Conversion of DB to DC – A Case Study


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Conversion of DB to DC – A Case Study

  1. 1. Conversion of DB to DC – A Case Study Hector H Mislavsky Principal PwC
  2. 2. What we will cover today  Replacement Ratios  Hybrid Plan Design – Philosophy to get out of DB; over time – Objectives to replicate future benefits in a DC environment – “Soft Freeze" means only benefits service is frozen and replaced by DC plan – Early retirement subsidies, bridging benefits and COLAs are preserved  Administration and Investments – Wide array of investment choices across risk spectrum – Low investment and administrative fees – Ability to add voluntary contributions and transfers from other registered plans – Company pension assets are invested alongside employees' 1
  3. 3. Replacement Ratios  Retirement income generally come from three sources: individual savings, employer contributions and social insurance (Canada Pension Plan/Quebec Pension Plan and Old Age Security Pension). • If employees commit to an individual savings plan and make prudent investment decisions, should receive an adequate and reasonable level of retirement income at normal retirement (age 65).  Published reports support the notion that individuals need less income after they retire. • Retirees do not pay payroll taxes and their income tax burdens decrease. • Business expenses such as business clothing, uniforms and commuting costs cease. • Retirees no longer need to save; rather, they begin drawing on their savings. • Homes may be paid off. • Expenses related to raising children end.  Pre-retirement income levels at or above $40,000, the replacement percentage required to provide the same standard of living ranges from approximately 75% to 85%. • Example: If your pre-retirement income is $60,000, you will need $45,000 to $51,000 post- retirement for the same standard of living. 2
  4. 4. Defined Contribution Formula  Plan design objective was to best replicate the benefits under the pension plan. The company selected a defined contribution (DC) plan design that became effective January 1, 2013.  The defined benefit (DB) will remain for all employees who were actively employed on December 31, 2012. At retirement, employees will receive a portion of their benefits from the DB section of the plan and a portion from the DC section of the plan. Older employees, will receive the vast majority of their benefits from the DB section of the plan.  Those with at least 50 points on December 31, 2012 were deemed grandfathered. • Higher contribution levels for those with long service and/or near retirement. • Each December 31 thereafter, points are recalculated for grandfathered employees to determine the contribution level for that year.  The purpose of grandfathering is to make up for older/longer service employees who have a shorter period of time to accumulate interest and company contributions to get to a similar level of benefits expected under the DB formula.  All other employees, including hires after December 31, 2012, would not be grandfathered. 3
  5. 5. Defined Contribution Formula Employees with at least 50 points on December 31, 2012. Grandfathered Points (determined at transition and each December 31 thereafter) Company Contribution Under 60 8% 60-69 9% 70-79 10% 80-89 11% 90-99 12% 100 or more 13% All other employees (less than 50 points), including hires after December 31, 2012. Not Grandfathered 6% 4
  6. 6. Other Important Elements of the Plan Plan elements Eligibility for contributions • Similar to the defined benefit plan, all full-time employees will be eligible for contributions immediately upon employment • Must have received compensation in the plan year • Contributions to member account will be made on a monthly basis Definition of compensation for calculating contributions • Similar to the defined benefit plan, compensation includes actual earnings, including bonuses and overtime • Does not include other taxable benefits Investment • Investments include 12 ‘target date funds’ and 13 other alternative funds (e.g. Canadian and international equities, long term and short term bonds), so that members can invest within their own risk tolerance • Members will decide how contributions are invested • Low expenses Vesting • Immediate vesting Defined benefit plan • Credited service used in the calculation of the benefit amount was frozen effective December 31, 2012. • Employees will continue to earn increases in final average earnings and eligibility towards unreduced early retirement • “Bridge” benefit will continue to be provided for early retirement • Periodic Cost-of-Living increases will continue to be provided in future years 5
  7. 7. Projected Replacement Ratios by Income Source (not grandfathered) Age:32 Svc: 5 Salary: $50,000 (not grandfathered) Age:40 Svc: 9 Salary: $60,000 (grandfathered) Age:50 Svc: 19 Salary: $68,000 (grandfathered) Age:57 Svc: 32 Salary: $70,000 32% 32% 27% 27% 25% 25% 24% 24% 38% 5% 37% 10% 38% 21% 45% 36% 34% 22% 19% 10% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Defined Contribution Defined Benefit Social Insurance Sample A 70% 71% 64% 63% 65% 70% Sample C Sample DSample B 59% 69% New Plan Current Plan New Plan New Plan Current Plan Current Plan New Plan Current Plan The replacement ratios shown below include employer contributions and social insurance. Individual savings are incremental. 6
  8. 8. Investments  A variety of investment options spanning major investment categories, including: equities (Canadian, US and other international), bonds (short term and long term), target funds (with attributes related to years until retirement and level of risk tolerance) and guaranteed contracts.  Investment management fees (IMF) are low and will average less than 40 basis points because of the combined assets of the DB and DC plan (1 basis point = 1/100%).  The plan was modeled with the expectation that employees will earn a long term annual rate of return of 6.5%, net of expenses. 7
  9. 9. Fund Returns as of December 31, 2012 8
  10. 10. Fund Returns as of December 31, 2012 9
  11. 11. Fund Returns as of December 31, 2012 10