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Making Sense Of The Joint Forum’s CAP Guidelines

By: Christopher Cartwright

It was the best of times. It was the worst of times.” Assessing how the Joint Forum’s proposed guidelines will affect the Canadian group retirement industry calls to mind Charles Dickens’ classic opening lines to A Tale of Two Cities. Are we seeing a constructive effort that will bring clarity and harmony or is this the ‘perfect storm’ that will provoke sponsors to abandon their plans in favour of the no-hassles simplicity of cash remuneration?

There is much to support both views and each of us will draw his or her own conclusions. Your perspective might be influenced positively or negatively by your past experiences.

‘I’ve Seen This Movie Before…’

For example, long-time players have not forgotten the last upheaval known as ‘Pension Reform’ when the industry faced change on three fronts:

Law-makers focused their attention on improving the pension system by correcting identified weaknesses such as low coverage, insufficient inflation protection, portability, termination benefits, and survivor benefits. The approach taken at that time was to introduce more regulation across the many jurisdictions that comprise Canada’s patchwork quilt of pension plan rules.

At the same time, Ottawa revised the Income Tax Act to change the tax treatment of Registered Pension Plans, Deferred Profit-Sharing Plans, and RRSPs. By introducing the ‘rule of nine,’ the tax authorities created a simple equivalence between defined pension benefits and retirement contributions.

One bright spot during those times was the relatively robust capital markets which helped pension funds generate actuarial surpluses. Of course, pools of ‘surplus’ capital always attract attention and disputes over exactly who owned the surplus money were resolved in the courts. Before the judges ruled, sponsors had assumed that any surplus belonged to the same party that ‘owned’ any funding deficit in a Defined Benefit plan.

The results of the well-intentioned effort to reform the pension and tax system were profound. By increasing the regulatory burden and removing the fiscal advantages of complex Defined Benefit pension plans over the comparatively streamlined Defined Contribution pension plans, DPSPs, and Group RRSPs, the policy-makers eliminated the incentives sponsors had to maintain their DB plans.

The final straw was the new definition of fairness in the distribution of surplus. Many sponsors interpreted the outcome as a message that they were the sole owners of any deficit, but had to fight for any surplus the plan might generate. Sort of a ‘heads you win, tails I lose’ proposition.

With added complexity and reduced incentives, DB plan growth stopped and began to reverse itself. Between 1980 and the year 2000, Statistics Canada reported 6.7 per cent growth in the total number of Registered Pension Plans. However, this represented a drop of 12 per cent in Defined Benefit plans while Defined Contribution plans grew 32 per cent. Over the same period, the number of RRSP contributors (both group and retail) more than tripled while total pension plan membership rose less than 20 per cent. (See A Look Back in Numbers …)

Fast-forward to 2001 and the spectre of new regulatory intervention provoked a replay of the nightmares from years gone by. As one player contemplating the Joint Forum’s initiative was heard to say, “I’ve seen this movie before. I don’t want to see it again!”

What’s The Big Deal?

The alternative view arises from those who have experienced first hand the growth of the CAP market, despite the lack of clear and uniform rules to follow. At the end of 2000, approximately 30,000 of the Capital Accumulation Plans (CAPs) in Canada were administered by life insurers. Over the years, through intense and ongoing competition, leading service providers have continually set – and then raised – the standards for CAPs in Canada.

The proposals from the Joint Forum are simply a reflection of the standards set by the industry leaders.

In particular, insurers have achieved a level and quality of communication and education for CAP members that is enough to make any regulator smile. All of this has been accomplished in the absence of any laws, regulations, ‘national instruments,’ or guidelines which would compel sponsors to invest heavily in education and communication services.

In fact, what was done was done simply because it makes sense to do so in benefit programs where success is measured in terms of employee appreciation. The alignment of interests of the CAP sponsor and member is a powerful force that creates an environment that is quite different from the retail market for financial services. In the retail marketplace, consumers need to be protected from those seeking to profit from the consumer’s investment decisions. This is not so in the group world where plan sponsors play an indispensable role – as the proposed guidelines make oh so clear!

From this perspective, the Joint Forum’s recommendations seem to be merely an endorsement of what the leading providers are already doing and an indication of what is needed to be done to meet the ‘regulators’ expectations.’

As someone who has survived pension reform and has been on the inside of the competition to raise standards in CAPs, I can appreciate both points of view. Much of the draft text of the guidelines reflects pure common sense, but some sections could cause real pain – if interpreted strictly as written and implemented in a legalistic way. At heart, Canadians are a very compliant people and yearn to know that they are doing the best for their plan members and that their CAPs are fully onside. Any official guidance from regulators will be treated seriously.

What Do The Guidelines Say?

Let’s set aside our pre-conceived notions and sample the substance of the proposals and look at some particular provisions which could cause trouble.

Delegating to Service Providers (1.3.2)
The draft text allows the CAP sponsor to delegate responsibilities to service providers and suggests that the service providers would be responsible for following the guidelines and any applicable laws. The impression is that the sponsor is able to shift legal responsibility to a third party. But, should a dispute arise, it is unclear if the courts would endorse the view of the regulators in this regard. Sponsors might be wise to think twice before dismissing the concept of fiduciary responsibility!

Purpose (2.1.1)
Because the guidelines are intended to be broad in scope, each CAP must have a declared purpose in order for the guidelines to be adapted to the plan. It has been suggested that there could be unintended consequences from this innocuous provision. For instance, if the sponsor of a Structured Group RRSP (a pseudo-pension plan with employer contributions and non-statutory locking in) declared the plan’s purpose was “to provide retirement income,” would the plan be deemed to fall under the jurisdiction of the pension authorities?

Hiring Service Providers (2.1.2)
The guidelines suggest a new twist to what has until now been a simple business decision. “The CAP sponsors must prudently select any service providers it engages with regard to the best interests of the CAP members.” Could a low-cost choice be attacked because the sponsor selected a service provider that did not offer members premium service and all the bells and whistles? What is in the best interests of the members? Who decides?

Selecting Investment Option (2.2.1)
“The CAP sponsor must prudently select investment options.” This function can be ‘entirely’ delegated to a service provider. However, the factors that should be considered include a number which are specific to the composition of the CAP’s membership. Such criteria imply that simply grabbing an off-the-shelf package may not be “prudent.” The range of investment options must also be “appropriate” considering the purpose of the CAP. If the sponsor is not already doing so, they may want to consider getting more involved in the selection process to avoid the accusation that their CAP’s investment options reflect convenience more than prudence.

Fund Compliance (2.2.2)
This section states that funds of insurers must comply with the investment provisions of IVIC (the rules written for retail seg funds) while mutual funds must comply with the investment rules of National Instrument 81-102. If the CAP is a pension plan, then the funds (not the plan) must comply with the investment provisions of pension legislation as well.

This section is a rather unhelpful description of the problem that industry faces trying to simultaneously comply with different rules written for different jurisdictions. The same feeling is expressed in the film As Good As It Gets when Jack Nicholson’s character Melvin seeks advice from Greg Kinnear’s character Simon. Not helped by Simon’s advice, Melvin declares, “I’m drowning here – and you’re describing the water!” Section 2.2.2 just describes the water. It is disappointing in light of the Joint Forum’s stated goal of co-ordinating and streamlining the regulatory treatment of CAPs.

Correcting Errors (2.3.1)
“CAP sponsors should promptly correct any identified errors.” What could be wrong with something so straightforward? This provision lacks any sense of materiality. Strict interpretation could see $100 spent to correct a $1 error. Is this “best practices” or the abandonment of common sense?

Member Statements (5.1.3)
Disclosure is not a new principle, but the level of detail prescribed in the proposed guidelines can be daunting. A member with employee, employer, and voluntary contributions deducted from a biweekly payroll who invests in five funds will see 390 lines of transaction detail in his or her annual statement! (3 contribution sources X 26 pay periods X 5 investment options = 390 transactions)

Monitoring Investment Options (6.2.3)
“The CAP sponsor must take appropriate action where the performance of a selected investment option is unsatisfactory.” This is another simple-sounding statement which can create unrealistic expectations and unintended consequences. The drafters have helpfully used words like “appropriate,” “unsatisfactory,” and “performance” … without providing any definitions. We interpret that “appropriate” signals as different sponsors can pursue different actions in their particular circumstances – and both can be on the side of the angels. We can guess at the meaning behind the other terms.

“Unsatisfactory” would probably be seen as “below expectations,” but that simply shifts the question to whose expectations? I would venture to say that it’s the CAP members’ expectations that count most.

“Performance” is almost always immediately interpreted in terms of rate of return. In fact, fund managers are actually hired to look after the assets, managing the level of risk through agreed-upon constraints. Adherence to the stated policy, process, and style, together with stability of the firm and the accuracy and timeliness of reporting are the typical measures that underlay performance. Nonetheless, the common focus will be rates of return, as perceived by CAP members.

As written, this section will support the cry from unhappy members, “I find performance unsatisfactory! What are you doing about it?” Is it “appropriate action” for the sponsor to fire the manager whose rates of return are below expectations? To do so would force members to sell after the deterioration of performance and lock in any losses. This is often referred to as the ‘Buy High/Sell Low’ approach. Anyone can make a small fortune with this technique – if they start with a large fortune!

Given the realities of the capital markets, it is hard to imagine a CAP whose members won’t be disappointed at some time by some investment option’s “unsatisfactory performance.” The Joint Forum has dropped that hot potato in the sponsor’s lap.

General Comments

The tone of the text and the vocabulary used can also be a source of uncertainty. The tone is prescriptive and the terms used are inconsistent. When reviewing the two dozen pages of proposed guidelines, the reader may be struck by the frequent use of words like “must” and “should.” These words reflect the latent desire for the “guidelines” to be enforceable rules that could take the place of existing regulations. In truth, this is probably more a result of legal habits than the express intent of the drafters. Everyone agrees that communication of important information must be clear. In just one section of the proposed guidelines, the reader is told that the CAP sponsor must “clearly communicate,” “explain,” “provide information,” give information,” and “inform.” Furthermore, members must “be informed,” “receive a description,” and “be given sufficient detail …” Although there may be no intention whatsoever to suggest different shades of meaning, the lack of uniformity in the terminology used and the absence of definitions can give rise to varying interpretations. Effective guidelines are clear guidelines. Implementation When the proposed guidelines were released for comment, the Joint Forum had not decided how they would be implemented. It is recognized that the Joint Forum itself does not have the power to turn the guidelines into legislation nor to enforce their application. (That’s one reason the request for a ‘safe harbour’ was rejected and the quest for harmony remains elusive.)

To ask the legislators to amend existing laws or enact new ones, is to ask for a delay which would be measured in terms of years – if not decades! Furthermore, it would defy Canadian history if the result were to reveal unity and consistency. This leaves the option of voluntary compliance. To the extent that the guidelines already reflect widespread practices, enforcement is hardly an issue. The vast majority of CAP sponsors are in compliance today. To the extent that the guidelines might raise standards, market competition will enforce them. The insurers will continue to go beyond the requirements of the law to serve the best interests of their clients. As a last resort, dissatisfied members will always turn to the courts – and adherence to the guidelines may be regarded as a minimum defence for a sponsor.

In the end, the goals which we all support – harmony, clarity, and transparency – will be well-served when the Joint Forum’s process results in standards and practices which foster the growth of CAPs to the benefit of the many Canadian workers who depend on their plans for a better chance at a worry-free retirement.

Time will tell how much progress we’ve made.

Christopher Cartwright is manager, marketing strategy, group savings and retirement, at Standard Life.

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