Canada: DB – Time For The Comeback

Last Updated: November 1 2018
Article by Joe Nunes

It's official, DB is coming back!

I wasn't sure about this until last week when revered actuary Fred Vettese declared not only were private sector DB pension plans dying but the date of final death could now be reasonably predicted to be 2026. The only thing I know is that when the experts are all confident that there can only be one outcome it is generally the inflection point where things start going the other direction {bitcoin and Toronto housing prices will keep going up forever as recent examples}.

I will admit that when I convinced my partner to start Actuarial Solutions Inc. twenty years ago, I knew there were going to be more DB plan sponsors who would decide that DC was a better way to go. After all, managing a DB plan is not for everyone. Along my journey I have never tried to convince a CFO who wanted absolute cost certainty that DB would still work for them. What I didn't know back then was that rumours would spread among accountants in the private sector that 'everyone was converting to DC' leaving the CFO who was satisfied with the DB status quo to wonder if they were misinformed or just plain stupid.

Now in fairness to Mr. Vettese he backs off from his salacious opening of "The obituary for defined-benefit pension plans in the private sector was written long ago. Now we can add a date to it" and then provides caveats such as "likely there will be a few holdouts in capital intensive industries in which labour costs are a little less important or in businesses that compete directly with the public sector for new hires". He also mentions "plans that were closed to new hires might still be around then". Fred fails to mention the DB pension plans backed by unions, who figured out long ago that DC isn't a pension plan at all – at best DC is a savings plan and with all the pressure to let people 'unlock' DC accounts it is far from certain that those savings will remain intact until retirement.

Facing Reality

Facing reality 20 years ago meant accepting that DB plans that invested in a 50/50 balanced fund were subject to unpredictable changes in funding levels and volatile contribution patterns. Find me a CFO who wants to say yes to that reality. Even HR departments that knew DB would be a better tool to 'attract and retain' had trouble telling CFOs that the reality of DB was justified.

Today however, the perception of reality is shifting. First, the case against DC. We have known for decades that most DC plan members are under-saving for retirement, largely based upon a flawed model of how much money is enough. What in the beginning was interest rates 'below historical averages' has become a persistent cyclical decline in forward rates. It doesn't matter how bonds performed for the last 30 years – that will definitely not be the experience of the next 30 years. The second big problem with DC that is coming into focus is that 'decumulation' is not a tidy exercise that actuaries model on an excel spreadsheet. Decumulation is messy and uncertain and the best financial planners, investment advisors, and actuaries are all ill-equipped to provide a solution to the question of 'how much can I spend?' – other than recommending annuities. The problem with the annuity is the simple fact that if your retirement model assumes your portfolio will earn 5% or 6% per annum during retirement – there is no annuity that is going to provide that level of return in today's global economy awash in cash. If workers revise their models to assume an annuity purchase at retirement – they will need to double their rate of savings or invest in much risker assets until that day comes (that seems to be the solution in the public sector – more on that subject in a future blog).

Second, the case for DB. There is a growing demand for a DB solution by employees and employers and recent efforts by CAAT and OPTrust to provide employers with a solution to the failure of DC shows promise. This isn't just private sector employees with their noses up against the window looking out at their friends in the public sector – this is also private sector employers realizing that they are spending enormous amounts of time and energy trying to get employees engaged in their own welfare with mediocre results at best. The promises of 'employees want control over their investments' and 'if employees reap the outcomes they will engage in the process' have proven false. The CFO who was able to wash their hands of the pension problem 20 years ago by handing it to employees have found it back in their laps with HR retention problems (both losing the good folks and retaining the weaker performers) and a new cost in the form of severance to move out the obsolete who cannot afford to retire.

Smart DB

It has been my dream since CAPSA's Capital Accumulation Plan guidelines came out in 2004, that DC plans would mature into effective retirement programs. For a while now I have been arguing for 'Smart DC'. Higher mandatory contributions and a more automated approach to investments.

But it is now time to waive the white flag. DC is never going to be DB – and continuing to pretend it will happen isn't being fair to plan members or plan sponsors. For sponsors that cannot withstand any effort to manage a DB plan there are single-employer target benefit plans on the horizon as well as the opportunity to join programs like CAAT.

For sponsors that are open to 'rethinking DB', there is likely an opportunity to scale back benefit promises and take advantage of new funding rules in Ontario and Quebec (and likely expected to evolve elsewhere) to manage contributions more effectively. Managing the volatility in contributions and financial statement reporting in DB are the most important efforts to getting CFOs back on board.

Timing

This is the point where most readers will decide that I am crazy or just publishing a desperate attempt to revive DB plans out of self-interest. While the former is definitely possible; the latter is not.

Of course, the question is when will this comeback for DB plans take hold? The signs are definitely there, but unfortunately, I tend to see things coming and then it takes 5+ years to materialize. Evidence my December 2014 prediction that oil under $60 a barrel would rebound in a year above $80. We are almost there 4 years later.

Unlike Fred's bold call on DB being put into its casket and into the ground in 2026, I am not going to call a year. I am not even going to predict that by 2026 there will be more DB plan members in the private sector than there are today. What I do see is that employers are looking for a better answer on providing workers with the ability to retire before age 75 and I think a new version of DB will be part of that solution.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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