Hammerstein’s lyric melodiously sums up the opportunity that now presents itself; pension reform in Canada is about to be shaped by a private-sector solution that Canada’s Finance Minister Jim Flaherty has called ‘…a major breakthrough for the Canadian pension market, a well regulated, low cost plan accessible to millions of Canadians who have, until now, not had access to such plans.’ Enter Canada’s Pooled Registered Pension Plan (PPRP).

Conceptually, the idea is sound. Offer the 11-million Canadians who do not have access to a workplace pension a vehicle that encourages them to save for their retirement through a low cost option (Figure 1 suggests that a cost effective PRPP will be priced somewhere between Defined Benefit plans and large Defined Contribution offerings). Assets would be ‘pooled’ thereby generating economies of scale.

Theoretically, those economies would have a positive impact on overall performance.

Structuring trust: the private-sector’s responsibility to build on a good beginning

Reducing management expense ratios (MERs), albeit a positive step, is only a good beginning. With the PRPP, Mr. Flaherty has given private enterprise an unprecedented opportunity to initiate lasting reform that extends well beyond pricing. Yet, there remains widespread skepticism that the private sector will be able to rise to Flaherty’s vision. Susan Eng, Vice-president of Advocacy at The Canadian Association of Retired Persons (CARP) stated in a Financial Post article on December 20th 2011 that she remains skeptical that, ‘banks and insurance companies will keep fees as low as they suggest or that they will truly do what’s best for clients’.

In the same article, pension consultant Keith Ambachtsheer comments, ‘The biggest drawback is that PRPPs are voluntary for both employers and employees. Both empirical evidence and common sense tell us the purely voluntary uptake of these PRPPs will be minimal’. Ken Giorgetti, President of the Canadian Labour Congress, in a December 16th, 2010 Globe & Mail article was even more blunt and forceful, maintaining that voluntary systems do not work. Clearly a great deal of work remains to be done to turn the promising PRPP idea into an effective reality. The perceptual and experiential hurdles are formidable. But we believe that these hurdles can be traversed, not with rhetoric, but with a structure of trust; the very structure inherent in the CFA Institute’s Code of Professional Conduct.

A PRPP worthy of 11 million Canadians is both timely and needed

The Alberta-British Columbia joint Expert Panel on Pension Standards (The ABC Plan) issued a report in 2008 that concludes: ‘Participation of workers in occupational pension plans is in decline in Canada… recent statistics indicate that only 22 percent and 23 percent of British Columbians and Albertans, respectively, employed in the private sector are covered by any form of occupational pension plan. Moreover, recent statistics indicate that personal savings rates in Canada have been in decline since 1982 and estimates indicate the average family will have substantially less than the 70 percent of retirement income replacement believed by many to be required to maintain a sufficient standard of living in retirement. Given that the debt loads of Canadians are at an all-time high, which the Panel and others suggest will continue to result in Canadians neglecting to save adequately for their retirement, the introduction of a cost-efficient, professionally-managed pension plan available to all workers in our provinces may help reverse these troubling economic trends.’

The C.D. Howe Institute, in its December 2010 paper entitled ‘ Canada’s Looming Retirement Challenge: Will Future Retirees Be Able to Maintain Their Living Standards Upon Retirement?’, identifies the problem on a national scale. ‘After four decades of improvement, the proportion of newly retired individuals unable to replace at least three-quarters of their average pre-retirement consumption from the sources we model is projected to nearly triple over the next 40 years. If current trends persist, by the 2046-50 period, about 45 percent of workers currently aged between 25 and 30 years would not meet our 75 percent threshold- a jump of nearly 30 percentage points from those who reached retirement in the last five years.’

A Globe & Mail article on August 18,2011, entitled ‘Pension Plans Slide into Deficit After Market Turmoil‘, surmises that ‘Canadian pension plans have taken a double hit from the recent market turmoil, losing money on their investments while simultaneously seeing their funding obligations grow thanks to falling bond yields…The results show pension plans have been on a roller coaster with high volatility and daily swings of more than two percentage points in their funded position on many of the days in August so far.’ The article goes on to say, ‘The hit facing companies this year is expected to be worsened by new global accounting standards that Canada adopted last January (2011). The rules will not permit the same sort of ‘smoothing’ that was done in the past by which companies could slowly record the hit to their balance sheets from soaring pension liabilities over a number of years.’

One potential answer to the problem is doubling or enhancing the Canada Pension Plan. As much as the argument continues to be voiced, Canada has chosen to forego the public route in favour of a private-sector solution. Jonathan Chevreau stated bluntly and with foresight in a July 16th, 2011 article in the National Post entitled ‘ Back in the Private Pool’ : ”You can forget about the greatly expanded or ‘Big’ Canada Pension Plan the Liberals, NDP and Big Labour have pushed for”. Canada’s Minister of State (Finance) Ted Menzies who is responsible for the introduction of the PRPP appears to be committed to creating a system that will be run by the private sector with risks borne equally by employees and employers. Any lingering hopes for a CPP solution were snuffed out on November 17th 2011 with the introduction of Bill C-25, the Pooled Registered Pension Plans Act. Now progressing to its third reading, the PRPP’s marketplace arrival is imminent.

Average Canadians deserve better than average

In his keynote address at the World Pension Summit in Amsterdam last November, Ted Menzies put forward the virtues of a citizen-centric PRPP stating, ‘PRPPs will allow small business owners and their employees to have access to an accessible, large-scale, low-cost defined contribution plan for the very first administrators working to ensure that funds are invested in the best interests of plan members.’ That speech was expanded upon by Mr. Menzies back home on February 24th, 2012 when he addressed the Charlottetown Chamber of Commerce saying, ‘Professional administrators will be subject to a fiduciary standard of care to ensure that funds are invested in the best interests of plan members.’

Many would argue that government should allow the private sector to determine the PRPP’s structure independently. However, given the skepticism cited earlier and the magnitude of the PRPP’s potential, Mr. Menzies, representing the needs of all working Canadians, is compelled to intervene. Government, it appears, will serve as Canada’s ultimate fiduciary.

An Advisor’s Edge article which appeared in September 2011 points to what segments of Canada’s population have always known, ‘Discretionary managers take charge of finances so wealthy people don’t have to. What can they teach us about trust?’ The Canada Pension Plan, most defined benefit plans and high net worth individuals rely on discretionary managers to invest on their behalf. The fact that these entities understand the need for discretionary management raises a simple question: if discretionary investment management is prudent for Canada’s privileged, why would it not be just as prudent for all working Canadians?

With the PRPP, discretionary management could serve the investment needs of all Canadians

Cass Sunstein and Richard Thaler, in their often-quoted 2003 paper, Libertarian Paternalism Is Not an Oxymoron, state: ‘the false assumption is that almost all of the people, almost all of the time, make choices that are in their best interest or, at the very least, are better by their own lights, than the choices that would be made by third parties’. Jonathan Kesselman, in his October 2010 paper, Expanding Canada Pension Plan Retirement Benefits, supports Sunstein and Thaler’s conclusion commenting: ‘most individuals, other than the professionally advised and wealthy, make their investment decisions based on hunches about the course of equity and bond markets; in short, they engage in market timing in an attempt to secure better returns. These efforts usually work against the investor by the tendency to ‘buy high’ (when enthusiasm reigns in markets) and to ‘sell low’ (when gloom predominates)’.

Common sense tells us that, despite the implementation of the recent findings of the government’s Task Force on Financial Literacy, no amount of investment education, even from grade school forward, will prepare average Canadians to make objective, informed financial decisions. Teaching Canadians about the merits of long term saving is important in engaging them. Teaching them on how to best invest those long term savings is beyond their reach. As Jack Mintz concludes in his Financial Post commentary on January 13th, 2011, ‘Even with all the financial education in the world, literacy can only go so far. Even the best and brightest who are busy with their own professions will not have the time to become financial experts. I want my doctor to know something about medicine, not which investments to make’.

In their spring 2011 paper, titled Redesigning Choice and Competition in Australian Superannuation, the Rotman International Journal of Pension Management goes further than Mr. Mintz’s conclusion stating: ‘There are few certainties in life, but one of them is: Investment education has zero chance (not 10% chance or even 1% chance) of making the average person an expert investor.’ Global observations aside, Deloitte, in its February 14th, 2012 PRPPs shares a similar view: ‘From a policy perspective, we have a concern that a member of a PRPP that has such investment discretion may make inappropriate investment decisions. An example may serve to illustrate this concern. An administrator may offer a number of different investment funds (mutual funds, pooled funds etc.) from which a member can choose. One or more of such funds may have a relatively high-risk profile (e.g., small cap, emerging markets, non-investment grade debt). In addition, there would likely be a wide array of asset classes represented by the menu of funds offered, including equities and debt. A ‘reasonable and prudent person’ would not likely allocate all of his or her PRPP assets to a single small cap or emerging markets fund. Such a person would also choose a portfolio of funds that would, together, provide a reasonable risk-reward balance, taking into account asset allocation principles and the age of the member.

However, subsection 23(2) only states that an administrator must provide a choice of investments that could be used to build a reasonable and prudent portfolio. We suspect that certain members would not have the “reasonable-ness” and “prudence” or the investment acumen to choose the right portfolio of funds and to monitor that portfolio on an ongoing basis. A member could put all of his or her PRPP assets in an emerging markets fund or make inappropriate asset allocation decisions. We believe that there must be some other protection provided in the PRPP Act to guard against this possibility.’

On a more human front, Ursula Menke, Commissioner of the Financial Consumer Agency of Canada, in a June 14th, 2011 Globe & Mail article, Pension Battle at Heart of Air Canada Strike, states:, ‘It’s asking an awful lot of people who are not comfortable with investing.’ Defined contribution plans have two problems. First, the employer must select a good manager for the company plan–a difficult task.

Second, the employee needs to receive good information and advice in order to select the right mix for their plan. Employers tend not to provide that advice going in.’

This wide range of commentaries, as disparate as the sources may be, embraces a shared conclusion: average Canadians are ill-equipped to make financial decisions on their own and therefore must be protected.

Protection is best provided by a ‘true fiduciary’

On March 22nd, 2012, Teamsters Canada was asked to testify in front of the Standing Committee on Finance. In an unprecedented move toward real compromise, they tabled a submission for PRPP’s that stressed the importance of serving only workers’ best interests, ’We think the fiduciary duty is a critical idea and it should encompass specifically no trailer fees. No proprietary products should be permitted unless it can be proven to be the best product for the plan. Plans should be subject to discretionary investing. Let the professionals make investment decisions not individual investors. If we call it pooled pensions then let’s deliver pensions.’ As much as the Teamsters, along with many like-minded organizations, believe that ‘modest increases to the CPP would be a better solution for workers’ retirement savings,’ they also recognize their vision for a PRPP would make the Pooled Registered Pension Plan ‘a better retirement vehicle.’ Proponents of the Canada Pension Plan can take some solace however, knowing that it is possible to replicate many of the features of the CPP/QPP if the discretionary-managed PRPP option suggested by the Teamsters and others is selected (see Figure 2 below).

For PRPPs, a bell’s not a bell ‘til a CFA rings it.

‘Today, the ethical and professional responsibilities of firms that manage assets on behalf of clients have never been more significant. The CFA Institute Asset Manager Code of Professional Conduct was established to ensure that, big firm or small, the people you entrust to make decisions on your behalf-subscribe to a single, universally accepted, set of standards.’ That statement, taken from the July 12th, 2010 issue of Pensions & Investments, serves as a bellwether for all PRPP structures if they are to best serve the needs of all working Canadians.

The private sector has been granted an unparalleled opportunity to increase the odds that 11 million working Canadians- those not fortunate enough to participate in any form of workplace pension- retire well, to ensure that employers previously shut out of efficient pension models, enjoyed by others, now have a chance to provide plans embraced by their employees and to reduce dependence on government. However, without a framework that ensures individuals are protected from themselves- their inability to make objective, well-advised investment decisions- and equally protected from the private sector’s tendency to look after its own needs first, any PRPP structure stands to fall far short of the ideals Mr. Flaherty, Mr., Menzies, Mr. Ambachtsheer or Teamsters Canada have called for.

For CFA’s, PRPPs represent a significant opportunity to demonstrate the value that our designation, our code and our practice bring to creating a structure of trust- one that simply, easily and affordably introduces the PRPP in its best light. ‘Best light’ is defined as a fiduciary managed, discretionary asset model that mirrors the success of the CPP while complementing the solid foundation the CPP provides.

As an industry, we have a responsibility to all Canadians. Cynicism, abundant in the broader marketplace, reflects a sometimes faltering adherence to that responsibility. PRPP’s are a telling moment; a substantial opportunity to prove the private sector is worthy of that opportunity, worthy of the trust of all working Canadians.

As CFAs, we have a pivotal role to play in ensuring that trust is established. The bell for PRPPs must be rung. Canada is counting on us.

The PRPP (Bill C-25) in brief:

What: A voluntary defined contribution retirement vehicle that will allow potentially thousands of unrelated employers to participate in a plan that pools their assets and is administered by a third party administrator.

Who: Membership is targeted towards 11 million Canadians currently not covered by a pension plan, and more specifically small employers and the self-employed.

Regulation:

• Bill C-25 provides a national framework; however, PRPPs will require provincial enabling legislation. Quebec is the first province to table legislation for the Voluntary Registered Savings Plan (VR SP) and expects it to be available January 1st 2013. Federally regulated employers and the territories will be eligible to offer PRPPs first because they are governed by the Federal Act.
• OSFI has been appointed the regulator for the national framework, provinces have their own regulator.
• A PRPP is not a registered pension plan (RPP) under the federal Pension Benefits Standards Act (PBSA) or a RR SP under the Income Tax Act (the ITA). Thus it’s viewed as a new pension structure.

Contributions: Although there are no mandatory contributions for either the employee or employer, there is auto enrolment of employees where an employer has elected to offer a PRPP. In this situation, the employee will have 60 days to opt out preventing any contributions to the PRPP.

Contributions of employees that do participate will be locked-in.

Pricing: Administrators must provide the PRPP at a “low cost” to members. See figure 1 for estimates.

For more information, www.ampersandadvisory.com has a comprehensive collection of PRPP materials.

The PRPP and What it means for CFAs…

• A new high volume low margin retirement vehicle where CFA’s will be able to deliver discretionary management to millions of Canadians.
• A shift from managing focused mandates to managing balanced or diversified pools of passive and active mandates.
• A fiduciary relationship between the administrator or investment professional and the plan member.
• Locking in provisions will make assets stickier
• The low cost nature of PRPPS and the potential ability to consolidate other assets such as RRSPs and locked in accounts creates the potential for flows of assets into PRPPs.
• The arrival of PRPPs will likely create pricing pressure for retail offerings.
• An increase in the number of Canadians saving for retirement.
• New entrants, administrators, into the Canadian retirement space.
• The CFA gold standard is now more relevant than ever.