Watson Wyatt Special Memoranda - English

In recent years, the Canadian pension landscape has seen a shift away from defined benefit (DB) plans in favour of defined contribution (DC) plans. There are numerous reasons for this shift, ranging from the lower financial burden DC plans place on plan sponsors, to lower administrative costs compared with DB plans. 

DC plans are not without their risks, which include the challenge of providing adequate member education, overcoming member apathy about their pension investments and, perhaps most importantly, concerns about the lack of adequate retirement income these plans are likely to provide. Pension plan sponsors in the United States, the United Kingdom and Canada are looking to different types of automatic features in DC plans in an attempt to resolve some of these concerns. 

Concerns about DC Plans

Many DC plan members are experiencing low investment returns, which will leave them with insufficient savings to retire. This problem can be compounded where high investment and administration fees are being charged to participants’ accounts. While high fees have led to a growing number of breach of fiduciary duty lawsuits in the United States, it remains to be seen whether similar lawsuits will be launched in Canada. In addition to low returns and in some cases high fees, the lack of adequate retirement savings in DC plans is also due to low contribution rates, especially in plans where matching employer contributions are based on the level of contributions elected by the plan member. 

DC plan sponsors are concerned about the risk of their plans providing insufficient retirement income. Watson Wyatt’s fifth annual Pension Risk Survey, conducted with The Conference Board of Canada, asked Canadian Chief Financial Officers and senior human resource executives a number of questions about the issues and concerns they face regarding their DC plans. Fifty-eight percent of respondents indicated that the inability of DC plans to provide members with sufficient retirement savings, due to poor investment returns, was the greatest threat to the sustainability of such plans. In addition, possible employer liability for poor DC plan investment performance was cited as a major concern by 54% of respondents.

The reason for respondents' concerns may be based on the design of their DC plans. Fifty-eight percent of the 171 Pension Risk Survey respondents had some form of DC arrangement. The average employer contribution rate for the majority of these DC plans was less than 6%. In addition, almost 80% of the plans that do not allow optional member contributions have no target income replacement ratio and only 4% indicate that their projected DC pensions would be able to cover more than half of the members’ pre-retirement income. The situation is slightly better for those who expect their DC plan members to make optional contributions that generate the maximum employer contributions. But still, only 15% predict a replacement ratio of more than 50%.

Despite their concerns, plan sponsors are hampered by members’ apparent lack of interest in their own pension arrangements. In the 2008 Survey on Pension Risk, 45% of respondents indicated that lack of members’ interest in their pension arrangements was a major threat to the sustainability of DC plans. Auto-enrollment has been used in other countries to help compensate for lack of member interest and can form part of a DC plan design strategy to boost retirement income.

Why Auto-Enrollment?

Automatic enrollment (not to be confused with online enrollment) is of growing interest to Canadian DC plan sponsors. This term refers to the practice of enrolling all eligible employees in a plan and beginning participant deductions/contributions without requiring the employees to submit a request or enrollment form. However, while available in the U.S. and the U.K., there may be legislative obstacles to implementing auto-enrollment for Canadian DC plans.

Traditionally, employer-sponsored retirement savings vehicles have involved employers providing newly hired employees with a DC plan enrollment package that included various forms and investment options. For most Canadian pension plans, participation is mandatory. In the DC arena, this means that employees are required to “opt-in” to the DC plan by completing all required paperwork and making investment decisions. This contrasts with the United States, where membership in 401(k) plans is largely voluntary.

Unlike “opt-in” enrollment, auto-enrollment involves all newly hired employees and even longer term employees not yet in the plan sponsor's voluntary DC plan being automatically enrolled in the plan and automatically invested in a default investment fund. Instead of “opting-in” to the program, these automatically enrolled employees can choose to “opt-out” of the program if they do not wish to participate. While subtle, the change to auto-enrollment can be very helpful in increasing plan participation and compensating for some of the consequences of the lack of member interest in their DC plans.

While it may not increase the level of plan member engagement in their DC plan by itself, the concept has expanded rapidly in both the U.S. and in the U.K. Studies from the U.S. reveal that participation rates have increased dramatically after automatic enrollment is introduced, particularly for low wage earners and women.

The U.S. Experience

The Internal Revenue Service (IRS) introduced regulations for automatic contribution arrangements in late 2007, which eliminated many of the previous legal and legislative barriers to auto-enrollment. These regulations impose restrictions on opt-out measures and the types of qualified investments permitted for what it terms qualified automatic contributions arrangements (QACAs). Essentially, a plan may be considered a QACA if it provides a specified schedule of automatic contributions beginning with a minimum three percent of compensation.

A 2006 Watson Wyatt survey of U.S. plan sponsors revealed that one-third of respondents had implemented auto-enrollment for either all employees or for new hires. Reasons stated for not implementing auto-enrollment included high employee turnover, legal liability around default investments and the high cost of an employer match. Firms with larger DC plan accounts were more likely to have auto-enrollment, compared to firms with smaller account balances. No difference was detected with firms having a lower or higher number of employees.

The U.K. Experience

Like the U.S., the U.K. currently permits auto-enrollment and is taking steps to enshrine it as a basic legislative requirement. In December 2007, the government introduced the Pensions Bill, which would require auto-enrollment in all DC plans. The legislation is currently being considered by Parliament and would require all new employees to be automatically enrolled into a qualifying workplace pension scheme. If the employer does not have a pension plan of its own, workers would be enrolled into a “personal account”, a pension saving vehicle aimed at moderate to low income earners and administered by the government. Opt-out rights will exist for employees who wish to exit the plan. Some employers will be exempt from this requirement, including employers who offer a DB or DC plan of their own that meets minimum requirements.

Auto-Enrollment: Coming to Canada?

Canada’s experience with automatic enrollment has been different from that in the U.S. and the U.K. Unlike the U.S., Canada’s pension and employment landscape is provincially-regulated, resulting in different legislative and regulatory rules for each province. The matter is further complicated by provincial employment standards legislation which, in most provinces, prohibits any deductions from an employee’s pay without some form of written consent. Automatic deductions for pension contributions without the employee’s written authorization may or may not be permitted, depending on the statutory language of the province in question.

Some employers have found that they can attain partial auto-enrollment by obtaining consent for pension plan participation and deductions in their contract of employment. However, this only enrolls new hires into the DC plan and does not assist in enrolling longer term employees who did not avail themselves of the plan at the time they were hired. Legislative changes are necessary to most provincial employment statutes in order for Canada to fully implement automatic enrollment. Whether governments make these changes will likely depend on whether DC plan sponsors and other stakeholders press for them.

Please contact Lori Satov, Martine Sohier, Lydia Maldonado or your Watson Wyatt consultant for additional information.