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Issues in Pension Program Management

Issues in Pension Program Management. June 14, 2004. Overview. Overview of the Universities pension landscape Risk management Governance The Universities’ Forum. The Pension Landscape. Terminology DB = Defined Benefit Promise is a monthly pension

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Issues in Pension Program Management

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  1. Issues in Pension Program Management June 14, 2004

  2. Overview • Overview of the Universities pension landscape • Risk management • Governance • The Universities’ Forum

  3. The Pension Landscape • Terminology • DB = Defined Benefit • Promise is a monthly pension • Determined by formula typically based on service and earnings • Typically risk rests with the sponsor • DC = Defined Contribution • Promise is specified contribution • Accumulates with investment returns • Lump sum value at retirement • Risk rests with the member

  4. Pension Plan Income Replacement Ratios

  5. The Pension Landscape • Basic history over the last 15 years: • Federal and provincial pension legislation reform in mid 1980s through early 1990s resulting in: • Increased minimum funding requirements • Limited RRSP room for many DB participants • Maximum transfer limits for DB plans • Maximum surplus limits in DB plans • No guidance on surplus ownership • Maximum pension limits that were frozen until 2004 • Different (yet similar) minimum standards legislation across each provincial jurisdiction

  6. The Pension Landscape • Basic history over last 15 years (cont’d) • Strong investment returns from equity markets and falling interest rates through most of the 1990s resulting in: • surpluses in DB plans • DC plans appealing to employees – more conversion to DC primarily in the private sector • disputes over surplus ownership • Contribution holidays / improved DB benefits

  7. The Pension Landscape • Basic history over last 15 years (cont’d) • Market setback in 2001-2002 with interest rates remaining low resulting in: • Disenchanted DC participants • Disenchanted DB sponsors • Significant deficit issues • Forced into benefit improvements / contribution holidays when surplus too high • Benefit promises are unaffordable in many cases

  8. The Pension Landscape • Basic history over last 15 years (cont’d) • On top of all of this: • Complexity of having to deal with 11 different legislative jurisdictions • Rising administration costs • Need to implement supplemental plans for executives and quite possibly middle managers • Demands for improved pension governance • Increased fiduciary liability concerns especially around DC plans • Limited flexibility for phased retirement

  9. The Pension Landscape • Sponsors questioning why they are sponsoring a pension plan? • Becoming an increasingly important element of an employee’s compensation • Proponents of a looming labour shortage forsee the importance that pension plans will play in recruiting and retaining key talent

  10. The Pension Landscape • Within University circles, the influence of the past 15 years has resulted in many different combinations of plan designs: • DC with / without investment options • DC without investment options and DB minimum • DB with a DC minimum • Traditional DB with various forms of risk sharing • Converted Plan – closed DB and DC for new hires

  11. The Pension Landscape • Challenges associated with University plan designs • General: • Is the pension deal clear and fair • Past use of surpluses to improve benefits • DC with / without investment options • Adequacy of benefits • Education – liability for bad decisions • DC without investment options and DB minimum • Adequacy of benefits better • Costs of DB minimum can be volatile • Liability associated with offering single DC fund

  12. The Pension Landscape • Challenges associated with University plan designs • DB with a DC minimum • More “tools” to manage cost volatility but costs can be significant • Impact of maximum transfer limits • Traditional DB with various forms of risk sharing • Significant costs (regardless of who pays)

  13. The Pension Landscape • Challenges associated with University plan designs • Converted Plan – closed DB and DC for new hires • DC challenges – adequacy of benefits and education • Added DB challenges: • evolution of the investment policy • evaluation of the current financial position • the surplus tontine

  14. Risk Management • Risk management has become an important focus in past five years: • Old risks become material • New risks emerge • Approaches to pension risk management are evolving: • no risk management • identifying • evaluating

  15. What are the Risks? • Traditional measures of risk have been: • Fluctuating contribution rates • Deficits and additional funding • Deficits and reduced benefits • Risks that are gaining much more attention: • Excess surplus and having to improve benefits • Thin line between being conservative and creating intergenerational inequities • Legal liability - not fulfilling fiduciary responsibility • Inadequate pension incomes

  16. What are the Risks? • Key financial related risk measures are influenced by: • Hiring practices • Investment performance • Asset / liability mismatch • Early retirement programs • Longevity • Key fiduciary liability related risk measures are influenced by: • Governance practices • Administration • Member communication

  17. Approaches to Managing Risk • Identification • Education – increasing awareness • Shifting priorities from transactional to strategic • Controlling expectations – defining the “pension deal” or who should bear the risk

  18. Approaches to Managing Risk • Quantifying • Evaluation of margins in assumptions • Efficient frontier analysis for investments • Stochastic modeling or projected valuations of financial factors • Models impact on plan of repeating history into future under different benefit, funding and investment polices • Obtaining legal opinions • Benchmarking practices

  19. Approaches to Managing Risk • Evaluating • Examining all pension risks in a holistic fashion • Assessing reserves – both within and external to the pension plan • Evaluating pension risks in context with other non-pension risks • Contrasting pension risks to benefits

  20. Approaches to Managing Risk • Organizations have typically “signed-on” for identification • Many are or have moved forward to quantification • Most struggling with evaluation due in large part to: • pension risks only recently creating concerns • Managing of pension risks are often viewed as being “external” to the sponsor

  21. Approaches to Managing Risk • Generally, organizations find pension risks harder to manage because: • Longer tail liabilities • Conflicting expectations • Fiduciary responsibility – may differ from institution’s objectives

  22. Evolution of DC Risk Management • Increase in DC plans has introduced a different set of risks that need to be managed • Risks with which DC sponsors currently struggle: • Where to reside on the communication continuum (I.e. information vs. education vs. advice) • Where to reside on the investment continuum (I.e. the degree of investment choice to offer) • Level of risk passed on to employees • Recent CAP guidelines expected to help clarify (?)

  23. Governance • Significant attention now being paid to pension plan governance • A result of similar factors giving rise to increased focus on corporate governance • Added dimension stemming from fiduciary responsibility recognized in statute and trust law • Current state: • General concern expressed by regulators • Guidelines established for industry standard • Self assessment and regular governance reviews becoming common place

  24. Governance • Issues being encountered: • Assessment and review can be perceived to be overwhelming • Realigning risks with control • Expense control • Enhancing investment structures

  25. Governance Issues • That “overwhelming feeling”: • CAPSA guidelines are considered comprehensive • Roles / responsibilities / delegation • Risk management / monitoring / objective setting • Communication / information flow • Where “revolutionary” approach taken – concerns this may be adding to governance risks • Where “evolutionary” approach taken – concerns that evolution is not rapid enough

  26. Governance Issues • Realigning risks with control: • Governance reviews can lead to a realization that those taking the risks do not necessarily have appropriate control • Can lead to renegotiation and/or clarification • Particularly important in DC environments

  27. Governance Issues • Expense controls • Expenses paid from pension plan funds have come under significant scrutiny • General rule - only expenses which result in a direct benefit to the members can be paid from the plan • At the same time, sponsor costs are increasing as is desire for sponsor to charge plan for “services rendered” • Ambiguity surrounds expenses such as accounting costs, governance reviews and pension design

  28. Governance Issues • Enhancing Investment Structures: • Growth of pension plan assets has led to “creative” investment approaches • Typically, investment policy is handled by a pension / HR committee of the Board • Consideration now being given to separating the pension investment function from the broader pension governance framework • Theory is that it results in more effective investment management • Continued search for the “holy investment grail” – alternative investments, private placements, real estate, etc.

  29. Universities’ Forum • Forum of pension plan reps from various Western Canadian Universities sponsored by Aon • Session took inventory of key pension issues currently being faced • Discussion of issues followed

  30. Universities’ Forum • Key discussion points: • Funding policy for DB plans • Maximum surplus limits • Sustainability of current benefit and contribution levels • Communication and education policies • Information vs. education vs. Advice • Formal communication needs assessment - none

  31. Universities’ Forum • Key discussion points (cont’d) • Investment policy • Asset Liability Management (ALM) • Alternative investments – exploring but not significant interest yet • Foreign investments – significant number use derivatives to exceed cap – some as high as 45%

  32. Universities’ Forum • Key discussion points (cont’d) • Governance • Structure – significant diversity • Communication to membership – how much? • Protecting the “volunteer” • DC liquidation strategies • Significant interest in offering RRIF through registered plan • Use of variable annuities – limited use in future as no new ones can be setup

  33. Questions / Comments

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