2006 General Meeting

Assemblée générale 2006

Chicago, Illinois

2006 General Meeting

Assemblée générale 2006

Chicago, Illinois

Canadian Institute

of Actuaries

Canadian Institute

of Actuaries

L’Institut canadien desactuaires

L’Institut canadien desactuaires

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There are problems with the private pension system…..

• Pension coverage is decreasing– Complex regulatory framework

– Lack of flexibility in pension rules

– Alternatives that avoid pension regulation

– Employer perception that DB plans are too “risky”

– Perceived value not sufficient to offset the exposure/pitfalls

• Gradual process underway to move from DB to DC– Lack of symmetry

– Lack of member understanding of value

– Inappropriateness of traditional DB plan to today’s workforce

– Cost uncertainty surrounding DB plans

– Proposed changes in accounting rules

– Process has advanced much more quickly in UK and US

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Some interesting statistics….• In private sector, RPPs are disappearing

– Public sector plans (>10 members) have increased from 873 in 1992 to 1,064 in 2004(1)

– Private sector plans (>10 members) have decreased from 9,756 to 8,352 over the same period(1)

• For retiree with annual income of $30-40K(2):– 51% of earnings come from pension plans– 46% of earnings come from CPP/OAS

• For retiree with annual income of $70-80K(2):– 71% of earnings come from pension plans– 24% of earnings come from CPP/OAS

(1) Source: Statistics Canada(2) Source: Canada Revenue Agency (2004)

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Pension design principles• Retirement income system must contain three strong

participants

• Sharing of responsibilities is a key function in design– Employer historically focused on providing a reasonable

pension– Increasingly, private sector employers are looking to

employees to pick up a larger share of the responsibility (and risks)

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Potential outcome of move to DC• Key elements that affect member’s ultimate pension

– Age at which member begins contributing– Rate at which member contributes each year– Size of employer contribution or match– Investment strategy employed by member– Age at which member retires– Whether member buys annuity at retirement– Member’s longevity

• Risks involved in each factor are borne by each individual member

• Most evidence suggests that member’s are negatively affected by many of these risks

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Potential outcome of move to DC

• Member contribution risks– Young members often delay contributing– During first half of career, often contribute well below

maximum amount– Contributions above matching level subject to each

individual’s personal decisions– Member may withdraw money

• Retirement risks– Early/late retirement– Mortality risk– Inflation risk

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• Investment risks:– Difficulty understanding nuances of some options

– Invest more conservatively (individual vs. collective risk)

– Members tend not to adjust their asset mix over time

– Members tend to buy/sell funds at wrong time

– Members may not be fully aware of quality of investment performance

– Plan sponsors may not replace poorly performing products

– Members cannot obtain as much “fund” disclosure as plan sponsor

– Investment advisors may have potential bias/conflict if a commission structure is used to pay them

Potential outcome of move to DC

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• Member allocations(1)

(1) Based on information from 8 major Canadian record keepers as at December 31, 2004. Averages are weighted by number of members.

Fund Category Minimum Maximum Average

Balanced/Lifestyle 26% 59% 36%Equities:-- Canada 11% 30% 21%-- U.S. 0% 4% 2%-- International 1% 4% 2%-- Global 1% 6% 3%-- Company 0% 11% 4%-- Total 18% 52% 33%Fixed Income:-- Bonds 3% 13% 8%-- Term Deposits 0% 33% 16%-- Money Market 2% 15% 6%-- Total 11% 47% 31%

Potential outcome of move to DC

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• Based on Towers Perrin Benefits Data Bank– Employer contributions lower under DC than DB

• Median employer contribution to DC is 5%

• Median DB benefit is 1.45% FAE formula

– Translates into difference in ultimate benefit

• For career employee, DB provides double the benefit

• For employee with three equal length careers, DB plan provides 50% more pension

– Results are sensitive to:

• Assumed rate of salary increase (4%)

• Investment return assumption (7%)

• Annuity purchase rate (5%)

Potential outcome of move to DC

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Key Messages

• There are fundamental problems with the Canadian pension system

• If the problems are not addressed, inevitable move to DC– Not in anyone’s interests

– DB should remain as an option for employment pensions

• Significant change is required– Collaboration from all stakeholders