Over the past several years corporate Canada has moved away from defined benefit (DB) plans toward defined contribution (DC) plans. This shift in the basic structure of the retirement sector in Canada has left many plan members confused. According to a new MFS study the new responsibilities shifted onto plan members means there is an expanded role for investment advisors around DC plans.
"The new reality is that the plan member has a lot of choices to make. With DC plans they have to take an active role. We have put a tremendous amount of responsibility in the hands of plan members, many of whom have little expertise in investing or retirement planning," said Bradley Hicks, managing director with MFS Investment Management Canada Ltd. in an interview with Wealth Professional.
Unlike defined benefit plans, where the corporation takes on the risks of generating returns on the pension funds, in a DC plan much of that risk is shifted on to the individual, or plan member. This is good for companies—corporations don't have to worry about running short of money to fund a pension plan. But moving the risk onto the individual has resulted in a whole other series of issues. According to the MFS study, many plan members are just flat-out confused.
The numbers: More than one-fifth (22 per cent) of plan members said they had no idea how best to diversify their account. Only 10 per cent based their contribution decisions on how much they would need to reach their retirement goals. Forty two per cent of survey participants said that it was not necessary to contribute to the plan every year because they could always make up for it later. Remarkably, seventy per cent of members surveyed believed, incorrectly, that index funds are safer than the overall stock market. More than half (56 per cent) believed index funds deliver better returns than the stock market. Which is just flat-out wrong.
"One of the things we saw, still a lack of understanding on the investing basics," says Hicks. "For example, the different between index and passive investing and active investing…It's very clear plan members do not understand that. If we've left the plan member with this responsibility, how do we correct this?"
Better advice is one possibility. Evolving a plan to provide some kind of access to an advisor is a good idea. Though, Hicks does say there has already seen some positive evolution in the sector since the shift toward DC plans got underway in this country. "Canada is only catching up on DC plans. This is a relatively immature in Canadian market, as compared to some markets like the U.S.,” says Hicks.
In the early days of the transition, especially on corporate side, organizations went out of their way to transfer all risk around a plan onto a member. That is, corporations allowed plan members to make every single decision lest some perceived legal line was crossed. But plan sponsors have come to realize this is not great policy. “Moving to the new model, all the risk for decisions was put on the individual... [But] we created paralysis and inertia....People were making suboptimal choices," says Hicks.
The initial impulse--to allow every last decision in these plans up to the individual--has reversed somewhat over the last few years. Plan sponsors are deciding on more appropriate default choices in plans. As well, the choices being offered in the plan are taking the relative inexperience of the average investor into account.
"The needle has moved back a bit. It's come back a bit, closer to where it needs to be. There is increased governance from the plan sponsor on the DC side,” says Hicks. “Increasingly, plan sponsors are more appropriate in terms of default choices. They have an understanding that they have to keep the pension promise.”
Where in the past it may have been a money market fund in the account, some plans have taken a cue from US established plans and now offer a more appropriate default, such as a target rate fund (where risks are shifted over time in an attempt to provide age-appropriate diversification).
“Early thinking was...people are going to make choice, let's give them lots of choice. But the trend over last half decade has been to streamline the choices available to plan members. Some DC plans are beginning to look and feel like a DB plan. That's what we need to do,” says Hicks. “These are the kinds of things plan sponsors need to keep in mind when it comes to managing these plans successfully.”
He notes that better outcomes, and better returns, occur when an advisor is made available to plan members. “The best plan designs arise when a third-party consultant is made available,” says Hicks.
Nevertheless, the space continues to evolve. Back in 2010, ten percent of members offered a target rate fund. Just a few short years later that number is up to 28%. This is significant and rapid change when it comes to pensions. As Hicks points out—and as any advisor knows—“The first thing to come to mind with pensions, ‘I'll do it tomorrow.’”