Today, the Canadian Institute of Actuaries (CIA) unveiled a prescription for the country's ailing pension system at the non-profit Economic Club of Toronto. The 6 page report is quite readable and part of the Institute's desire to help guide public policy in Canada.
The prescription only addresses defined benefit pension plans.
Defined Benefit or Defined Contribution?
Fulltime employees in large companies usually get a pension through their employer. There are two common ways to convert savings into retirement income.
- defined benefit: employer bears the financial risk of providing the benefits (e.g., 2% of your final average earnings per year of service)
- defined contribution: employees bear the financial risks (the employer makes a contribution as you would with an RRSP and your pension depends on the growth of the savings)
Defined benefit plans are not perfect. Employer funding requirements fluctuate, which makes corporate financial results more volatile. As a plan member, what happens if you change employers or are self-employed? Portability is a problem. If you leave employers during the first two years, your pension benefits for that period are lost (don't vest). Plans can still fail. Plan assets can be used for purposes you don't support, such as offering incentives to others for early retirement.
Asymmetry of Risks and Rewards
With defined benefit plans, the employer bears the risks and the employees get the rewards. If investment returns are poor, the employer must increase contributions. So if returns are favourable, shouldn't the employer be entitled to withdraw some of the surplus? If an employer tries, there's often an outcry. Hardly fair. Hardly an incentive for employers.
Where's the Outcry for Defined Benefit Plans?
There isn't one. Employees don't understand how much they lose. With defined contribution,
- plan members bear the risk of poor investment returns
- employers reduce their costs by 2% of payroll (which means costs have been shifted to plan members)
- returns drop because of higher administration costs, less investment expertise and higher management fees than institutional investors
It wasn't clear what happens next. How will business owners react? Will politicians see a need to do anything? Do Canadians care? Are there other prescriptions that could help improve the defined contribution plans which predominate?
- press release from the Canadian Institute of Actuaries
- official report (6 pages, PDF)
- article from advisor.ca (June 27)
- Are Canadian's Saving Enough for Retirement, Part 2 (from Canadian Capitalist)