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June 19, 2006. Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan th e answer? Presentation to the Canadian Association of University Business Officers. Michel St-Germain Montréal. Agenda. Are DB pension plans too risky?
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June 19, 2006 Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan the answer?Presentation to the Canadian Association of University Business Officers Michel St-Germain Montréal
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?
Because interest rates have decreased by more than 2% since 2000. But are they going up?
And return on equities have gone up and down • Return on Canadian equities
But pension liabilities are growing faster than pension assets because of the decrease in interest rate Source: Mercer Pension Health Index
And pension solvency has lost 40% since 2000. But is it going up? Source: Mercer Pension Health Index
What would make the problem disappear? A 1% increase in interest rate and20% stock return
Alcoa to close its pension plan to new workers. GM to freeze salaried pension plan. IBM to freeze pension plan. When the spinning stops – Actuaries and the pension crunch.The Economist,28 January 2006 Dodge calls for reform of pension rules; overhaul needed to ensure system’s viability. Pension plans are in the news
What can be done to manage pension costs? • Reduce investment risk • Stop plan improvements • Increase employee contributions • Convert from DB to DC
Key difference between DB and DCWho supports the pension risk? Defined Defined Benefit Contribution • Employer Contributions Volatile Fixed • Employees Pensions Fixed Volatile
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
Canada is moving slower than the U.S. and UK toward DC. But for how long?
Currently, about 70% of retirement programs of publicly traded companies of Canada have a DC component Retirement programs Publicly-traded companies in Canada 35% 30% 25% 20% 15% 10% 5% 0% DB DB+DC DB closed DB DC Greater of closed/DC DB and DC new
Retirement programs Publicly-traded companies in Canada 35% 30% 25% 20% 15% 10% 5% 0% DB DB+DC DB closed DB DC Greater of closed/DC DB and DC new Mercer consultants expect that most of DB plans will move toward to DC
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
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
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
But, in Canada, expect that private sector employers will continue to replace DB by DC for non-unionized employees • Reduce cost • Reduce risk • Better meet employees’ needs • Introduce flexibility • Simplify administration • Eliminate early retirement subsidies • Follow the crowd
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