After 16 years in the mail room of one of Canada's pulp-and-paper giants, Angelo Strumos is, like most people with a mortgage and two young chil dren, still struggling to pay his bills. But Stru mos, a 35-year-old shipping and purchasing su pervisor, has always hoped that one day he would enjoy the traditional reward for company loyalty-a secure retirement. Until recently, he rarely gave much thought to his pension; his employer shouldered the responsibili ty for his benefits and promised a comfortable monthly cheque after he retired. But on Jan. 1, 1996, Strumos and 500 other employees at Abitibi-Price Inc. in Toronto (now part of Abitibi-Consôlidated Inc.) joined a growing trend in the retirement planning business. They took charge of their own pensions, and their futures, by signing up for a so-called defined-contribution pension plan that invests in a mix of stocks, bonds and other securities. -~--___1_____ 1_~__1 _____~__1__~____t_~~_ __~~_~__1_ ._~__
For Strumos, who had never bought a stock or a bond before in his life, it means watching over a personal retirement fund now worth more than $30,000. He’s off to a good start. The quarterly reports he receives from the fund’s trustee show that its value has increased by $6,000, or more than 20 per cent, in the past 18 months, thanks mainly to a buoyant stock market. But along with his new responsibilities comes an unsettling question for Strumos, the father of a four-year-old boy and six-year-old girl. “If the market crashes,” he asks, “do I lose my pension?”
Well, maybe. Under the terms of his new pension plan, Strumos and his employer both contribute to the fund, but he alone is responsible for the fund’s performance. In future, he will reap the rewards or suffer the consequences of the investment decisions he has made. It is a far cry from Abitibi’s old defined-benefit plan, which guaranteed members a monthly retirement benefit based on their salaries and years of service. That traditional plan reflected a bygone corporate culture that rewarded company loyalty and long-term service. “The old defined-benefit plans were telling employees, ‘Don’t worry, we’ll look after you. Stay with us and we’ll give you a pension at 65,’ ” says Howard Lyons, a principal at William M. Mercer Ltd., Canada’s largest pension consulting firm. “Now the message is: you’re responsible for yourself.” Currently, so-called definedcontribution pensions cover only a minority of the labor force. In 1996, an estimated 540,000 Canadians—10.5 per cent of those who were covered by employer pensions—belonged to definedcontribution plans, compared with 325,320, or seven per cent, a decade earlier. An overwhelming 88 per cent of Canadians in company pensions enjoy the security of traditional definedbenefit plans—still the pensions of choice for unionized workforces in the public sector and Canada’s biggest companies. (Those Statistics Canada figures do not count employees who have no company pension plan—more than half of the country’s paid workers.)
But while the pace of change is gradual, industry experts see defined-contribution plans as the wave of the future. Already, they represent the fastestgrowing portion of the $500-billion company pension market. A1996 survey of more than 100 mid-size and large companies by the Financial Executives Institute Canada showed that 15 per cent had introduced defined-contribution plans in the previous five years, while another 20 per cent were thinking about it. Molson Breweries, Hewlett-Packard (Canada) Ltd. and MacMillan Bloedel Ltd. are among those that have introduced them, while giving existing employees the option of staying with the old plan. Companies that are setting up pension plans for the first time invariably shun defined-benefit schemes for the newer defined-contribution plans or group RRSPs, which are similar but not subject to pension standards regulation. “All the new plans are defined-contribution,” says Robert Brown, a professor of actuarial science at Ontario’s University of Waterloo. New York “We haven’t had a new defined-
benefit plan in a long, long time.” trading floor: A variety of factors are driving
the trend. One of the most important is a desire on the part of em-
What will be your biggest source of retirement income?
RRSP savings 49% Company pension 20 Savings outside RRSP 11 Sale of home 7 Canada Pension Plan 5 Inheritance 2 Land/business/ properties 2 Other 3
ployers to reduce their exposure if the current booming stock market goes bust. Under a definedbenefit plan, companies are legally obliged to pay benefits to retirees regardless of how well or how poorly their pension plans perform. In the early 1990s, hundreds of large companies—including Lord, Chrysler and General Motors—were facing huge shortfalls in their retirement funds, which forced them to increase cash contributions over the following five to 15 years. Happily, the dramatic increases in stock prices since then—over the past five years, the Toronto
Stock Exchange 300 Index has risen 92 per cent— has transformed most of those deficits into comfortable surpluses. Although the ownership of those surpluses remains unclear, many pension managers have used the extra money to give companies or their employees a temporary break from contributions.
Still, the fear of a stock market collapse remains palpable, and many corporations are moving towards defined-contribution plans to remove any whiff of uncertainty from their pension systems. As Brown puts it, the new approach allows employers to “hand just about all the risk over to the individual worker.”
Despite the pitfalls, the trend towards defined-contribution plans is undeniably beneficial for some workers—particularly those who expect to change jobs several times in their working lives. Traditional pension plans rewarded loyal, lifelong employees but penalized mid-career job switchers because certain valuable benefits, such as early-retirement and cost of living provisions, only kicked in at age 55. Indeed, employees who take early retirement often fail to realize that those limitations can reduce the value of their pension funds by tens of thousands of dollars. “It means you leave a whole bunch of money on the table you never knew you had,” says Malcolm Hamilton, a pension specialist at William M. Mercer.
One example is a 36-year-old clerk who lost her job at Abitibi-Price in 1995, when her salary was $33,000. After belonging to the company pension plan for nearly 15 years, she had built up a retirement fund worth only $22,331, of which $17,449 consisted of her own contributions. Had she stayed until age 46, she would have left the company with about $38,000. But at age 55, her payout would have jumped to $133,538. While the defined-benefit system rewards loyalty, it is “dead wrong” for people who retire involuntarily, Hamilton says. It means “you’re out on the street with half your retirement savings gone.” He adds that the typical definedbenefit plan replaces 60 per cent of earnings for a lifelong employee, while a person whose career is divided among three companies can expect only about 30 per cent.
That difference recently hit home for workers at Abitibi-Price in Toronto. In May, the company merged with rival StoneConsolidated Corp. to form Abitibi-Consolidated Inc., with its headquarters in Montreal. Many of the employees at the former Toronto head office are giving up their jobs over the coming year because they do not want to uproot their families. Dave Eldridge, Abitibi’s 54-year-old director of personnel services, calculated he would have lost $70,000 had he stayed in the old defined-benefit plan and been forced to cash out a few years short of the age-55 threshold. “I’ve never regretted making the decision to switch,” he says.
In a sense, opting for a defined-contribution plan can mean trading an employment risk for an investment risk. ‘Tie risk is the day before you retire, the market crashes,” says Lyons. That prospect is one reason unions prefer the old-fashioned definedbenefit plans, says Mike Mazzuca, a lawyer whose firm represented former employees of T. Eaton Co. Ltd. in a recent dispute over pensions. “Defined-benefit plans are a much more secure form of retirement”
Mazzuca says. “The risk is with the employer, who has a better ability to absorb it”
Another frequently cited problem with defined-contribution plans is that the responsibility for investment decisions rests with individual employees, who may or may not have the necessary knowledge and experience. Typically, employees who sign up for such a plan are asked to choose from four or more investment options of varying risk and return—from low-interest-bearing GICs to higher risk but potentially more profitable stock funds with a large proportion of assets invested offshore. The risk, however, is that an employee who misunderstands the markets could make disastrous mistakes with his or her retirement savings. Just how little most people know about the fundamentals of investing was clear from the results of a survey conducted last year by Marketing Solutions, a Toronto-based financial services consulting firm. Of 1,000 investment decision-makers in households with at least $10,000 in savings, only 36 per cent knew the answer to the question: “What happens to the value of a bond fund if interest rates go up?” (It falls.)
Yet, faced with the daunting responsibility of investing their pension savings, many Canadians are actually too cautious. They invest in low-risk, low-return treasury bills and guaranteed investment certificates, which, over the long term, are unlikely to provide enough money for a comfortable retirement, says independent labor relations consultant John O’Grady. Simon Segall, vice-president of Trimark Investment Management Inc., knows of one company where three-quarters of the employees had invested their retirement savings in low-interest GICs. After they were told that such investments might not help them build an adequate nest egg,
only one to two per cent decided to keep their money in GICs, says Segall, whose company runs defined-contribution plans for more than 100 Canadian firms.
Educating employees has become a key point in the emerging defined-contribution pension business, although not all compa nies do it. At Abitibi-Price, management knew that many employees knew nothing about financial markets, so the company's pension experts, along with consultants from Mercer and Toronto-based invest ment management firm Integra Capital, tried to teach plan members the basics of balancing risk and return. Employees were given detailed financial statements com paring the performances of the defined-ben efit plan and the proposed defined-contribu tion plan under different scenarios. Training seminars, videos and one-on-one coun selling helped individuals choose the option that was best for their needs. Like most of Tn s about switching tegra's customers, Sirumos chose a diver sified fund that balances higherand lowerrisk investments. "Stocks and bonds are not my thing," he said. "I just wanted to play it safe."
Workers worry that the day they retire, the market will drop
n The increasing demand for employee education is rapidly trans s forming the pension business, says Dan Richards, president of Mar e keting Solutions. In the past, investment counsellors dealt with a handful of senior executives at their clients' firms to discuss the per 1formance of the company pension fund-while individual employ y ees were left in the dark. But when employees are the clients, it is
critical for pension providers to commu vorrv that nicate openly and effectively. As a result, A A J it is now standard practice to offer semih e' re ` nars, videos, one-on-one advice, a toll-free ,. telephone support system and an Internet home page. The questions from clients t %vill drop are often disarmingly simple: What is a stock? Is it possible to borrow from the fund? (No.) Are the returns from equity funds guaranteed? (No.) "The whole idea is to get people comfortable about looking at the long term," says Janice Hawes, an account manager at the Mutual Group, one of the country's leading provider of defined-contribution plans. Lately, she has been advising clients to scale down their ex pectations of growth at this point in the cycle and ignore the dayto-day gyrations of the market. "Our goal is to teach employees about time in the market instead of timing the market," she says. Most pension experts agree that the defined-contribution busi ness can only grow in the future. If current trends continue, Hamilton predicts that only the public service and big corpora tions with strong unions will keep traditional defined-benefit plans. Everywhere else, company pension plans will ensure that employees shoulder the risk and enjoy the rewards of investing for their own retirements.
There is, however, one thing that could interrupt this trend, says Hamilton: a stock market slump. "Investment risk is significant. The day will come when a new generation learns that," he adds. Nevertheless, Hamilton favors defined-contribution plans, in large part because they allow employees to control the level of risk and potentially earn higher returns. For Strumos, at least, it was a good choice. He is among more than 100 employees who will be leaving Abitibi-Consolidated over the next few months rather than move to Montreal. He will likely leave the company with several thousand dollars more in his pen sion fund than he would have had under the old plan. Yet Sirumos is typically cautious: "I could come out a liffle more ahead-as long as the stock market doesn't crash." n
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