Sears shows us the wisdom of defined-contribution pensions

TheGlobeandMail.com – ROB/Commentary
Jul. 23, 2017.   MARK MILKE

Back in the early 1980s, my mother worked at Sears in Kelowna, B.C., for a short time, to help my father during some mutual financial challenges. When I asked her about it recently, she recounted her fond memories. She had been employed in the cafeteria and enjoyed the social aspect of the job.

My family’s connection to Sears came to mind given the retail giant’s decline, its planned shuttering of 59 stores and court protection from creditors. Those creditors include retirees and 2,900 laid-off Sears employees who will receive no severance payments, though some medical and pension payments will continue until the end of September.

One hopes that the news becomes no bleaker for ex-Sears employees and pensioners. However, nervousness would be understandable: The pension fund that manages the defined-benefit pension plan for Sears Canada retirees and employees makes clear that it was already underfunded, by 19 per cent as of December, 2015, the date of the latest actuarial report.

In addition, while Sears Canada is required to make payments into the plan, if Sears goes bankrupt, “it would stop making those payments and your pension would be reduced to match the amount in the fund at that time,” notes the information page.

The Sears uncertainty is a reminder of why defined-benefit plans are not as guaranteed as assumed, especially in the private sector. Defined benefit plans, for those not in one, are near to what the words imply: A specific monthly benefit to be delivered to an employee upon retirement from the work force.

Problematically, to promise a certain pension amount decades out assumes the actuarial wisdom of a deity.

Decades ago, no one would have predicted near-zero interest rates or the longevity of today’s population. The latter is positive but both factors played havoc with prior actuarial assumptions upon which defined-benefit plans were initially based. It’s why many defined-benefit plans over the past 15 years required higher contribution rates from employers and employees, other top-ups and/or an underfunded plan, such as the one Sears Canada employees and retirees now face.

Defined-benefit plans have been on the decline in Canada’s private sector for decades.

In 1974, the earliest year for which statistics are available of private sector enrollees in a registered pension plan (over 1.9 million people), 88 per cent were enrolled in a defined-benefit plan. Another 9 per cent were enrolled in a defined-contribution plan. (That’s where pension payouts depend on the combination of employer/employee contributions and investment returns.) The remainder were enrolled in a hybrid variety, or “other.”

Fast forward to the most recent year available, 2015. Just over three million private-sector employees were enrolled in a registered pension plan but only 45 per cent were in a defined-benefit plan – nearly half the 1974 proportion, with 31 per cent of private sector employees in a defined-contribution plan. (The rest were in a hybrid or “other.”) The reason for the decline is unsurprising: Companies are increasingly reluctant to commit their unsure finances to defined pension plan benefits decades ahead. They have instead moved employees (as the percentages show) to defined-contribution plans.

The public sector is still mostly found in defined benefit plans. That’s because taxpayers can always be drafted into bailing out public-sector plans. That includes payments for increased employer contributions and also for the extra employee contributions, the latter via the tax dollars provided for salaries.

In 1974, almost 99 per cent of public-sector pension-plan enrollees were in a defined-benefits plan; that dropped to barely under 94 per cent as of 2015. The remainder in both years were in defined-contribution, hybrid or other types of registered plans.

Critics of defined-contribution plans dislike the non-specific dollar amounts that would accrue to retirees – again, contributions plus investment returns determine eventual pension paycheques. But given the Sears Canada experience with defined-benefit plans, and the uncertainty of ostensibly guaranteed returns, defined-contribution plans are more realistic given they are linked with market returns.

Also, properly designed, and as the Office of the Superintendent of Financial Institutions points out, defined-contribution accounts are individual accounts – though not managed individually – in the member’s name with investment earnings “credited to this account.” In other words, defined-contribution plans belong to individual employees from the start. That’s preferable to the uncertainty with which Sears’ retirees and ex-employees now grapple.

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