As workplace pensions evolve, rules and regulatory law should adjust to reflect the realities of the 21st century pension landscape, says a new report from the C.D. Howe Institute.
In “The Shifting Ground of Pension Design: Reflections on Risks and Reporting,” author Bob Baldwin (photo), a pension industry veteran, offers his personal reflections on the unhelpful hyperbole surrounding defined-benefit and defined-contribution plans and explores the way forward for workplace pension design.
Baldwin explores the risks associated with different pension arrangements, arguing that generalizing about the merits of defined-benefit (DB) and defined-contribution (DC) pension plans has little precise meaning. “The diversity in the design of the plans, combined with current financial and economic circumstances, has varied results for all types of pension and retirement savings plans, making it difficult to generalize the merits of each plan,” says Baldwin.
The relative advantage of DB plans in providing predictable benefits stems from cross-subsidies among the members. These are not inherently problematic but transparency problems may arise because cross-subsidies are not identified and measured, explains Baldwin.
Plan governors should therefore adopt measures to help reconcile the unpredictability of contributions and benefits and make DB plans more transparent, including:
• Establishing a clear appreciation of current and future plan members’ financial needs throughout the retirement period;
• Balancing retirement income needs with impacts on pre-retirement living standards with a view to achieving continuity of living standards;
• Understand the risks in providing the benefit promises and who gets the rewards and burdens associated with the risks; and
• Being as clear as possible about cross-subsidies within and between cohorts of plan members.
Finally, Baldwin argues that regulatory and tax policy should be adapted to facilitate more flexibility in plan designs and prevent current rules from becoming obsolete. This can include:
• Incorporating measures identified as good practice for plans with DB elements into requirements of regulatory law. Plans could be required to identify an outer limit of acceptable contributions and what happens when the limit is reached. Plans could also be required to assess and disclose the probability of the limit being reached; and
• Revising the regulatory law so the jointly governed plans face a more principles-based or objectives-based regulation. Plans with governance that is employer dominated will continue to be rules-based. Plans that incorporate flexibility with respect to benefit and financing rules will function best in a joint governance context.