S. – Many large companies have recently frozen their DB plans and have implemented less generous DC plans
International Business Machines Corp.
Verizon Communications Inc.
Circuit City Stores Inc.
Sears Holdings Corp.
Motorola Inc.
Lockheed Martin Corp.
Hewlett-Packard Co.
NCR Corp.
Rockwell Collins
General Motors
Alcoa
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Canada is moving slower than the U.S. and UK toward DC. But for how long?
0 10 20 30 40 50 60 70 80 90 100
USA
UK
Canada
DB DC Hybrid
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Currently, about 70% of retirement programs of publicly traded companies of Canada have a DC component
Retirement programsPublicly-traded companies in Canada
0%
5%
10%
15%
20%
25%
30%
35%
DB DB+DC DB closed DBclosed/DC
new
DC Greater ofDB and DC
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Retirement programsPublicly-traded companies in Canada
0%
5%
10%
15%
20%
25%
30%
35%
DB DB+DC DB closed DBclosed/DC
new
DC Greater ofDB and DC
Mercer consultants expect that most of DB plans will move toward to DC
Current DB plans, in 5 years
0%5%
10%15%20%25%30%35%40%45%50%
DB DB+DC DB closed DBclosed/DC
new
DC Greater ofDB and DC
Wound-up
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Why are employers moving away from DB?
Too costly – Decrease in interest rates
Too risky – Volatility of stock market returns
Not in interest of shareholders – Concentrate on business issues
Unfair funding rules – Employer pays deficits and shares surplus
Uncertain court decisions – Monsanto/Transamerica
Too complicated – Cumbersome legislation
Do not meet employees’ needs – Not flexible and not transferable
Outdated HR model
Too generous
– Early retirement incentives with expected shortage of labor
– For some, more disposable income after retirement
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But DB can add value
HR issues
– Guarantee of retirement income for baby boomers
– Some employees are not able to manage retirement capital
– Allocate more compensation to career employees
– Retention tool until early retirement
– Compete with public sector
– Need for selective early retirement subsidies
Financial issues
– More pension per $ of contribution
– Lower investment fees
– Higher investment returns
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Moving from DB to DC has many challenges
It is difficult to dismount a DB
Law prevents reduction in accrued benefits
Conversion of accrued DB into DC must be optional and is complex
Need to protect baby boomers
Short term increase in cost if current employees can continue in DB
What should the DC cost?
– Equivalent benefits
– Equivalent cost
Significant implementation issues
– Administration of choices
– Payroll adjustment
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There will be winners and losers in moving from DB to DC
Age
Va
lue
DB DC
Winners Losers
- Terminated employees - Early retirement
- Younger employees - Career employees
- If good returns - If low returns
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Maintaining a DC is not easy
Employees need support and education
– How much to contribute?
– Where to invest?
– What to do at retirement?
and would like to get advice not education Some employees will not be able to manage capital The employer will be blamed for poor performance Risk of litigation – and more fiduciary responsibility The employer will be in the banking business – every cent must be
reconciled
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Reduce cost
Reduce risk
Better meet employees’ needs
Introduce flexibility
Simplify administration
Eliminate early retirement subsidies
Follow the crowd
But, in Canada, expect that private sector employers will continue to replace DB by DC for non-unionized employees
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Universities may find DB more attractive than private sector employers
Cost can be shared with employees and retirees by adjusting contributions and indexing.
Funding rules may not require solvency valuations resulting in volatile contributions.
Single pension plan for all employees may be desirable; unions strongly object to DC.
A generous DB plan may be needed to compete with other public sector employers.
Early retirement incentives may be replaced by flexible working arrangements, such as phased retirement.
A total compensation package with more pension and less salary may be more attractive