Association of Canadian Pension Management’s Annual Conference
Funding Rules Encourage Riskier Behaviour
How current funding rules encourage riskier behaviour by pension plans, the impact of age on pension plans, and the importance of maintaining discipline were among the sessions at this year’s Association of Canadian Pension Management Annual Conference in Ottawa, ON.
Carole Field, senior director, pension and benefits, at ATCO Group, said current funding rules encourage riskier behaviour by pension plans as sponsors feel they need to hold on to return generating equities until the tide turns. In the session ‘Solvency Rules: The Unintended Consequences,’ she said that the solvency windup scenario funding was initially designed to measure and protect benefits in the case of bankruptcy of a corporate plan sponsor. Over time, it has become the driver of pension contributions. However, “is funding on a 100 per cent guaranteed plan windup basis the right approach?” The current system is not in balance and is moving toward a fully insured model funding focused on guaranteed benefits. She called for a complete review of funding rules and said it is time to move beyond tweaking or technical fixes and consider fundamental changes. One place to start would be requiring the use of only one liability measure. Currently, multiple liability measures are used – funding rules, going-concern funding, solvency funding, IFRS financial reporting, economic liabilities, and dynamic solvency testing. This is confusing, she said. One liability measure is preferable and cost effective.
Monitoring maintains discipline and ensures timely actions on solvency and performance of investment strategies, says Lucie Dutil, of Bell Canada. In the session ‘Workplace retirement plans across generations,’ she said, for example, they track solvency daily against a glide path so they know exactly where the plan is every day. When Bell decided to derisk its plan, it looked at all the elements available including benefit design, funding policy, investment policy, and financial alternatives. However, it also recognizes that circumstances change and the economic environment is in constant evolution. This means it must remain flexible so it gives plan managers the discretion to respond to changing situations.
Susan Kudzman, a partner at Mercer, said derisking is a journey that can unfold over time. Although advanced planning enables future actions, this means derisking actions can be taken in stages as the timing is right. Even if actions are delayed, planning now will make solutions possible in the future as conditions become advantageous.
J. Craig Maddock, vice president – investment management, at MD Physician Services Inc., delivered the message that the age of pension plan participants has an impact. In fact, it is one of the most important determinants on how they should go about investing, he told the ‘Dollars And Sense For The Future: Why Does Age Matter?’ session. For individuals, the time horizon approach best replicates the ALM approach used in defined benefit plans. However, considerations such as savings rate, duration of the plan, and desired benefits are all based on the age of the participant. This makes time horizon the most important factor. The closer a participant is to retirement, the shorter the time horizon and, with the increase in longevity, it means participants have to plan for longer retirement
When the Canada Pension Plan was launched in the mid-1960s, they took the easy way to deal with impoverished seniors, said Malcolm Hamilton, senior fellow at the CD Howe Institute. He told the session ‘Is One Generation's Gain Another's Grief?’ they could have doubled or tripled the old age benefit. Then, they would not have needed the CPP. They didn’t do it, however, because that would have required a tax increase and the governments of the day believed the working generation had no interest at all in paying taxes to support their parents. On the other hand, by creating CPP, they were saying Canadians were quite prepared to support a program where their children would pay for them. In fact, he said, Canadians never understood how it worked and, unfortunately, once this kind of system is created, it can’t be reversed. Canada has ignored what he called the “first law of holes” where if “you find yourself in a hole, stop digging.”
Dr. Jack Mintz, of the School of Public Policy at the University of Calgary, said when the CPP was created, it looked like a good system. Estimates on the pay-as-you-go program forecast increased population and increased growth, making it somewhat of a Ponzi scheme where new entrants paid for those already in it and more people were needed to sustain it. However, things changed. Fertility rates dropped, people started living longer, women entered the work force, and wages were depressed. Most of the assumptions used then are now wrong, he said, and we are at the point where we are passing the buck.
It is time to get rid of the solvency ratio for measuring the funded status of defined benefit pension plans, said W. Paul McCrossan, a retired actuary and former PC member of federal parliament who served on the New Brunswick Task Force on Protecting Pensions. In the session ‘Targeting a better future: Target Benefit Plans,’ he said when the solvency requirement was introduced in 1985, things were much different. For example, interest rates were in double digits.
Another actuary, Jacques Lafrance, president of the Canadian Institute of Actuaries, said if prudently managed and designed, defined benefit pension plans can still be a viable, efficient, and appropriate alternative. Speaking on ’DB Plans: Reasonable Funding and Responsible Security,’ he said there is no perfect solution, but the DB promise must be taken seriously. The CIA’s position is that the risk of pension failure must be reduced. To do so, legislation should favour the use of funding margins (e.g., allow solvency reserve accounts), allow increased use of letters of credit, allow target benefit plans, and allow more de-risking through, for example, annuity buy-outs.
And one way to deal with the demographic issues facing pension plans in Canada is to get rid of the breadwinner mentality, says Roderic Beaujot, emeritus professor of sociology at Western University. He told the session ‘A Populous Now: Adapting Pensions to Changing Demographics’ that most provisions today are based on a decades’ old breadwinner model where the husband worked and the wife stayed home and raised the family. Today, widowhood benefits, spousal allowance, pension splitting, and deductions for dependent spouses are no long relevant in an environment where often two people are working.