Rethinking DC

The real title of this commentary should be “Rethinking the role and format of defined contribution programs in the employer-sponsored retirement savings landscape in Canada.” But that isn’t the catchy title that the marketing department wants me to use.

I have been away from my desk this year more than ever before. Besides taking more time off in July and August to spend it with the kids before they head out for their post-secondary school adventure, I also have gone to more conferences this year than ever before. It seems that my passion for speaking about the ill-conceived and now dead ORPP has put me on the map as someone with some ideas worth listening to. And when there is nothing for me to talk about then I am becoming the go-to-guy for the role of moderator which at this point is really becoming my career goal.

The point to all of this is that when you go to six or so conferences in a year, you start to see patterns, and you start to see conflicts in what different speakers think are the answers, which gives you a unique opportunity to try and pull it all together.

What am I seeing? In the private sector, DB will be the domain of special case employer-employee groups that see the value in a semi-predictable retirement income along with the efficiency of professional investment management. Although I am pro-DC for small business, I wish more mid-size businesses could take the long-view on pensions and stick with DB. But here is where I am really going. For DC, I think we are doing it wrong.

When DC started to emerge in the 1990s, it was aided by the emergence of computing technology. Our recordkeeping industry was suddenly able to provide a platform of multi-manager multi-investment options to DC plan participants. As websites grew in sophistication with investment information, risk profile questionnaires, calculators, and trading capabilities, so too grew investors’ ability to make more and more complex choices about how to organize their investments tailored to their unique selves.

Unfortunately, what many investment-savvy, technology-capable and self-interested players in the industry lost sight of is that very few plan participants want to access this valuable information and even fewer participants can sort it out enough to make a reasonably good saving and investment decisions for themselves.

In the 1990s HRL (now Open Access) invented a competing model to the mainstream industry. Their model would offer 9 funds ranging from super-conservative to super-aggressive with the ubiquitous ‘balanced fund’ sitting in the middle. With a simple risk questionnaire, you would pick your risk profile and the fund that best reflected that profile. Ta-da!

Unfortunately for Open Access, just as they were getting traction, the big recordkeepers realized they were onto something and copied the model, offering asset-allocation funds as well as individual funds so plan sponsors could offer members both options – asset-allocation for those that wanted to delegate along with individual funds for those that were ‘builders’.

Amazingly, with this almost remote-control option for saving and investing, many participants were still screwing up. I hear stories from recordkeepers that some members would split their money five ways into the five different asset-allocation funds – after all, they had heard somewhere that diversification was a good thing. So finally, the industry came up with the pièce de résistance, the life-cycle or target date fund. This was remote control at its finest. You only needed to know the year in which you hoped to retire and you could pick a fund and walk away with the comfort that the 2040 fund would be as aggressive as it needed to be when you were starting out and as conservative as you needed it to be as you reached your golden years. Recent reports suggest that 80% of members who sign up for a new plan just default to target date funds.

So what could I possibly think we need to do next? The answer is that we need to kick the other 20% of plan members to the target date model. Horror – we can’t take something away…what about the folks that enjoy managing their funds? What about the 3% who are actually good at selecting investments?

My answer, tough luck. We spend all sorts of money in this industry publishing performance reports and trying to educate plan members on investments and savings goals. Sponsors that are living up to their duty to the CAP guidelines are labouring over when to fire a manager and who their replacement should be. In addition, recordkeepers have money spread all over the place with dozens of investment management firms – unable to trim their roster for fear someone will be upset.

All of this needs to stop now – we need to drive down the cost of target date funds and the fastest road to doing so is improving the economy of scale for those funds and also putting more power in the hands of the professional investment committee making the selection to pressure managers to offer their valuable service at the best price. The amateur investment committee is likely an idea whose usefulness is behind us. And of course the outside consultants that support the amateur committees are going to need to find new ways to add value.

Before the entire industry rises up to brand me a heretic, please be reminded that at the end of the day the entire industry is here to help the somewhat helpless plan participant and not to line our own pockets. And for those that think ‘choice’ is an inalienable right please be reminded that those participants will still have choices with savings they make outside of their employment. With that said, I am willing to bet that most participants will gladly give up that choice for the lower fees and for the relief granted to them that they can stop worrying about how to invest.



Joe Nunes
Joe Nunes
Joseph Nunes, Co-founder and Executive Chairman of Actuarial Solutions Inc., has practiced in the area of pensions and retiree health plans for over 30 years. He has experience with many types of plans including single-employer, multi-employer, private sector, government, unionized, non-unionized, as well as registered and non-registered executive plans.


  1. Avatar Louise Koza says:

    Joe – I love you but I am afraid I disagree. The Target Date Funds are not designed properly and I cannot stand behind products that suggest the entire population should be at 40% equity exposure magically at age 65 for the remainder of their now close to 30 years remaining life span- when the whole concept of “retirement” has changed. People actually don’t retire when they thought they were going to – family matters, health matters and opportunity for increased challenges, more often than not, change their plans – and drastically. Statute changes (OAS age limits, CPP accrual limits, human rights code changes to name a few) also significantly change plans. DC plans are appropriately designed when individuals are provided some safety net but also enough flexibility to align to their reality. I am sure you have noticed that people don’t actually stay with their same employer for 30 years anymore – and so an employer that provides a perfectly planned investment allocation over 30 years is really not adding any value. People also mostly have 2 incomes to replace and at least 2 pots of savings to draw from in retirement. Without seeing the full family assets and liabilities, without seeing all the sources of income in retirement, it is very hard to defend that the minor adjustments of equity exposure over a period of time is actually the right answer. I would not want to be a witness in a case defending target date funds, trying to articulate that the employees, who we have recruited, trained and entrusted with the success of our business, do not know better than some investment management firm when it comes to managing their own preparation for retirement years. I guess you were inviting this kind of health debate – happy to contribute 🙂

  2. Avatar Loyd Zadorozny says:

    Louise has some good points. The right Investment strategy depends on income and life event expectations and spending patterns and existing assets and liabilities and many other factors including risk tolerances. Simple rules of thumb, used often today, can create very incorrect answers most of the time. Better advice and better tools are needed that take account of people’s personal circumstances. Personalized solutions are needed and can be created more easily in today’s high tech world.

  3. Avatar Warren Laing says:

    Your monthly newsletter entitled – Rethinking DC – is a good commentary on the evolution of the DC business. So good, that I’d like to comment.

    Yes, the life industry has introduced Target Date Funds (“TDF”) to adjusting the asset mix of a plan participant’s investment portfolio as their appetite for investment risk matures during their working career. Of course there are other solutions that are worth examining as some of them have advantages that TDFs do not offer. Here are some of the important differences

    a) A TDF assumes that one size fits all, or that all employees of an identical age have the same ability to bear investment risk. This is of course inaccurate, and the determination of how much investment risk is appropriate should be based on more information than just the individuals age. There are products in the marketplace that adjust asset mix based on an in depth analysis of the participant’s financial ability to assume investment risk, this analysis is updated on a regular basis.

    b) Secondly, research indicates that fees matter. For example, if 2 hypothetical DC accounts start off at age 25 with $25,000 each, both receive annual contributions of $3,000, both earn a 6% annual investment return, and the only difference is that one pays an investment management fee that is 0.25% less than the other (1.66% vs 1.91%). Then after 40 years when annual contributions cease and they both retire, one will have a market value of $441,963 and the other $410,601. The question then is, with a life expectancy is 30 years, how much can be withdrawn monthly from each of the accounts assuming they both continue to earn a 6% annual investment return? The answer is $2,175.74 from the account with the lower fees and $1,963.89 from the account with the higher fees. A fee that is 0.25% less per annum produces monthly payments that are $211.85 more for 30 years. In other words fees certainly do matter, and the fees for TDFs and some of the other products in the marketplace vary widely.

    c) Finally, achieving above median investment results over extended time periods can enable participants to retire successfully. Attaining this goal consistently is difficult and virtually impossible if the investment options available are restricted to only the proprietary funds of one carrier. Some of the TDFs include third party funds and some of the other products offer only third party funds. So doing due diligence is important.

    In our opinion, the DC industry will likely adopt many of these attributes as increased competition places greater focus on risk adjusted investment returns and drives investment management fees down further. All in all, this is probably a good thing for plan participants as saving for retirement is an incredibly difficult task and employees need all the help they can get to retire well.

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