Seeking wins from retirement losses

>Workers being stuck with investment and financial risks as executives eagerly off-load company pension obligations
Don Smith, partner, Western Compensation and Benefits: “target benefit plans are a way of moving some of the risk away from the employer and sharing it with the members of the plan”

Gerry Edwards sat at the negotiating table in B.C. for more than two decades as an area supervisor for the United Steelworkers union.

Reflecting on his career, the 78-year-old found that most companies he dealt with were genuinely interested in developing a good relationship and setting reasonable wages for workers.

But it was the unscrupulous, unpleasant and stingy employers he was wary of, especially if the company provided a pension plan.

“Even the long-established company can wiggle their way around saying, ‘It’s hard times. We can’t put money into the pension plan but we’ll catch up,’” explained Edwards. “Well, when the time is right, they declare bankruptcy and you can whistle Dixie for your money.”

The lack of legislative protection for employees who belong to a defined-benefit (DB) pension plan has remained one of their biggest risks, especially since the 2008 financial crisis. Unprecedented stock market volatility, record low interest rates and declining economic growth have created a worst-case scenario for companies with pension plans that provide a specific benefit at retirement. (See “Devaluing retirement dreams” – BIV issue 1153; November 29-December 5.)

Unfortunately, the Great Recession has created some significant pension casualties. Among the largest has been Nortel Networks’ bankruptcy, in which 12,000 company pensioners face up to a 43% cut in their benefits. The cuts resulted from the company’s pension being $1.5 billion under-funded when Nortel filed for bankruptcy.

For years, Edwards, who is now president of the BC Federation of Retired Union Members, has lobbied for legislation to protect company pensions. The move gained momentum in March 2010 when the federal NDP filed a private member’s bill proposing changes to the Bankruptcy and Insolvency Act that, in the event of bankruptcy, would place a company’s pension obligations ahead of secured lenders such as banks.

The bill received a lot of corporate opposition. A report by Vancouver’s Phillips, Hager & North Investment Management suggested creditors would be less willing to lend to companies with a large senior obligation like a company pension plan. The legislation could also increase borrowing costs for companies.

The bill died in March thanks to a federal election. But the NDP launched a similar bill in October. Instead of putting pensions ahead of secured lenders, Bill C-331, would place pension obligations ahead of other unsecured lenders.

But the bill will continue to face strong opposition from federal Conservatives, who can use their majority to kill it if it reaches the Senate.

Such an outcome wouldn’t surprise Edwards. But given the idea that an employee pension consists of deferred wages, he said, “there needs to be legislation to protect those funds. Otherwise, a pension plan is almost useless to you. There is a need to protect pensions from unscrupulous operators, and there are many of them around.”

The Supreme Court of Canada decided last week to wade into the issue. It agreed to hear an appeal of an Ontario court ruling that concluded former employees of aluminum processor Indalex Ltd. had priority claim on the company’s assets to find a shortfall in their pension plan.

Heavy risks in defined-contribution plans

To avoid the financial risks associated with DB pension plans, companies are opting to provide defined-contribution (DC) pension plans. Under a DC plan, the employer and the employee contribute a specific amount into the pension plan, but the final retirement benefit is not guaranteed.

According to Statistics Canada, the number of Canadians in DC plans climbed 7.7% to 961,845 between 2006 and 2010. Meanwhile, the number of people in DB plans fell 1.6% to 4.52 million during the same period.

The growing number of people with DC pensions means that more Canadians risk not having enough money come retirement, even with a pension.

Chris Roberts, a senior researcher of social and economic policy for the Canadian Labour Congress, noted that DC plan members not only have to manage their investment risk, but also have to deal with inflation risk and the possibility of outliving their nest egg.

“In a DB plan, you pool the risk over a number of people so you can shoot for the average. With DC plans, individuals are required to over-save,” said Roberts.

Also, DC plan members might not be getting the advice they need to protect their pension nest egg or help it grow.

Kaveen Kapahi, manager of Mercer’s retirement practice in Western Canada, noted that companies are not yet legally required to provide financial advice to assist employees managing their own DC plans.

But even with financial advice, Kapahi said DC plans tend to underperform compared with their DB counterparts. This is primarily because individuals will generally be more conservative in their investment decisions than investment managers who run DB plans.

An analysis of various public B.C. companies found the asset mix of Teck Resources’, Catalyst Paper’s and Canfor’s DB plans were fairly stable at 60% equities and 40% fixed income. Some plans included real estate and infrastructure investments that provide cash flow returns. In individual plans, however, the investment mix tends to be less aggressive.

Kapahi said the conservative investment approach of most individuals adds up to lower rates of return over the long term.

He also noted a low-interest environment and historic market volatility hurts individual pensioners even more, because they have no buffer to protect their pension principal.

“In a DB plan, if it’s a short-term interest rate drop, the plan may be able to ride it out,” Kapahi said. “You’re sharing [the risk] among a broader group of people.”

Plan costs erode returns

In addition to investment returns, DC plan costs erode employee nest eggs because they require more savings to yield the same level of retirement benefit.

A U.S. National Institute on Retirement Security study suggested that individually managed DC plans can cost 46% more to operate than a standard DB plan. The report found that in order for a DC plan to provide the same level of retirement benefit as a DB plan, employees would have to contribute 22.9% of their payroll into the DC plan, compared with only 12.5% of their income for the DB plan. All told, DC plan members would need to save 55% more money to get the same benefits under a DB plan.

The report said DB plans provide a better pension because they:

•avoid the need to save more than what is necessary;

•stay forever young, so the asset mix doesn’t have to become more conservative over time; and

•achieve higher investment returns on average than individual DC plans.

“For employers, shifting the risk to employees looks good ... but for employees it’s an inferior deal,” said Roberts.

Hybrid pension benefits

While the trend to close DB plans has grown, some industry experts suggest hybrid plans provide the best options for employers and employees. For example, under a target benefit (TB) pension plan an employee’s benefits are not guaranteed, but it takes a DB approach by pooling the assets of individual members and having the fund professionally managed.

“Target benefit plans are a way of moving some of the risk away from the employer and sharing it with the members of the plan,” said Don Smith, a partner at Vancouver’s Western Compensation and Benefits. “This is a huge advantage relative to defined contribution arrangements, where each person is basically left to bear his or her own risks.”

TB plans have not been a popular option in the private sector, but Smith said they have been in the public sector. He said the four largest public sector plans in B.C. have become TB plans as employees seek to have greater control over their pension plans.

Smith said TB plans generally provide a far better option for employees because the retirement risks would be shared between plan members.

“But in order for TB plans to really gain traction, it needs initiative from the employee’s side or from companies that appreciate from an HR standpoint that having a well-structured, well-financed target benefit plan is an important factor in attracting and retaining employees.”

A growing number of Canadians with company pension plans have pensions that are partly DB and partly DC, so part of the pension benefit is guaranteed, and part is not.

According to Statistics Canada, the number of people under such arrangements has skyrocketed 880% to 392,076 between 2006 and 2010.

Some recent labour disputes involving pension benefits have resulted in hybrid plans, including an agreement between Air Canada and its flight attendants.

Such a move, however, isn’t likely to benefit Air Canada. Smith noted the airline still has its DB obligations and now will operate a DC plan for new employees.

“Air Canada and its employees would be far better off in the long run to move to some form of TB arrangement.”

Pooled plans unlikely to benefit Canadians

Even though more Canadians now have DC pension plans, the number of private-sector employees covered by a workplace pension plan has consistently declined.

According to Statistics Canada, the proportion of private-sector employees with a pension dropped to 25.5% in 2007 compared with 35.2% in 1977.

The federal government’s new pooled registered pension plan (PRPP), legislation expected to be tabled this year, aims to halt the declining pension coverage by creating a new, more affordable way to provide registered pension plans.

Kapahi noted that a basic DC plan becomes affordable for companies with at least 75 employees. Today, most smaller companies that provide some staff retirement benefits do so by providing contributions to group RRSP plans.

But Smith said PRPPs only complicate the retirement savings landscape by adding yet another savings vehicle to the mix.

“We already have DC plans and Group RRSPs,” said Smith. “PRPPs are just another name but a different iteration of the same thing. It’s naďve to think that just by introducing this new vehicle that suddenly the costs of these plans will fall precipitously and that people will participate much more.”

Whatever new options the government provides, Roberts believes DB plans remain the best option for employees. He noted that despite executives decrying the costs of DB plans for companies, it remains the pension plan of choice for corporate management.

“The vast majority of DB plans are very small ... these plan members are executives,” Roberts said.

“We’ve always pointed out that what managers and CEOs get for themselves should be available to all employees.” •

Pension Points:

962,000 the number of Canadians with defined contribution pension plans

880% the increase in hybrid pension plan arrangements in the past five years

46% the amount a defined contribution pension plan costs more than a defined benefit plan

25% the percentage of private-sector workers with a workplace pension plan

20% the decline in defined benefit coverage in the private sector

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