You Can’t Out-invest a Savings Problem
The thing I love most about Toronto is the traffic. Second on my list is the cost of parking. Oh wait, my list was upside down, those are my two least favourite things about my visits to Hogtown. My favorite part of my visits is always the people. There are hundreds of dedicated professionals in my network trying to move the pension industry forward and it is always fun to share ideas which always helps shape my thinking.
Last year I gave several presentations about the need for sponsors to think more clearly about their workforce goals and their DC plan design. At last week’s Sun Life Investment Conference I was describing to my friend Jay (not to be confused with my partner Jason) my theory about chronic under-saving in DC plans as a result of poor design and an over-focus on investment options. Jay looked at me and said that he likes to tell plan sponsors and members “you can’t out-invest a savings problem”. Brilliant I said and immediately told him I would be ‘borrowing’ this expression going-forward.
The gist of my presentations is that if you have been running a DC plan for 20 or 30 years with a 4%+4% contribution formula and you are secretly hoping your older workers retire early so that you can replace them with a younger, more productive, and cheaper workforce of new graduates, you are probably setting yourself up for disappointment.
Since the dot-com bust in the early 2000s, I have been going to see clients to tell them that they need to increase their contributions to their DB plan for two reasons – first, investment losses in a DB plan are re-paid by the sponsor and second, falling interest rates (and falling expected investment returns) meant that the cost of a good pension was increasing. Interestingly, as the first decade of the new millennium was ending, I started to notice that DC plan sponsors were not increasing the contribution formula in their plans.
As part of my last trip I ended up seeing my friend Leslie on the golf course. I make no secret of the fact that I love industry conferences for the networking and if networking events are held on a golf course then I am even more likely to sign up. Before anyone gets upset that I golf too much, please be reminded that when I am not working for clients I am not ‘billing’ time and I am not being paid. I am ok with this tradeoff that I made 20+ years ago when I started my own firm. When I do work for clients, I am a better consultant for all my travels.
During our visit, Leslie and I were talking about industry surveys for pension costs and the desire of one of her clients to be competitive with a group of employers that have historically offered employees a generous DB plan. In our discussion I made two points. First, those employers may not have DB any longer, at least not for new hires. Second, we are playing the wrong game if we just focus on how much others are contributing to a DC plan as the benchmark of what we need to do to be competitive. This approach is ensuring that almost all DC plan sponsors design a plan that delivers inadequate retirement benefits.
The gold standard for DC of 5%+5% from the 1990s cannot compare to the 12%+12% teachers in Ontario contribute – and that is even if you ignore the fact that my friend Malcolm has pointed out that there is a taxpayer guarantee behind that 24% that makes the pension worth closer to 40% of pay. Therefore, the early retiree school teacher next door is spending 2.5 to 4 times the amount that the average private sector worker is spending on pensions. No wonder none of them are in the classroom past age 57 unless they started teaching later in life and no wonder private sector workers need to move away from the dream that they too will get to retire at an age where time in the workforce is likely to be shorter than time in retirement.
In the end, I wish that the actuaries that helped convert sponsors from DB to DC were kept involved to help sponsors recalibrate contribution rates periodically. If we told DC plan sponsors that they should still get a valuation every three to five years, then they would have been better informed on the gradual shift in the global economic framework (and longevity changes).
Sponsors now have two options. The first is to play catch up with contributions to get workers back on track towards a retirement age before age 75. The second is to build an HR plan around age 75 retirement, which would include either keeping workers until then or, now that mandatory retirement is not an option, planning a severance program to exit the workers that can’t afford to leave on their own.