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June 19, 2006

June 19, 2006. Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan th e answer? Presentation to the Canadian Association of University Business Officers. Michel St-Germain Montréal. Agenda. Are DB pension plans too risky?

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June 19, 2006

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  1. 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

  2. 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?

  3. Most pension plans are significantly underfunded

  4. Because interest rates have decreased by more than 2% since 2000. But are they going up?

  5. And return on equities have gone up and down • Return on Canadian equities

  6. Total returns on pension funds have not been bad

  7. But pension liabilities are growing faster than pension assets because of the decrease in interest rate Source: Mercer Pension Health Index

  8. And pension solvency has lost 40% since 2000. But is it going up? Source: Mercer Pension Health Index

  9. What would make the problem disappear? A 1% increase in interest rate and20% stock return

  10. Alcoa to close its pension plan to new workers. GM to freeze salaried pension plan. IBM to freeze pension plan. When the spinning stops – Actuaries and the pension crunch.The Economist,28 January 2006 Dodge calls for reform of pension rules; overhaul needed to ensure system’s viability. Pension plans are in the news

  11. What can be done to manage pension costs? • Reduce investment risk • Stop plan improvements • Increase employee contributions • Convert from DB to DC

  12. Key difference between DB and DCWho supports the pension risk? Defined Defined Benefit Contribution • Employer Contributions Volatile Fixed • Employees Pensions Fixed Volatile

  13. 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

  14. Canada is moving slower than the U.S. and UK toward DC. But for how long?

  15. 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 DB closed DB DC Greater of closed/DC DB and DC new

  16. Retirement programs Publicly-traded companies in Canada 35% 30% 25% 20% 15% 10% 5% 0% DB DB+DC DB closed DB DC Greater of closed/DC DB and DC new Mercer consultants expect that most of DB plans will move toward to DC

  17. Why are employers moving away from DB?

  18. 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

  19. 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

  20. There will be winners and losers in moving from DB to DC

  21. 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

  22. 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

  23. 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

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