Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.
The Public Service Alliance of Canada (PSAC) put out a press release, Liberal bill an attack on pensions:
The Liberal government is following the Conservatives’ lead by introducing legislation that will allow employers to reduce pension benefits.
Bill C-27, An Act to amend the Pension Benefits Standards Act, had its first reading in the House of Commons last week.
A target benefit pension plan is a big gamble
This bill will allow employers to shift from good, defined benefit plans that provide secure and predictable pension benefits, into the much less secure form of target benefits.
Unlike a defined benefit plan, where the employer and employees contribute and retirees know how much they can expect when they retire, the amount you receive under a target benefit pension plan is just that, a target. Meaning, the plan aims to give you a certain pension benefit, but there’s no guarantee.
The other big difference is that target pension benefit plans shift the financial risk from the employer to employees and pensioners.
PSAC will oppose this bill
Bill C-27 opens the door to eliminating or reducing defined benefit pension plans. PSAC has opposed target benefit pension plans since the previous Conservative government introduced consultations.
We will continue to resist any move in this direction, and continue to push for retirement security for all Canadians.
A PSAC union member brought this to my attention, providing me with some context:
Bill C-27 was introduced in the Parliament of Canada on October 19th, 2016 and will allow for the conversion of defined benefit pension plans to less secure “target benefit” pension plans. Quite remarkably this legislation has thus far been flying under the mainstream media radar.
In the opinion of the PSAC, Bill C-27 will eventually lead to the demise of “defined benefit” pension plans in the federal jurisdiction and is a component of the Morneau agenda to dismantle the Public Service Superannuation Act.
To say the least, I was shocked when I read this and replied: “Wow, interesting, I thought only the Harper government would try to pull off such sneaky, underhanded things. Hello Trudeau Liberals!” (at least Harper wore his colors on his sleeve when it came to pensions and his government did introduce cuts to MP pensions).
It never ceases to amaze me how politicians can act like slimy weasels regardless of their political affiliation. If Bill C-27 passes to amend the Pension Benefits Standards Act, it will significantly undermine public pensions of PSAC’s members and they are absolutely right to vigorously oppose it.
Who cares if the pensions of civil servants are reduced or shifted to target benefit plans? I care and let me state this, this bill is a farce, a complete and utter disgrace and totally incompatible with the recent policy shift to enhance the Canada Pension Plan (CPP) for all Canadians.
Think about it, on the one hand the Trudeau Liberals worked hard to pass legislation to bolster the Canada Pension Plan and on the other, they are introducing an amendment to the Pension Benefits Standards Act which will open the door to eliminating or reducing defined-benefit plans at the public sector.
The irony is that PSAC’s members helped the Trudeau Liberals sweep into power and this is how they are being treated? With friends like that, who needs enemies?
More importantly, there is no need to amend the Pension Benefits Standards Act to introduce target pension benefit plans because these pensions are safe and secure and managed properly at arms-length from the federal government at PSP Investments.
[Note: I can just imagine what the folks at PSP think of Bill C-27, something like “what the hell is the federal government trying to do here?!?”].
And let me repeat something, just like variable benefit plans which I covered in my last comment, target date benefit plans offer some interesting ways to help people invest properly for retirement, but they too suffer from the same deficiencies of defined-contribution plans because they invest solely in public markets and offer no guarantees whatsoever.
In fact, John Authers of the Financial Times wrote an article on this in the summer, Target-dated funds are welcome but no panacea for pension holes:
Much is riding on target-dated funds. As this week’s FT series on pensions should make clear, defined benefit pensions face serious deficits — but the same mathematics of disappointing returns and ever greater expense for buying an income also applies to defined contribution plans.
DC plans have been poorly designed. For years, 401(k) sponsors were lulled by the equity bull market into allowing members to choose their own asset allocations, and switch between funds and asset classes at will. This was a recipe for disaster, as members tended to sell at the bottom and buy at the top. The strong returns of the 1990s convinced many that they could get away with saving far less than they needed.
The industry and regulators have been alive to the problem, and their response is sensible. Now they offer a default option of a fund that aims to ensure a decent payout by a “target date” — the intended retirement date. These funds automatically adjust their asset allocation between stocks and bonds as the retirement date approaches, which in general means starting with mostly stocks and shifting to bonds as retirement approaches. This (good) idea mimics the best features of a DB plan.
Such funds are undeniably an improvement on the “supermarket” model of the 1990s. Savers avoid the pitfalls of taking too much or too little risk, and regular rebalancing helps them sell at the top and buy at the bottom.
But TDFs have problems, which are growing increasingly apparent. First, are their costs under control? Second, do they have their asset allocation right? And third, can we benchmark their performance?
On costs, the news is good. US regulations require 401(k) sponsors to look at costs, and the response has been to drive down fees. According to Morningstar’s Jeff Holt, TDFs’ average asset-weighted expense ratio stood at 1.03 per cent in 2009, and by last year had dropped to 0.73 per cent — a 30 basis point fall, which in a low return environment could make a very big difference when compounded.
But if TDFs are coming under pressure to limit costs, the pressure over asset allocation is taking them in every direction. They are designed as mutual funds, so they still do not hold the kind of illiquid assets that the best DB funds can fund, such as infrastructure. That is a problem.
So is the entire balance between stocks and bonds. The notion from the DB world was to reach 100 per cent bonds by the retirement date, when the fund could be used to buy an annuity. With low bond yields making annuities expensive, and life expectancy far longer than it used to be, this no longer makes much sense. A 65-year-old, with a decent chance of making it to 90, should not be 100 per cent invested in bonds.
But high equity allocations tend to emphasise that the TDFs expose savers to greater risk than a DB plan. According to Morningstar the average drawdown for 2010 TDFs during the crisis year of 2008 was 36 per cent — a potentially disastrous loss of capital for people about to retire. As stocks rapidly recovered, and as those retiring in 2010 would have been unwise to sell all their stocks, this should not be a problem — but it plainly hit confidence.
The early stages are also a problem. Our 20s and 30s are a time of great expense. Should young investors really be defaulted into heavy equity holdings when the risks that they lose their job are still high, and when they face possible big drains on their income, such as a baby, or downpayments on a first house?
So the “glide path” of shifting from equity to bonds is controversial. And there is no standard practice on it. According to Mr Holt, TDFs’ holdings of bonds at the target date for retirement vary from 10 to 70 per cent.
What about benchmarking? Such differences make it impossible. Asset allocation differences swamp other factors, and are driven by different assumptions about risk.
Establish bands for asset allocation at each age, but allow them to vary according to valuation. Funds designed for retirement should never take the risk of being out of the market altogether. But if, as now, bonds and US equities look overpriced while emerging market equities look cheap, an approach that took US equities’ weighting to the bottom of its band, while putting the maximum permissible into emerging markets, would probably work out well.
There is not, as yet, an incentive to do that, and there needs to be. TDFs, or something like them, should be at the heart of future pension provision. It is good that their costs are under control, but there are ways to make them far more effective: by allowing more asset classes, accepting that people at retirement should still have substantial holdings in equities, and encouraging TDFs to allocate more to asset classes that are cheap.
I agree with Authers, there are ways to make target-dated funds more effective and folks like Ron Surz, President of Target Date Solutions are at the forefront of such initiatives.
But no matter how effective they get, target-dated pensions or variable benefit plans will never match the effectiveness of an Ontario Teachers, HOOPP, Caisse, CPPIB, PSP Investments and other large, well-governed Canadian defined-benefit pensions which reduce costs, address longevity risk (so members never outlive their savings) and invest across public and private markets all over the world, mostly directly and through top funds.
All this to say that PSAC is right to vigorously oppose Bill C-27, it’s a total assault on their defined-benefit pensions, and if passed, this amendment will undermine their pensions, the ability of the civil service to attract qualified people to work for the federal and other governments, and the Canadian economy.
In short, it’s dumb pension policy and if Trudeau thinks he had a tough time in the boxing ring, let him try to pull this off, it will basically spell the end of his political career (this and the asinine housing market policies won’t help the Liberals’ good fortunes).
Stay tuned, more to come on this topic from other pension experts. I will update this comment as experts send in their views and if anyone has anything to add, feel free to reach me at LKolivakis@gmail.com.
Update: Jim Leech, the former president and CEO of the Ontario Teachers’ Pension Plan and co-author of The Third Rail, shared this with me (added emphasis is mine):
I think everyone is missing the point of this bill.
Until now, federal pension legislation has only recognized plans as either DC or DB – there was no provision for a hybrid/risk shared plan.
That is one reason contributing to the switch all the way from DB to DC at many companies – if the DB plan was not sustainable, the only alternative was to move all the way to DC – a middle ground was not available even if the parties wanted a middle ground.
As I understand it, this bill simply allows transition to a risk shared model as an alternative to closing the DB and going all the way to DC.
Greater legislative flexibility is a positive step.
While I agree with Jim, some form of a shared risk model like the one New Brunswick implemented makes perfect sense for all public pension plans, especially if they are grossly underfunded, I’m not convinced the federal government needs to introduce hybrid plans at this stage and share PSAC’s concern that this amendment opens the door to cutting DB pensions altogether.
Also, Bernard Dussault, Canada’s former Chief Actuary, shared these insights with me (added emphasis is mine):
There are two big fairness-related points with this legislation, namely:
- not only does it allow the reduction of future accruing pension benefits of both active and retired (deferred and pensioned) members, a vital right so far covered under federal and provincial (except NB since 2014) pension legislation;
- but it also allows the concerned sponsoring employers to shift to active and retired members the liability pertaining to any current (as at effective date of the tabled C-27 legislation) deficit under any concerned existing DB plan.
As shown in the two attachments hereto, I have been promoting over the past few years that the shortcomings of DB plans can be easily overcome in a manner that would make DB plans much more simple, effective and fair than TB plans. Points not to be missed.
One of the attachments Bernard shared with me, Improving Defined Benefit (DB) plans within the Canadian Pension Landscape, is available here. I thank Bernard and Jim for sharing these insights.