Don Ireland Issues In Pension Program Management


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Don Ireland Issues In Pension Program Management

  1. 1. Issues in Pension Program Management June 14, 2004
  2. 2. Overview <ul><li>Overview of the Universities pension landscape </li></ul><ul><li>Risk management </li></ul><ul><li>Governance </li></ul><ul><li>The Universities’ Forum </li></ul>
  3. 3. The Pension Landscape <ul><li>Terminology </li></ul><ul><ul><li>DB = Defined Benefit </li></ul></ul><ul><ul><ul><li>Promise is a monthly pension </li></ul></ul></ul><ul><ul><ul><li>Determined by formula typically based on service and earnings </li></ul></ul></ul><ul><ul><ul><li>Typically risk rests with the sponsor </li></ul></ul></ul><ul><ul><li>DC = Defined Contribution </li></ul></ul><ul><ul><ul><li>Promise is specified contribution </li></ul></ul></ul><ul><ul><ul><li>Accumulates with investment returns </li></ul></ul></ul><ul><ul><ul><li>Lump sum value at retirement </li></ul></ul></ul><ul><ul><ul><li>Risk rests with the member </li></ul></ul></ul>
  4. 4. Pension Plan Income Replacement Ratios
  5. 5. The Pension Landscape <ul><li>Basic history over the last 15 years: </li></ul><ul><ul><li>Federal and provincial pension legislation reform in mid 1980s through early 1990s resulting in: </li></ul></ul><ul><ul><ul><li>Increased minimum funding requirements </li></ul></ul></ul><ul><ul><ul><li>Limited RRSP room for many DB participants </li></ul></ul></ul><ul><ul><ul><li>Maximum transfer limits for DB plans </li></ul></ul></ul><ul><ul><ul><li>Maximum surplus limits in DB plans </li></ul></ul></ul><ul><ul><ul><li>No guidance on surplus ownership </li></ul></ul></ul><ul><ul><ul><li>Maximum pension limits that were frozen until 2004 </li></ul></ul></ul><ul><ul><ul><li>Different (yet similar) minimum standards legislation across each provincial jurisdiction </li></ul></ul></ul>
  6. 6. The Pension Landscape <ul><li>Basic history over last 15 years (cont’d) </li></ul><ul><ul><li>Strong investment returns from equity markets and falling interest rates through most of the 1990s resulting in: </li></ul></ul><ul><ul><ul><li>surpluses in DB plans </li></ul></ul></ul><ul><ul><ul><li>DC plans appealing to employees – more conversion to DC primarily in the private sector </li></ul></ul></ul><ul><ul><ul><li>disputes over surplus ownership </li></ul></ul></ul><ul><ul><ul><li>Contribution holidays / improved DB benefits </li></ul></ul></ul>
  7. 7. The Pension Landscape <ul><li>Basic history over last 15 years (cont’d) </li></ul><ul><ul><li>Market setback in 2001-2002 with interest rates remaining low resulting in: </li></ul></ul><ul><ul><ul><li>Disenchanted DC participants </li></ul></ul></ul><ul><ul><ul><li>Disenchanted DB sponsors </li></ul></ul></ul><ul><ul><ul><ul><li>Significant deficit issues </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Forced into benefit improvements / contribution holidays when surplus too high </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Benefit promises are unaffordable in many cases </li></ul></ul></ul></ul>
  8. 8. The Pension Landscape <ul><li>Basic history over last 15 years (cont’d) </li></ul><ul><ul><li>On top of all of this: </li></ul></ul><ul><ul><ul><li>Complexity of having to deal with 11 different legislative jurisdictions </li></ul></ul></ul><ul><ul><ul><li>Rising administration costs </li></ul></ul></ul><ul><ul><ul><li>Need to implement supplemental plans for executives and quite possibly middle managers </li></ul></ul></ul><ul><ul><ul><li>Demands for improved pension governance </li></ul></ul></ul><ul><ul><ul><li>Increased fiduciary liability concerns especially around DC plans </li></ul></ul></ul><ul><ul><ul><li>Limited flexibility for phased retirement </li></ul></ul></ul>
  9. 9. The Pension Landscape <ul><li>Sponsors questioning why they are sponsoring a pension plan? </li></ul><ul><ul><li>Becoming an increasingly important element of an employee’s compensation </li></ul></ul><ul><ul><li>Proponents of a looming labour shortage forsee the importance that pension plans will play in recruiting and retaining key talent </li></ul></ul>
  10. 10. The Pension Landscape <ul><li>Within University circles, the influence of the past 15 years has resulted in many different combinations of plan designs: </li></ul><ul><ul><li>DC with / without investment options </li></ul></ul><ul><ul><li>DC without investment options and DB minimum </li></ul></ul><ul><ul><li>DB with a DC minimum </li></ul></ul><ul><ul><li>Traditional DB with various forms of risk sharing </li></ul></ul><ul><ul><li>Converted Plan – closed DB and DC for new hires </li></ul></ul>
  11. 11. The Pension Landscape <ul><li>Challenges associated with University plan designs </li></ul><ul><ul><li>General: </li></ul></ul><ul><ul><ul><li>Is the pension deal clear and fair </li></ul></ul></ul><ul><ul><ul><li>Past use of surpluses to improve benefits </li></ul></ul></ul><ul><ul><li>DC with / without investment options </li></ul></ul><ul><ul><ul><li>Adequacy of benefits </li></ul></ul></ul><ul><ul><ul><li>Education – liability for bad decisions </li></ul></ul></ul><ul><ul><li>DC without investment options and DB minimum </li></ul></ul><ul><ul><ul><li>Adequacy of benefits better </li></ul></ul></ul><ul><ul><ul><li>Costs of DB minimum can be volatile </li></ul></ul></ul><ul><ul><ul><li>Liability associated with offering single DC fund </li></ul></ul></ul>
  12. 12. The Pension Landscape <ul><li>Challenges associated with University plan designs </li></ul><ul><ul><li>DB with a DC minimum </li></ul></ul><ul><ul><ul><li>More “tools” to manage cost volatility but costs can be significant </li></ul></ul></ul><ul><ul><ul><li>Impact of maximum transfer limits </li></ul></ul></ul><ul><ul><li>Traditional DB with various forms of risk sharing </li></ul></ul><ul><ul><ul><li>Significant costs (regardless of who pays) </li></ul></ul></ul>
  13. 13. The Pension Landscape <ul><li>Challenges associated with University plan designs </li></ul><ul><ul><li>Converted Plan – closed DB and DC for new hires </li></ul></ul><ul><ul><ul><li>DC challenges – adequacy of benefits and education </li></ul></ul></ul><ul><ul><ul><li>Added DB challenges: </li></ul></ul></ul><ul><ul><ul><ul><li>evolution of the investment policy </li></ul></ul></ul></ul><ul><ul><ul><ul><li>evaluation of the current financial position </li></ul></ul></ul></ul><ul><ul><ul><ul><li>the surplus tontine </li></ul></ul></ul></ul>
  14. 14. Risk Management <ul><li>Risk management has become an important focus in past five years: </li></ul><ul><ul><li>Old risks become material </li></ul></ul><ul><ul><li>New risks emerge </li></ul></ul><ul><li>Approaches to pension risk management are evolving: </li></ul><ul><ul><li>no risk management </li></ul></ul><ul><ul><li>identifying </li></ul></ul><ul><ul><li>evaluating </li></ul></ul>
  15. 15. What are the Risks? <ul><li>Traditional measures of risk have been: </li></ul><ul><ul><li>Fluctuating contribution rates </li></ul></ul><ul><ul><li>Deficits and additional funding </li></ul></ul><ul><ul><li>Deficits and reduced benefits </li></ul></ul><ul><li>Risks that are gaining much more attention: </li></ul><ul><ul><li>Excess surplus and having to improve benefits </li></ul></ul><ul><ul><ul><li>Thin line between being conservative and creating intergenerational inequities </li></ul></ul></ul><ul><ul><li>Legal liability - not fulfilling fiduciary responsibility </li></ul></ul><ul><ul><li>Inadequate pension incomes </li></ul></ul>
  16. 16. What are the Risks? <ul><li>Key financial related risk measures are influenced by: </li></ul><ul><ul><li>Hiring practices </li></ul></ul><ul><ul><li>Investment performance </li></ul></ul><ul><ul><li>Asset / liability mismatch </li></ul></ul><ul><ul><li>Early retirement programs </li></ul></ul><ul><ul><li>Longevity </li></ul></ul><ul><li>Key fiduciary liability related risk measures are influenced by: </li></ul><ul><ul><li>Governance practices </li></ul></ul><ul><ul><li>Administration </li></ul></ul><ul><ul><li>Member communication </li></ul></ul>
  17. 17. Approaches to Managing Risk <ul><li>Identification </li></ul><ul><ul><li>Education – increasing awareness </li></ul></ul><ul><ul><li>Shifting priorities from transactional to strategic </li></ul></ul><ul><ul><li>Controlling expectations – defining the “pension deal” or who should bear the risk </li></ul></ul>
  18. 18. Approaches to Managing Risk <ul><li>Quantifying </li></ul><ul><ul><li>Evaluation of margins in assumptions </li></ul></ul><ul><ul><li>Efficient frontier analysis for investments </li></ul></ul><ul><ul><li>Stochastic modeling or projected valuations of financial factors </li></ul></ul><ul><ul><ul><li>Models impact on plan of repeating history into future under different benefit, funding and investment polices </li></ul></ul></ul><ul><ul><li>Obtaining legal opinions </li></ul></ul><ul><ul><li>Benchmarking practices </li></ul></ul>
  19. 19. Approaches to Managing Risk <ul><li>Evaluating </li></ul><ul><ul><li>Examining all pension risks in a holistic fashion </li></ul></ul><ul><ul><li>Assessing reserves – both within and external to the pension plan </li></ul></ul><ul><ul><li>Evaluating pension risks in context with other non-pension risks </li></ul></ul><ul><ul><li>Contrasting pension risks to benefits </li></ul></ul>
  20. 20. Approaches to Managing Risk <ul><li>Organizations have typically “signed-on” for identification </li></ul><ul><li>Many are or have moved forward to quantification </li></ul><ul><li>Most struggling with evaluation due in large part to: </li></ul><ul><ul><li>pension risks only recently creating concerns </li></ul></ul><ul><ul><li>Managing of pension risks are often viewed as being “external” to the sponsor </li></ul></ul>
  21. 21. Approaches to Managing Risk <ul><li>Generally, organizations find pension risks harder to manage because: </li></ul><ul><ul><li>Longer tail liabilities </li></ul></ul><ul><ul><li>Conflicting expectations </li></ul></ul><ul><ul><li>Fiduciary responsibility – may differ from institution’s objectives </li></ul></ul>
  22. 22. Evolution of DC Risk Management <ul><li>Increase in DC plans has introduced a different set of risks that need to be managed </li></ul><ul><li>Risks with which DC sponsors currently struggle: </li></ul><ul><ul><li>Where to reside on the communication continuum (I.e. information vs. education vs. advice) </li></ul></ul><ul><ul><li>Where to reside on the investment continuum (I.e. the degree of investment choice to offer) </li></ul></ul><ul><ul><li>Level of risk passed on to employees </li></ul></ul><ul><li>Recent CAP guidelines expected to help clarify (?) </li></ul>
  23. 23. Governance <ul><li>Significant attention now being paid to pension plan governance </li></ul><ul><li>A result of similar factors giving rise to increased focus on corporate governance </li></ul><ul><li>Added dimension stemming from fiduciary responsibility recognized in statute and trust law </li></ul><ul><li>Current state: </li></ul><ul><ul><li>General concern expressed by regulators </li></ul></ul><ul><ul><li>Guidelines established for industry standard </li></ul></ul><ul><ul><li>Self assessment and regular governance reviews becoming common place </li></ul></ul>
  24. 24. Governance <ul><li>Issues being encountered: </li></ul><ul><ul><li>Assessment and review can be perceived to be overwhelming </li></ul></ul><ul><ul><li>Realigning risks with control </li></ul></ul><ul><ul><li>Expense control </li></ul></ul><ul><ul><li>Enhancing investment structures </li></ul></ul>
  25. 25. Governance Issues <ul><li>That “overwhelming feeling”: </li></ul><ul><ul><li>CAPSA guidelines are considered comprehensive </li></ul></ul><ul><ul><ul><li>Roles / responsibilities / delegation </li></ul></ul></ul><ul><ul><ul><li>Risk management / monitoring / objective setting </li></ul></ul></ul><ul><ul><ul><li>Communication / information flow </li></ul></ul></ul><ul><ul><li>Where “revolutionary” approach taken – concerns this may be adding to governance risks </li></ul></ul><ul><ul><li>Where “evolutionary” approach taken – concerns that evolution is not rapid enough </li></ul></ul>
  26. 26. Governance Issues <ul><li>Realigning risks with control: </li></ul><ul><ul><li>Governance reviews can lead to a realization that those taking the risks do not necessarily have appropriate control </li></ul></ul><ul><ul><li>Can lead to renegotiation and/or clarification </li></ul></ul><ul><ul><li>Particularly important in DC environments </li></ul></ul>
  27. 27. Governance Issues <ul><li>Expense controls </li></ul><ul><ul><li>Expenses paid from pension plan funds have come under significant scrutiny </li></ul></ul><ul><ul><ul><li>General rule - only expenses which result in a direct benefit to the members can be paid from the plan </li></ul></ul></ul><ul><ul><li>At the same time, sponsor costs are increasing as is desire for sponsor to charge plan for “services rendered” </li></ul></ul><ul><ul><li>Ambiguity surrounds expenses such as accounting costs, governance reviews and pension design </li></ul></ul>
  28. 28. Governance Issues <ul><li>Enhancing Investment Structures: </li></ul><ul><ul><li>Growth of pension plan assets has led to “creative” investment approaches </li></ul></ul><ul><ul><li>Typically, investment policy is handled by a pension / HR committee of the Board </li></ul></ul><ul><ul><li>Consideration now being given to separating the pension investment function from the broader pension governance framework </li></ul></ul><ul><ul><ul><li>Theory is that it results in more effective investment management </li></ul></ul></ul><ul><ul><li>Continued search for the “holy investment grail” – alternative investments, private placements, real estate, etc. </li></ul></ul>
  29. 29. Universities’ Forum <ul><li>Forum of pension plan reps from various Western Canadian Universities sponsored by Aon </li></ul><ul><ul><li>Session took inventory of key pension issues currently being faced </li></ul></ul><ul><ul><li>Discussion of issues followed </li></ul></ul>
  30. 30. Universities’ Forum <ul><li>Key discussion points: </li></ul><ul><ul><li>Funding policy for DB plans </li></ul></ul><ul><ul><ul><li>Maximum surplus limits </li></ul></ul></ul><ul><ul><ul><li>Sustainability of current benefit and contribution levels </li></ul></ul></ul><ul><ul><li>Communication and education policies </li></ul></ul><ul><ul><ul><li>Information vs. education vs. Advice </li></ul></ul></ul><ul><ul><ul><li>Formal communication needs assessment - none </li></ul></ul></ul>
  31. 31. Universities’ Forum <ul><li>Key discussion points (cont’d) </li></ul><ul><ul><li>Investment policy </li></ul></ul><ul><ul><ul><li>Asset Liability Management (ALM) </li></ul></ul></ul><ul><ul><ul><li>Alternative investments – exploring but not significant interest yet </li></ul></ul></ul><ul><ul><ul><li>Foreign investments – significant number use derivatives to exceed cap – some as high as 45% </li></ul></ul></ul>
  32. 32. Universities’ Forum <ul><li>Key discussion points (cont’d) </li></ul><ul><ul><li>Governance </li></ul></ul><ul><ul><ul><li>Structure – significant diversity </li></ul></ul></ul><ul><ul><ul><li>Communication to membership – how much? </li></ul></ul></ul><ul><ul><ul><li>Protecting the “volunteer” </li></ul></ul></ul><ul><ul><li>DC liquidation strategies </li></ul></ul><ul><ul><ul><li>Significant interest in offering RRIF through registered plan </li></ul></ul></ul><ul><ul><ul><li>Use of variable annuities – limited use in future as no new ones can be setup </li></ul></ul></ul>
  33. 33. <ul><li>Questions / Comments </li></ul>