PRPPs – ‘Ah! What A Chance Missed!’
A golden opportunity for much needed precedent-setting legislation and regulations was missed when the proposal for pooled registered pension plans (PRPPs) was brought forward.
The federal government's PRPPs are a type of defined contribution pension plan. Yet, DC is still at the early development stage in Canada. Other than the CAP Guidelines, there is little specific legislation or jurisprudence to assist sponsors or administrators in overseeing DC plans. And if PRPP is a type of DC plan, it is not clear how, or if, the CAP Guidelines will apply. This adds to the debate and uncertainty regarding the purpose and shortcomings of PRPPs.
The PRPP act and regulations presented an opportunity for the federal government to provide legislation which would address a number of grey areas and set a precedent for CAPs and provincial PRPPs. Unfortunately the federal legislation and regulations avoid contentious issues and are ambiguous in key areas. The result is more questions than answers! Provincial PRPP legislation, however, still presents an opportunity to address many of these issues and advance the evolution of CAPs and PRPPs.
For sponsors with existing DC or other CAPs, the opportunity1 to transfer their fiduciary roles and responsibilities and the potential legal and financial risk to a third-party administrator should be appealing. The question is would this be in the best interests of the members?
Conflicts Of Interest
The potential for conflicts of interests in PRPPs should be a huge concern. Conflicts could take the form of administrators (employees of the financial institutions) selecting sub-optimal or new proprietary investment and default funds, use of higher cost products, 'tailoring' of communication and education, promotion or locking members into certain types of products, or extensive use of related parties (e.g. advisors) and services of a financial institution.2 The act and regulations address some of these areas, but do not address many key issues.
Accountability is limited in the act and regulations resulting in poor governance. For example, it appears that the oversight of a PRPP is primarily the responsibility of the financial institution providing the PRPP. There is no requirement for independent boards or a governing body. The PRPP administrator has sole discretion in selecting the investment funds. Performance and benchmarking criteria, which are important in assessing service provider performance, are not prescribed.
There is no direction on whether a sponsor should or can intercede on behalf of members. At this point, the sponsor simply collects contributions for the administrator. The administrator also has total discretion in terms of setting and changing contribution rates.3 Would it not be more appropriate for the sponsor and or member to have some say in this? What are the checks and balances?
Even the simplest form of accountability – leaving a PRPP if dissatisfied – is stymied. Members only have one opportunity to withdraw funds from a PRPP account.4 If there is a problem, a sponsor could change PRPP providers, but this is not without cost and risks (particularly if target date funds have been included as investment options). A further impediment to changing a PRPP is the requirement that the sponsor must bear the cost of transferring assets from one PRPP to another.5
Inconsistencies undermine credibility and create confusion. Under the act, an administrator must not offer an employer an "inducement" to have a PRPP. Yet, this is allowed under the regulations.6 Under the act, the employer is not responsible for the "acts or omissions of the administrator" which leads one to question 'who oversees the PRPP administrator?'7 Can the financial consumer agency or superintendent, for example, be expected to do this effectively? Profit driven administrators and sponsors with little accountability are a recipe for future problems.
A 2011 study undertaken by Blackrock found that 52 per cent of employees felt DC sponsors weren't helpful in safeguarding assets after retirement. With the sponsor now once removed from the PRPP pension program, will PRPP members feel any differently? What's their recourse?8
The regulations are the responsibility of the governor in council which acts on the advice of the federal cabinet. Political agendas and lobbying by profit-oriented financial institutions could easily result in conflicts with the needs of PRPP members. As was the case with DC plans, with time, a few court cases, and CAPSA involvement, a whole new level of costly sponsor intervention may be required.
The question remains: who is responsible for looking after the interests of PRPP members?
Index funds representing broad classes of securities are allowed under the regulations. Most academic research indicates that, over a longer term, passive investments, after fees, outperform most actively managed investments. The retail investment industry, as you would expect, disagrees. Nevertheless the advantages of passive management are significant:
- lower fees
- comparable or better long-term returns, after fees
- reduced volatility (versus benchmarks)
- the facilitation performance comparisons with other PRPPs for returns, fees, and services
- it is simpler to understand from a member and sponsor perspective
- it is easier to change PRPP providers
Allowing only a passive investment approach would minimize the potential conflicts of interest and facilitate the purpose of PRPPs: to achieve retirement savings at a lower cost in relation to investment management and plan administration.9
New low cost products are also available such as ETFs which increase the choice and flexibility of passive investments. The majority of CAP members, however, will be disengaged investors who are committed to long-term investing. Having only passive investments in PRPPs would be a simpler low cost approach with little downside for all stakeholders.
Definition Of 'Investment Option'
While the regulations limit the number of PRPP investments, including the default fund, to six choices, the term 'investment option' is not defined.10 The lack of a definition is a potential problem. From a diversification perspective, each investment option should have a specific risk and return profile. Are life cycle funds – such as a series of target date funds, asset allocation funds, or one-, three-, and five-year GICs – considered to be one investment option or individual investments?
This is also important for TDFs since the act states that any change of a member’s investments must be requested by the member.11 The limit of six investment options will become meaningless if each financial institution is allowed to decide what constitutes an investment option. The term 'investment option' needs to be defined in the regulations.
Allowing only six investment options supports the argument that a limited number of choices can be sufficient to provide a diversified and prudent set of investments. A suite of six broadly based index funds would appear to be ideal in this situation. For example, the options might include a balanced (default) fund; Canadian, U.S., EAFE, and global equity funds; and a bond fund. A choice of investment product within each of the asset classes does leave room for some risk and return customization. A passive approach with a limited number of investment options would provide a simple, low cost approach that is easier to understand and administer.
A significant administration and fiduciary burden will be assumed by the PRPP administrator. Will an administrator be able to deliver low costs under these circumstances?
The fees paid by members are a major DC issue. In the U.S., recent ERISA legislation significantly strengthened fee disclosure requirements. The impact, however, has been debatable with many service providers managing to circumvent disclosing any meaningful information. Getting straight answers on the amount members pay and for what are difficult. In Canada, the PRPP act only requires that the administrator provide a PRPP at a low cost and a description of fees.12 The regulations state that "costs are to be at or below ... defined contribution plans ... of groups of 500 or more members."13 Does this make sense?
The key determinate in lowering fees is the dollar amount of assets, not the number of members in a plan. Given the unique nature of DC plans, will the superintendent be able to make meaningful comparisons based on the number of members in a plan? Where will this sensitive pricing data come from? Who will have access to the data? How often will it be done? What will this cost and who will pay for it?
To add to the uncertainty, 'costs' are defined as "all fees, levies, and other charges that reduce a member's return on investment other than those triggered by the actions of the member."14 Is the selection of an investment option not an action of a member?
The fund manager component of fees paid by PRPP members will differ between PRPP providers. Disclosure of the fund manager component of fees is, therefore, important in selecting a PRPP provider. Using a passive approach would facilitate fund manager fee comparisons and selection of PRPP providers.
The fee issue could be addressed by requiring the administrator to disclose each component of fees for recordkeeping (administration), fund managers, and financial advisors (if applicable). A requirement to provide an easily understood fee breakdown format for recordkeepers/administration, fund managers, and advisors of the costs paid by a member on member statements would be useful information. In selecting and monitoring a PRPP provider, a sponsor needs to be able to compare the cost components. The administrator portion is of particular importance given the scope of the administrator's duties.
Education And Communication
Communications and education are important, awkward, and costly CAP issues. The CAP Guidelines recommend that a sponsor provide investment information and decision-making tools.15 This topic is not addressed in the act or regulations. Under the CAP Guidelines, the roles and responsibility for communication and education are clear. However, it is debatable whether the PRPP act falls under the CAP Guidelines. Direction is needed in the legislation on the issue of communication and education.
For example, investment risk is an important, but confusing, topic for most DC and PRPP members. The CAP Guidelines and PRPP requirements on this key issue are minimal: only the degree of risk associated with an investment needs to be described.16 Since PPRP members bear the investment and longevity risk, they need more information on these issues and better tools to manage risk (a simplistic risk profiling approach is not adequate).
The awareness and understanding of investment risk could be improved by providing a definition of risk(s) and requiring disclosure of historical information regarding the volatility of each investment option.
Employers need to understand their role and responsibilities for communication and education when considering a PRPP.
Suggesting that specific direction on a number of contentious issues be included in the PRPP legislation is not unreasonable. The new Alberta and proposed BC pension acts, for example, have not been shy about including detailed governance requirements. Adding the governance sections of Alberta and BC pension acts would improve the PRPP legislation and governance.
Given the level of sophistication of investors likely to be in PRPPs, the low-cost objective, the expectation of reasonable and defensible market returns, and the need for transparency, these changes would enhance provincial PRPP programs.
Keeping it simple (KISS), and effective, should be the primary goal for PRPP legislation.
'Ah! What a chance missed! God! What a chance missed!'17
Gerry Wahl is managing director, senior consultant, at Ampersand Advisory Group
- PRPPA SS 45(1)
- PRPPA SS 41(5) & (2)
- PRPPA S45 & Regs SS 21(1)
- PRPP Act P41(5) & (2) and SS43 (2)
- PRPPA SS 43(3)
- PRPPA S24 & PRPP Regs S19
- PRPPA S30
- Benefits Pension Monitor May 25, 2011
- PRPPA S3.
- PRPP Regs SS 17(a)
- PRPP Act S25
- PRPPA S26 & PRPP Regs P23(c)(vii)
- PRPP Regs SS20(a)
- PRPPA S1
- CAP Guidelines 2004 S3.2
- CAP Guidelines 2004 S3 & S 4.2.1 & Regs 23(1)
- Joseph Conrad » Lord Jim » Chapter 7