June 19, 2006
Health of Defined Benefits
Pension Plan
Is a Defined Contribution
Pension Plan the answer?
Presentation to the Canadian Association
of University Business Officers
Michel St-Germain
Montréal
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?
Mercer Human Resource Consulting
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Most pension plans are significantly
underfunded
50%
40%
30%
% of plans
20%
10%
0%
<80%
80%-90%
90%-100%
100%-110% 110%-120%
>120%
Solvency ratios
Déc. 31, 2003
Mercer Human Resource Consulting
Déc. 31, 2005
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Because interest rates have decreased by
more than 2% since 2000.
But are they going up?
7%
Bond Yields
6%
5%
4%
3%
Jan-99
Jan-00
Jan-01
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Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
4
And return on equities have gone up and
down

Return on Canadian equities
40%
30%
20%
10%
0%
-10%
-20%
1997
1998
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1999
2000
2001
2002
2003
2004
2005
5
Total returns on pension funds have not been
bad
20%
15%
10%
5%
0%
-5%
-10%
1997
1998
1999
Mercer Human Resource Consulting
2000
2001
2002
2003
2004
2005
6
But pension liabilities are growing faster than
pension assets because of the decrease in
interest rate
1.90
Asset Performance
Liability Performance
1.70
1.50
1.30
1.10
0.90
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Source: Mercer Pension Health Index
Mercer Human Resource Consulting
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And pension solvency has lost 40% since
2000. But is it going up?
1.30
Solvency Index
1.20
1.10
1.00
0.90
0.80
0.70
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Source: Mercer Pension Health Index
Mercer Human Resource Consulting
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What would make the problem disappear?
A 1% increase in interest rate and
20% stock return
Employer contribution
Solvency ratio
40%
120%
110%
30%
100%
20%
90%
10%
80%
70%
2006
Base
2007
2008
Interest + 1%
2009
2010
2011
Int. + 1%, eq. 20%
Mercer Human Resource Consulting
0%
2006
Base
2007
2008
Interest + 1%
2009
2010
2011
Int. + 1%, eq. 20%
9
Pension plans are in the news
GM to freeze
salaried
pension plan.
Alcoa to close
its pension
plan to new
workers.
Dodge calls for
reform of pension
rules; overhaul
needed to ensure
system’s viability.
Mercer Human Resource Consulting
IBM to freeze
pension plan.
When the spinning
stops – Actuaries
and the pension
crunch.
The Economist,
28 January 2006
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What can be done to manage pension costs?

Reduce investment risk

Stop plan improvements

Increase employee contributions

Convert from DB to DC
Mercer Human Resource Consulting
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Key difference between DB and DC
Who supports the pension risk?

Employer Contributions

Employees Pensions
Mercer Human Resource Consulting
Defined
Benefit
Defined
Contribution
Volatile
Fixed
Fixed
Volatile
12
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
Mercer Human Resource Consulting
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Canada is moving slower than the U.S. and UK
toward DC. But for how long?
Canada
UK
USA
0
10
20
30
40
DB
Mercer Human Resource Consulting
50
DC
60
70
80
90
100
Hybrid
14
Currently, about 70% of retirement programs of
publicly traded companies of Canada have a DC
component
Retirement programs
Publicly-traded companies in Canada
35%
30%
25%
20%
15%
10%
5%
0%
DB
DB+DC
Mercer Human Resource Consulting
DB closed
DB
closed/DC
new
DC
Greater of
DB and DC
15
Mercer consultants expect that most of DB
plans will move toward to DC
Retirement programs
Publicly-traded companies in Canada
35%
30%
25%
20%
Current DB plans, in 5 years
15%
10%
5%
0%
DB
DB+DC
50%
45%
40%
DB closed
35%
30%
25%
20%
15%
10%
5%
0%
DB
closed/DC
new
DB
Mercer Human Resource Consulting
DC
Greater of
DB and DC
DB+DC
DB closed
DB
closed/DC
new
DC
Greater of Wound-up
DB and DC
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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
– Early retirement incentives with expected
Too generous
shortage of labor
– For some, more disposable income after
retirement

Mercer Human Resource Consulting
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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
Mercer Human Resource Consulting
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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
Mercer Human Resource Consulting
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Value
There will be winners and losers in moving
from DB to DC
Age
DB
DC
Winners
Losers
- Terminated employees
- Early retirement
- Younger employees
- Career employees
- If good returns
- If low returns
Mercer Human Resource Consulting
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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
Mercer Human Resource Consulting
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But, in Canada, expect that private sector
employers will continue to replace DB by
DC for non-unionized employees

Reduce cost

Reduce risk

Better meet employees’ needs

Introduce flexibility

Simplify administration

Eliminate early retirement subsidies

Follow the crowd
Mercer Human Resource Consulting
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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
Mercer Human Resource Consulting
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