issues in pension program management june 14, 2004

Issues in Pension Program Issues in Pension Program ManagementManagement

June 14, 2004June 14, 2004

OverviewOverview

Overview of the Universities pension landscape

Risk management

Governance

The Universities’ Forum

The Pension LandscapeThe Pension Landscape

TerminologyDB = Defined Benefit

Promise is a monthly pension Determined by formula typically based on

service and earningsTypically risk rests with the sponsor

DC = Defined Contribution Promise is specified contributionAccumulates with investment returnsLump sum value at retirementRisk rests with the member

Pension Plan Income Replacement Pension Plan Income Replacement RatiosRatios

Historical Comparison of Pensions Provided UnderDefined Contribution and Defined Benefit Pension Plans

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

Year of Retirement

% o

f F

inal

Yea

r's

Sal

ary

Defined Benefit

Defined Contribution

Assumptions: - Retirement at age 60 - 30 years of service - 50/50 bond/stock mix (money purchase)

- Annual DC contributions of 10% of salary - Defined benefit formula = 1.47% of final average 5 years' salary - Pensions are non-indexed


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


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 plansDC plans appealing to employees – more

conversion to DC primarily in the private sector

disputes over surplus ownershipContribution holidays / improved DB benefits


Basic history over last 15 years (cont’d)Market setback in 2001-2002 with interest rates

remaining low resulting in:Disenchanted DC participantsDisenchanted DB sponsors

– Significant deficit issues– Forced into benefit improvements /

contribution holidays when surplus too high

– Benefit promises are unaffordable in many cases


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


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


Within University circles, the influence of the past 15 years has resulted in many different combinations of plan designs:

DC with / without investment optionsDC without investment options and DB

minimumDB with a DC minimumTraditional DB with various forms of risk

sharingConverted Plan – closed DB and DC for new

hires


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


Challenges associated with University plan designsDB with a DC minimum

More “tools” to manage cost volatility but costs can be significant

Impact of maximum transfer limitsTraditional DB with various forms of risk

sharingSignificant costs (regardless of who pays)


Challenges associated with University plan designsConverted Plan – closed DB and DC for new

hiresDC challenges – adequacy of benefits and

educationAdded DB challenges:

– evolution of the investment policy– evaluation of the current financial position– the surplus tontine

Risk ManagementRisk Management

Risk management has become an important focus in past five years:

Old risks become materialNew risks emerge

Approaches to pension risk management are evolving:

no risk managementidentifyingevaluating

What are the Risks?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

What are the Risks?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

Approaches to Managing RiskApproaches to Managing Risk

IdentificationEducation – increasing awarenessShifting priorities from transactional to strategicControlling expectations – defining the

“pension deal” or who should bear the risk


QuantifyingEvaluation of margins in assumptionsEfficient frontier analysis for investmentsStochastic modeling or projected valuations of

financial factorsModels impact on plan of repeating history

into future under different benefit, funding and investment polices

Obtaining legal opinionsBenchmarking practices


EvaluatingExamining all pension risks in a holistic fashionAssessing reserves – both within and external

to the pension planEvaluating pension risks in context with other

non-pension risksContrasting pension risks to benefits


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 concernsManaging of pension risks are often viewed as

being “external” to the sponsor


Generally, organizations find pension risks harder to manage because:

Longer tail liabilitiesConflicting expectationsFiduciary responsibility – may differ from

institution’s objectives

Evolution of DC Risk ManagementEvolution 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 (?)

GovernanceGovernance

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

GovernanceGovernance

Issues being encountered:Assessment and review can be perceived to be

overwhelmingRealigning risks with controlExpense controlEnhancing investment structures

Governance IssuesGovernance 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


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 clarificationParticularly important in DC environments


Expense controlsExpenses paid from pension plan funds have

come under significant scrutinyGeneral 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


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.

Universities’ ForumUniversities’ 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


Key discussion points:Funding policy for DB plans

Maximum surplus limitsSustainability of current benefit and

contribution levelsCommunication and education policies

Information vs. education vs. AdviceFormal communication needs assessment -

none


Key discussion points (cont’d)Investment policy

Asset Liability Management (ALM)Alternative investments – exploring but not

significant interest yetForeign investments – significant number

use derivatives to exceed cap – some as high as 45%


Key discussion points (cont’d)Governance

Structure – significant diversityCommunication to membership – how much?Protecting the “volunteer”

DC liquidation strategiesSignificant interest in offering RRIF through

registered planUse of variable annuities – limited use in

future as no new ones can be setup

Questions / Comments

issues in pension program management june 14, 2004

Documents

pension landscape sponsors

monthly pension

pension landscape challenges

db plans dc plans

db minimum db

improved pension governance

benefits dc

pension program management