Michel St-Germain Montréal Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan the answer? Presentation to the Canadian Association

Michel St-GermainMontréal

Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan the answer?

Presentation to the Canadian Association of University Business Officers

June 19, 2006

Mercer Human Resource Consulting 2

Agenda

Are DB pension plans too risky?

How many employers are moving away from DB?

Why replace a DB by a DC?

Are Universities different?


Most pension plans are significantly underfunded

0%

10%

20%

30%

40%

50%

% of plans

<80% 80%-90% 90%-100% 100%-110% 110%-120% >120%

Solvency ratios

Déc . 31, 2003 Déc . 31, 2005


Because interest rates have decreased by more than 2% since 2000. But are they going up?

3%

4%

5%

6%

7%

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06

Bond Yields


Return on Canadian equities

-20%

-10%

0%

10%

20%

30%

40%

1997 1998 1999 2000 2001 2002 2003 2004 2005

And return on equities have gone up and down


Total returns on pension funds have not been bad

-10%

-5%

0%

5%

10%

15%

20%

1997 1998 1999 2000 2001 2002 2003 2004 2005


But pension liabilities are growing faster than pension assets because of the decrease in interest rate

Source: Mercer Pension Health Index

0.90

1.10

1.30

1.50

1.70

1.90


Asset Performance

Liability Performance


And pension solvency has lost 40% since 2000. But is it going up?

Source: Mercer Pension Health Index

0.70

0.80

0.90

1.00

1.10

1.20

1.30


Solvency Index


Solvency ratio

70%

80%

90%

100%

110%

120%

2006 2007 2008 2009 2010 2011

Base Interest + 1% Int. + 1%, eq. 20%

Employer contribution

0%

10%

20%

30%

40%

2006 2007 2008 2009 2010 2011

Base Interest + 1% Int. + 1%, eq. 20%

What would make the problem disappear? A 1% increase in interest rate and20% stock return


Pension plans are in the news

GM to freeze salaried

pension plan.

Alcoa to close its pension plan to new

workers.

IBM to freeze pension plan.

Dodge calls for reform of pension

rules; overhaul needed to ensure system’s viability.

When the spinning stops – Actuaries and the pension

crunch.The Economist,28 January 2006


What can be done to manage pension costs?

Reduce investment risk

Stop plan improvements

Increase employee contributions

Convert from DB to DC


Key difference between DB and DCWho supports the pension risk?

Defined DefinedBenefit

Contribution

Employer Contributions Volatile Fixed

Employees Pensions Fixed Volatile


In the U.S. – Many large companies have recently frozen their DB plans and have implemented less generous DC plans

International Business Machines Corp.

Verizon Communications Inc.

Circuit City Stores Inc.

Sears Holdings Corp.

Motorola Inc.

Lockheed Martin Corp.

Hewlett-Packard Co.

NCR Corp.

Rockwell Collins

General Motors

Alcoa


Canada is moving slower than the U.S. and UK toward DC. But for how long?

0 10 20 30 40 50 60 70 80 90 100

USA

UK

Canada

DB DC Hybrid


Currently, about 70% of retirement programs of publicly traded companies of Canada have a DC component

Retirement programsPublicly-traded companies in Canada

0%

5%

10%

15%

20%

25%

30%

35%

DB DB+DC DB closed DBclosed/DC

new

DC Greater ofDB and DC


Retirement programsPublicly-traded companies in Canada

0%

5%

10%

15%

20%

25%

30%

35%


new


Mercer consultants expect that most of DB plans will move toward to DC

Current DB plans, in 5 years

0%5%

10%15%20%25%30%35%40%45%50%


new


Wound-up


Why are employers moving away from DB?

Too costly – Decrease in interest rates

Too risky – Volatility of stock market returns

Not in interest of shareholders – Concentrate on business issues

Unfair funding rules – Employer pays deficits and shares surplus

Uncertain court decisions – Monsanto/Transamerica

Too complicated – Cumbersome legislation

Do not meet employees’ needs – Not flexible and not transferable

Outdated HR model

Too generous

– Early retirement incentives with expected shortage of labor

– For some, more disposable income after retirement


But DB can add value

HR issues

– Guarantee of retirement income for baby boomers

– Some employees are not able to manage retirement capital

– Allocate more compensation to career employees

– Retention tool until early retirement

– Compete with public sector

– Need for selective early retirement subsidies

Financial issues

– More pension per $ of contribution

– Lower investment fees

– Higher investment returns


Moving from DB to DC has many challenges

It is difficult to dismount a DB

Law prevents reduction in accrued benefits

Conversion of accrued DB into DC must be optional and is complex

Need to protect baby boomers

Short term increase in cost if current employees can continue in DB

What should the DC cost?

– Equivalent benefits

– Equivalent cost

Significant implementation issues

– Administration of choices

– Payroll adjustment


There will be winners and losers in moving from DB to DC

Age

Va

lue

DB DC

Winners Losers

- Terminated employees - Early retirement

- Younger employees - Career employees

- If good returns - If low returns


Maintaining a DC is not easy

Employees need support and education

– How much to contribute?

– Where to invest?

– What to do at retirement?

and would like to get advice not education Some employees will not be able to manage capital The employer will be blamed for poor performance Risk of litigation – and more fiduciary responsibility The employer will be in the banking business – every cent must be

reconciled


Reduce cost

Reduce risk

Better meet employees’ needs

Introduce flexibility

Simplify administration

Eliminate early retirement subsidies

Follow the crowd

But, in Canada, expect that private sector employers will continue to replace DB by DC for non-unionized employees


Universities may find DB more attractive than private sector employers

Cost can be shared with employees and retirees by adjusting contributions and indexing.

Funding rules may not require solvency valuations resulting in volatile contributions.

Single pension plan for all employees may be desirable; unions strongly object to DC.

A generous DB plan may be needed to compete with other public sector employers.

Early retirement incentives may be replaced by flexible working arrangements, such as phased retirement.

A total compensation package with more pension and less salary may be more attractive

Documents

Michel St-Germain Montréal Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan the answer? Presentation to the Canadian Association