The Downside of PRPPs
Beware of the risks and unintended consequences.
January 17, 2011
Pension reform has been the focus of much attention over the past 18 months in Canada. The defined contribution (DC) Pooled Registered Pension Program (PRPP) recently proposed by the Minister of Finance is primarily intended to provide an efficient, effective and low cost retirement savings vehicle for the many Canadians without employer pension programs. Because of differing retirement needs and agendas however, it may be difficult to avoid unintended or undesirable outcomes.
The Minister acknowledges that the PRPP requires a high level of regulatory harmonization across major jurisdictions. Harmonization however has proved to be difficult: achieving the 12-month deadline for the PRPP, as suggested by the Minister, therefore appears optimistic. It is also debatable as to whether Western and Atlantic Canada will accept a program where control and most key high-paying jobs will reside in one or two provinces.
While many Canadian workers do not have employer-sponsored pensions they do have access to tax assisted savings programs such as registered retirement savings plans (RRSPs) and Tax Free Savings Accounts (TFSA) through local financial institutions. Many taxpayers do not take full of advantage of these existing programs therefore it is questionable whether the PRPP will foster more saving. Undoubtedly, the argument will be that lower PRPP fund manager and administration fees will encourage more workers to save. High costs however are generally not given as being the main reason taxpayers don’t make greater use of RRSPs.
Perhaps the underlying issue is that the average worker simply doesn’t have enough spare cash to make pension contributions. While regulated financial institutions are capable of taking on the fiduciary role implicit in the PRPP it will be interesting to see how much less the fees will be, given the fiduciary risks the financial institutions assume and their considerable responsibilities (i.e., administration, investment option selection, evaluating investment options performance, communication and education requirements under the Capital Accumulation Plan (CAP) Guidelines).
The largest component of MERs paid by DC plan members is generally related to the record keeper’s administrative cost vs. the actual fund manager fees. Keeping in mind that the Administrator must always act in the best interests of the PRRP members (vs. their own profit or organizational objectives), financial institutions may find it difficult to avoid the perception of a conflict of interest.
The PRPP must also be designed to allow members to construct portfolios (balanced funds) consistent with their particular needs. Given the diversity of the PRPP membership a large number of investment options may be necessary which make member investment decisions less straight forward and result in higher administrative costs. Perhaps the more intriguing question will be whether financial institutions are allowed to use their own investment fund offerings vs. the best performing lowest cost investment options available in an asset class. This is a particularly complex issue if more than one financial institution is involved and balanced finds, life cycle or target dates funds are offered.
The PRPP Administrator will also be responsible for communication, education and providing member with tools to assist in making investment decisions. DC plan sponsors in the past have found this to be a difficult, frustrating and costly aspect of administering DC plan. They undoubtedly would be happy to transfer this responsibility to a PRPP.
The Minister also makes the comment that a PRPP default option will be required and may include some risk exposure. The level of risk in a default option has troubled many pension committees. Undoubtedly the approach taken by the financial institutions with respect to the level of risk within a default fund will set a best practice standard for the industry.
The employers’ (sponsors) residual responsibilities under in the PRPP are similar to those in a defined contribution (DC) plan however, the financial Institution(s), as Administrator(s) would relieve employers of almost all of their Administrator fiduciary responsibilities, and risks. This is a significant difference and a very compelling reason to add a PRPP from an employer perspective.
PRPPs appear to be intended for smaller organizations (Employed Members) or the self employed (Individual Members); however, it does not appear there are restrictions in terms of size of the organization nor does it appear that employers already offering DC plans are precluded from transferring their DC plans to a PRPP. Given fiduciary responsibilities and risk inherent in administering a DC plan many sponsors would likely jump at an opportunity to transfer their DC plans to the PRPP. This shift could be the final nail in the DB coffin and result in fewer employers offering their own DC plans. The potential loss of revenue and clients may also be a concern for financial institutions and other record keepers.
Implementation of the PRPP (a new form DC plan) would require some changes to pension legislation and significant modifications to the Income Tax Act. Given the shift in fiduciary responsibilities and the nature of the PRPP, a “safe harbor” type environment similar to the available under ERISA in the USA would likely evolve in Canada. This would be a significant change from an overall pension governance perspective.
Stepping back from the PRPP structure, many CAP members have indicated they want a savings vehicle that minimizes their involvement in investment decision-making, is not subject to market risk and fluctuations and results in a guaranteed pension income. Since the PRPP does not address these issues many workers will likely continue to avoid participation in yet another savings program.
Whether the PRPP mitigates the governments’ underlying concern that certain Canadians may not be saving enough for retirement is questionable – the devil will be in the details. The PRPP is an interesting proposal however hasty implementation may result in high administration costs and unintended consequences.