Michel St-Germain Montréal Health of Defined Benefits Pension Plan Is a Defined Contribution Pension Plan the answer? Presentation to the Canadian Association of University Business Officers June 19, 2006

Mercer Human Resource Consulting 2 Agenda Are DB pension plans too risky? How many employers are moving away from DB? Why replace a DB by a DC? Are Universities different?

Mercer Human Resource Consulting 3 Most pension plans are significantly underfunded

Mercer Human Resource Consulting 4 Because interest rates have decreased by more than 2% since But are they going up?

Mercer Human Resource Consulting 5 Return on Canadian equities And return on equities have gone up and down

Mercer Human Resource Consulting 6 Total returns on pension funds have not been bad

Mercer Human Resource Consulting 7 But pension liabilities are growing faster than pension assets because of the decrease in interest rate Source: Mercer Pension Health Index

Mercer Human Resource Consulting 8 And pension solvency has lost 40% since But is it going up? Source: Mercer Pension Health Index

Mercer Human Resource Consulting 9 What would make the problem disappear? A 1% increase in interest rate and 20% stock return

Mercer Human Resource Consulting 10 Pension plans are in the news GM to freeze salaried pension plan. Alcoa to close its pension plan to new workers. IBM to freeze pension plan. Dodge calls for reform of pension rules; overhaul needed to ensure system’s viability. When the spinning stops – Actuaries and the pension crunch. The Economist, 28 January 2006

Mercer Human Resource Consulting 11 What can be done to manage pension costs? Reduce investment risk Stop plan improvements Increase employee contributions Convert from DB to DC

Mercer Human Resource Consulting 12 Key difference between DB and DC Who supports the pension risk? DefinedDefined BenefitContribution Employer ContributionsVolatileFixed Employees PensionsFixedVolatile

Mercer Human Resource Consulting 13 In the U.S. – Many large companies have recently frozen their DB plans and have implemented less generous DC plans International Business Machines Corp. Verizon Communications Inc. Circuit City Stores Inc. Sears Holdings Corp. Motorola Inc. Lockheed Martin Corp. Hewlett-Packard Co. NCR Corp. Rockwell Collins General Motors Alcoa

Mercer Human Resource Consulting 14 Canada is moving slower than the U.S. and UK toward DC. But for how long?

Mercer Human Resource Consulting 15 Currently, about 70% of retirement programs of publicly traded companies of Canada have a DC component Retirement programs Publicly-traded companies in Canada 0% 5% 10% 15% 20% 25% 30% 35% DBDB+DCDB closedDB closed/DC new DCGreater of DB and DC

Mercer Human Resource Consulting 16 Retirement programs Publicly-traded companies in Canada 0% 5% 10% 15% 20% 25% 30% 35% DBDB+DCDB closedDB closed/DC new DCGreater of DB and DC Mercer consultants expect that most of DB plans will move toward to DC

Mercer Human Resource Consulting 17 Why are employers moving away from DB? Too costly – Decrease in interest rates Too risky – Volatility of stock market returns Not in interest of shareholders – Concentrate on business issues Unfair funding rules – Employer pays deficits and shares surplus Uncertain court decisions – Monsanto/Transamerica Too complicated – Cumbersome legislation Do not meet employees’ needs – Not flexible and not transferable Outdated HR model Too generous – Early retirement incentives with expected shortage of labor – For some, more disposable income after retirement

Mercer Human Resource Consulting 18 But DB can add value HR issues – Guarantee of retirement income for baby boomers – Some employees are not able to manage retirement capital – Allocate more compensation to career employees – Retention tool until early retirement – Compete with public sector – Need for selective early retirement subsidies Financial issues – More pension per $ of contribution – Lower investment fees – Higher investment returns

Mercer Human Resource Consulting 19 Moving from DB to DC has many challenges It is difficult to dismount a DB Law prevents reduction in accrued benefits Conversion of accrued DB into DC must be optional and is complex Need to protect baby boomers Short term increase in cost if current employees can continue in DB What should the DC cost? – Equivalent benefits – Equivalent cost Significant implementation issues – Administration of choices – Payroll adjustment

Mercer Human Resource Consulting 20 There will be winners and losers in moving from DB to DC WinnersLosers - Terminated employees- Early retirement - Younger employees- Career employees - If good returns- If low returns

Mercer Human Resource Consulting 21 Maintaining a DC is not easy Employees need support and education – How much to contribute? – Where to invest? – What to do at retirement? and would like to get advice not education Some employees will not be able to manage capital The employer will be blamed for poor performance Risk of litigation – and more fiduciary responsibility The employer will be in the banking business – every cent must be reconciled

Mercer Human Resource Consulting 22 Reduce cost Reduce risk Better meet employees’ needs Introduce flexibility Simplify administration Eliminate early retirement subsidies Follow the crowd But, in Canada, expect that private sector employers will continue to replace DB by DC for non-unionized employees

Mercer Human Resource Consulting 23 Universities may find DB more attractive than private sector employers Cost can be shared with employees and retirees by adjusting contributions and indexing. Funding rules may not require solvency valuations resulting in volatile contributions. Single pension plan for all employees may be desirable; unions strongly object to DC. A generous DB plan may be needed to compete with other public sector employers. Early retirement incentives may be replaced by flexible working arrangements, such as phased retirement. A total compensation package with more pension and less salary may be more attractive