‘But You Promised!!’
By: Chris Cartwright
Whether it is a Defined Benefit Pension plan or a Defined Contribution plan, sponsors must make sure that they and the members are on the same page when it comes to the pension promise, says Chris Cartwright, of Standard Life.
Every parent knows the intensity of a child’s disappointment when they think the parent has failed to live up to a promise. It may have been a simple misunderstanding. It may have been a change of plans for the child’s own benefit. It may have been unexpected circumstances beyond anyone’s control. Whatever the reasons, the child’s indignation is strong, immediate, and clear ... “You promised!!!” ... and the unmistakable implication is the demand that you must keep your promise.
Employees are not children and plan sponsors are not parents, but that deep sense of entitlement is not entirely foreign to the world of employee benefits. Managing a group retirement plan is all about doing what it takes to keep a longterm promise to your employees. But does everyone know what promises have been made? Or, put another way, does everyone agree on the promises that have been made? Would plan members give the same answer as the human resources department?
Keeping A Promise
It seems rather obvious that keeping a promise depends on avoiding misunderstandings, so that everyone knows exactly what the promise is. Although the promise varies between a Defined Benefit pension plan and a Defined Contribution arrangement, the pension promise should be relatively clear and simple.
In a DB plan, it’s a written formula that spells out exactly what will be paid when specified conditions are met. However, there may be significant assumptions that are not spelled out so clearly. For example, is the sponsor of a DB plan promising to:
- ensure the plan is 100 per cent fully funded at all times?
- never withdraw surplus or take a contribution holiday?
- continue to offer the plan indefinitely?
- never amend the plan or convert it to a Defined Contribution formula?
- only improve the benefits, never reduce them?
- index the plan to keep up with CRA’s maximum benefit limits?
- pay all expenses?
- never merge the plan with another?
- stay in business forever?
Recent experience suggests that sponsors are not implying such promises at all and assumptions to the contrary may not be entirely well-founded.
On the DC or CAP side, the promise seems, at least on the surface, to be even simpler. The sponsor promises to put make a defined contribution to an investment vehicle for the employee’s future benefit. It appears 100 per cent straightforward.
In fact, the keeping of this basic promise is so ‘under the radar’ that the CAP Guidelines do not even mention the possibility of a sponsor not keeping the promise to ensure that the required employee and employer contributions make it safely into the plan’s investment vehicle.
Such silence over the fundamental promise leaves room for other implicit promises to creep in.
Again, we must ask, is the sponsor promising:
- a particular retirement lifestyle or income replacement ratio?
- a particular amount of accumulated assets at retirement?
- to make up for inadequate government pensions?
- a minimum rate of return on invested contributions?
- the ‘best’ funds?
- favourable investment markets?
- education, advice, or other help to manage the member’s assets?
- to continue to offer the plan indefinitely?
- to never amend the plan?
- to only improve the benefits, never reduce them?
- to increase plan contributions to keep up with CRA’s maximum contribution limits?
- to pay all expenses?
- to never merge the plan with another?
- to stay in business forever?
Even with a fairly straightforward promise, there is room for unspoken assumptions to take root and grow into powerful expectations. Where does this come from? Plan booklets, employee seminars, past experience, other people’s retirement plans, and even consumer advertising can influence how employees perceive the promise and what they expect from their plan. For example, if the employees were previously eligible for a DB plan, they may have formed expectations based on the DB promise – or the paternalistic attitude it may have implied – even though the current plan may be a DC design.
In order to practice good governance and manage the operational risks inherent in any benefit promise, it’s a good idea to do a fundamental review and take appropriate action. Confirm what promises have been documented and communicated. Verify what your employees expect you will deliver to them. Confirm what management wants to promise. These may reveal significantly different ‘promises’!
When you’ve found discrepancies between what you think you’ve promised and the promises your employees think you made to them, you’ve begun to identify your exposure to legal liability. It would be a good time to remind everyone affected of what is – and is not – promised under the plan. Some text from a pension plan established many years ago may offer a clue to best practices.
“The establishment and continuation of the Plan shall not be interpreted as conferring any right whatsoever on any Employee as to the continuation of his employment…”
While few plan members today would expect job security as part of the pension promise, the concept of unspoken promises and assumptions is not new. In this example, it was confronted head on to dispel any misunderstandings or unfounded expectations. Similar communications efforts – albeit with a more user-friendly tone – may be appropriate in today’s environment.
The missing ingredient in all of the talk about expectations is the benefit that your plan is actually going to deliver to members. If the actual payout is higher than employee expectations, there is a very small risk of being sued.
On the other hand, when what is delivered fails to meet expectations, there’s a good chance that disappointed employees will look for someone to ‘make good on the promise.’ In such a case, you just might start hearing terms such as ‘class action,’ ‘negligent misrepresentation,’ and ‘contingency fees.’
Before you find yourself in that predicament, take the time to review the purpose of your plan, the promises which you have made – and the promises that have been implied. You’ll be glad you did. I promise!
Chris Cartwright is manager, market strategy, group savings and retirement, at Standard Life.
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