Global perspective on Canada’s pension conundrum

Financial Post
By Dan Ovsey
May 27, 2013

With many of Canada’s Defined Benefit pensions experiencing historically high deficits and many employers choosing to do away with DB pensions entirely (or to opt for a hybrid Defined Benefit/Defined Contribution model), Canada’s pension landscape is looking somewhat bleak. Yvan Legris, CEO of Aon Hewitt’s global consulting practice, recently spoke to the Toronto Board of Trade about the pension conundrum and risk management from an international perspective. Afterward, he spoke with FP’s Dan Ovsey about the relevance of the Defined Benefit pension today, how Canada’s pension landscape compares with other industrialized nations, and what alternative pension models the country could explore. Following is an edited transcript of their conversation. [EXPAND Read more]

Q: Canadian executives are often accused of being more risk averse than their counterparts in other industrialized nations. Given your global perspective on the pension and investment landscape, do you believe that to be true?
A: I don’t see that at all. I think what there is in Canada, actually, is a very thoughtful view about some attributes like solidarity and trying to think about all stakeholders before a decision gets made. So, the decision is more thoughtful, but not necessarily more conservative. The notion of a public good and public interest is much more pronounced in Canada than a lot of other countries.

Q: You mentioned in your presentation about the swapping arrangements that are taking place in some other regions. Can you explain a bit more about that?
A: Essentially what you have is a financial settlement for pension plans where you are committed to pay pensions to your pensioners until they die (so, you have an unknown term to that particular flow of money). So, what happens is you’re able to go turn that unknown term into a fixed term and pass the risk that people live longer than that fixed term to your counterparts in the swap. Depending on what happens, the longevity of the people within the portfolio, there are mechanism in the swap for cash to move from one side or the other (depending on how many people go over the trigger). So, what it does is bring more certainty to the pension plan as to what is the time commitment and the amount of money it needs to meet that payment, with potentially paying more than just that amount in order to buy the insurance (if you will), of people living beyond that time that they’ve chosen. So, it’s a good device but it comes at a price and it really then boils down to what is the price that a pension plan or a sponsor is prepared to pay in order to buy off and insure that tail risk within the longevity curve.

The UK introduced a compulsory defined contribution system for all workers because the system had existed previously where employers were not required to offer a pension plan to their employees

Q: We’re currently exploring alternative pension models — such as the Pooled Registered Pension Plan and an expanded CPP — to fill the gap left by the disappearance of the Defined Benefit pension. What alternative models are being explored in other industrialized nations?
A: There are different systems. The UK, for example, introduced a compulsory defined contribution system for all workers because the system had existed previously where employers were not required to offer a pension plan to their employees, so they were just relying on the state for their own savings. As of October of last year they introduced a new plan where — larger employers first and then all employers, in the second wave — would have to offer a minimum contribution to a Defined Contribution plan to all of their workers. So, in retail, for example, typically coverage wasn’t very high and this has brought a lot of people back into pensions. They can opt out if they choose. Typically the contribution rate goes in by the employee and the employer has to match or pay more into the plan. So, that’s a common device I’ve seen in a number of places.

Q: But it isn’t pooled?
A: It isn’t pooled, but the assets are pooled. The individual risks are still there. They tend to be quite low cost. That’s the other part. The government required these to have a maximum charge that was a lot less than if you went out and bought your own individual pension plan. So, it’s more efficient than that.

Q: Originally pensions were offered as a means of staff retention. Do you believe that given the mobility of labour today — both within nations and internationally — that the Defined Benefit model is still relevant as a retention tool for employers?
A: I think a lot of the drivers behind why Defined Contribution became popular in the late 1990s and early 2000s is precisely that. The employment patterns were changing. People were spending, on average, less than 10 years in a job, and sometimes less than that. In a Defined Benefit plan, you don’t necessarily get great value for short periods, especially if you were quite young, because the payments would be discounted by you from the retirement age when you seek the amount. So, if you look at what’s produced after 10 years in a Defined Contribution plan it can often be quite a bit more for that same short period. That was the big driver. So, I agree that Defined Contribution plans are a better model for the mobile employee.

Q: We tend to have a significant disparity in the number of private sector pensions versus public sector pensions in that the latter greatly outnumbers the former. Is that comparable to most other industrialized nations?
A: It is absolutely. When I look at the places where I spend a lot of time — in the U.S. and UK, for example — that is the case. Some of that is driven by the planning horizon and the ability to look at pensions in their true guise. You’re able to do that in the public sector because some of the short-term measures and short-term hurdles that you have to pass don’t exist for the public sector. So, that’s one thing. The second thing is an argument that’s been made in many cases that on many other aspect the public sector pay package is not as generous as the private sector and the pension plans are a big part of why people choose to be in the public sector. So, it’s part of that broader deal and that argument is used quite a lot in other countries as well.

In a Defined Benefit plan, you don’t necessarily get great value for short periods, especially if you were quite young

Q: When you look at organizations that offer a DB plan — be they in the public or private sector — more often than not it’s an organization in which there is an organized labour arrangement in place. Given that union ranks have been decreasing, do you believe  we will see the re-adoption of the DB plan in its traditional form (or even perhaps in a revised form) in the private sector if there’s no organized labour model to help drive it forward?
A: I think the interest to de-risk or manage risk is there. I talk to a lot of private-sector employers and there are a number that are interested in having a different balance of risk and not necessarily go all the way to a Defined Contribution plan where the risk on the employer is minimized. So, it is possible and conceivable to me that you would have that shift and that it doesn’t really depend on organized labour but rather much more on the philosophy of the employer in terms of that balance of risk sharing. And the pension is seen in the context of the broader deal with the employees. From my perspective, it’s pay, it’s the bonus system and whatever share participation you have, and then the pension is another aspect of that within the range of benefits that are provided. But it’s conceivable, it’s feasible and I’ve seen it in cases.

Q: As a reaction to historically high household debt, Canada’s federal government has made a lot of moves to try and steer Canadians away from the use of credit and toward greater savings for retirement. Do you believe it’s government’s role to push people to save for retirement?
A: I think there is a strong element of social good by forcing a minimum level of savings among people. Particularly in times of stress and recession, such as those of today, there can often be other priorities people have and they’re kind of de-saving a lot of the time. So, compulsory savings is one way to ensure a minimum level. Now, if compulsory saving is too high and choking other things that people could be spending money on, that’s not necessarily good for the economy. So, there’s a balance, but having that minimum level of savings tends to me to be part of that first pillar. [/EXPAND]