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Freedom from Choice

Posted by on Apr 1, 2008 in Employee Benefit News, Retirement | 0 comments

By: Sheryl Smolkin

Read this article and comments at HRInsider.ca 


More than half of defined contribution plans offer members 10 or more investment options, yet 74% of DC plan sponsors think members are confused about investment options, according to a survey recently released by ACS Buck Consultants.

Responses from 80 plan sponsors show 57% of survey participants offer more than 10 investment choices, as opposed to only 40% of respondents surveyed in 2003.

“I think in some cases it’s an evolution to meet the risk/return profiles of membership, based on both their investment sophistication level and what they can handle going forward in terms of the education platform offered,” says ACS Buck investment consultant Peter Arnold.

Prepackaged portfolios

Arnold also notes the nature of investment choices offered may vary, depending on whether the plan sponsor is a Canadian company or a U.S. affiliate/ subsidiary.

“We are certainly seeing an increased interest from U.S. companies in the level of passive funds being used, particularly for U.S. equities. That discussion quickly changes when my U.S. contacts find out how high the fees are for passive investing in Canada, by worldwide standards,” he says.

Not surprisingly, survey results reveal a growing interest in prepackaged portfolio solutions, with 50% offering lifestyle funds, and 47% of those who do not, interested in offering them in future.

While for the purposes of the survey they were lumped together, lifestyle funds can be broken down between:

Risk profile funds in which the asset allocation is fixed, labeled less risky, moderate or aggressive.

Retirement or target date funds where all assets are with one investment manager and the asset mix or “glide path” is adjusted over time.

“In any given portfolio, we see the majority of assets in risk profile funds or balanced funds, followed by Canadian equity funds,” notes Arnold. “We’re starting to see plans gravitate toward retirement date funds and away from other options, but I wouldn’t say it has been enormous.”

Not only are the track records of target date funds less established than risk profile funds, but they tend to be “one manager investment vehicles.”

Given that each investment manager has his strength, and DB plan sponsors are not inclined to give the whole pension fund to one investment manager, he says some DC sponsors are questioning whether they should expose plan members to this risk.

“One possible solution to this dilemma might be portfolios using multiple managers that have retirement date features,” he suggests.

Quality, not quantity

So how many choices are too many?

“That’s a tough one,” says Arnold. “But our general rule of thumb is that if one option looks like another, you are probably not properly diversified.”

By way of example, he says that if a DC plan has 20 or 30 options and 10 of these are Canadian equity funds, the question to ask is whether or not the investment managers are really looking at the marketplace in 10 different ways. “This is where we tend to prune these options down to two or three.”

Where Canadian manger A is removed from the investment platform, if Canadian manager B has the same inherent investment philosophy, employee assets can typically be “mapped” to the other fund, and, subsequently, members can be informed.

However, Arnold cautions that if the proposed transfer options have a different risk/reward profile, members should be asked to choose whether to move their money into one of several funds or into the default option.

Based on recent client mandates, Arnold thinks the pendulum also may be shifting in regard to how frequently members are permitted to move money from one fund to another.

Survey results indicate that currently 75% of plans allow employees to change their investments daily, and 45% allow unlimited transactions with no cost to the member.

But Arnold says, “If the DC plan is intended to be a long-term vehicle, built-in rebalancing is probably a much more important thing to offer than being able to change in and out of funds on a regular basis.” At minimum, he believes monthly investment changes should be permitted. “Daily might be too much. Quarterly might not be often enough.”

The right default option

Another hot topic sponsors were asked about is their choice of default options. According to survey data, money market funds are the default investment for 45% of companies; 31% default to a balanced fund; and only 5% have designated lifestyle funds, primarily risk based funds, as the default.

Yet recent regulations under the 2006 U.S. Pension Protection Act provide that there generally will no longer be a “safe harbour” for plan sponsors that retain money market funds as the default, suggesting we may also be on the cusp of change in this country.

“Money market funds can be on the right side or the wrong side of risk. However, they are currently viewed as a poor default choice because, over the long term, they are expected to have the lowest returns on investment vs most of the asset class options available in any given program,” comments Arnold.

That said, he feels strongly that a default fund should only be a short-term parking place for assets until the member makes a decision. “Regardless of what the default fund is, we think sponsors have to stay on these members to make sure they are making decisions.”

Promoting employee understanding

Arnold confessed he was a bit surprised by the number of plan sponsors (74%) who said their members are confused about investment options, but agrees this is one of the biggest challenges currently faced by the industry.

While online tools are making a difference in enhancing employees’ understanding and comfort level in offices where plan members are working at computers every day, he says use of Internet tools is very low among field staff. “You have to reach these people through various other media, such as posters and bulletin board campaigns.”

In addition, he notes that some plan sponsors who are very engaged with their members are providing company time to review the CAP program.

“Having the CEO or a member of the executive team stand up in front of groups of employees and say, This stuff is very important and we are here to answer your questions,’ is a great way to get a feedback loop going and promote employee understanding of the retirement savings process,” he says.

“Many well-run DC plans are taking a less is more approach’ to helping employees get through the investment maze,'” Arnold says. “Fewer investment options, more delegation and a better understanding of employee investment patterns. These sponsors are establishing priorities and focusing on them, instead of trying to do everything under the sun.”


In praise of a safe harbourA recently released backgrounder by the C.D. Howe Institute’s President and CEO William B.P Robson advocates for U.S.-style safe harbour provisions for Canada’s money-purchase plan sponsors.

While acknowledging safe harbour legislation risks becoming so prescriptive that it impedes, rather than aids, well-motivated employers, Robson proposes the following outline for Canadian action:

  • Address roadblocks to automatic enrolment, and give employers guidance about the kinds of automatic enrolment and contribution escalation figures that will be safe.
  • Give employers protection as they attempt to steer employees into wise investment choices.
  • Extend safe harbour protections to service providers, because their fees are a natural target for discontented participants.

However, industry experts are divided as to whether legislated safe harbour provisions will or will not facilitate delivery of improved DC benefits.

Borden Ladner Gervais partner Freya Kristjanson says, “The capital accumulation plan guidelines don’t have the force of law. If I were an administrator or employer, I would rather have a legislated safe harbour I knew would protect me.

But Murray Campbell (Lawson Lundell) thinks there is no need to further codify the guidelines. “The CAP guidelines are enough,” he says. “Sponsors who are worried about the CAP guidelines should just get rid of choice. They only have to follow the guidelines if they give participants control over their investments.”

While ACS Buck investment consultant Peter Arnold can relate to both of these arguments, he wants to see “how” employers must comply more clearly spelled out in the guidelines. He also believes the guidelines should be incorporated into legislation.

“We need to rewrite the rules so there are two well-defined routes to retirement savings. There must be clearly demarcated DB and DC lanes that will get you there,” he says.

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