The Rise Of The Pension Consultant
By: Randy Dutka
Like most actuarial students who started their pension careers in the late 1960s, my first job was with a life insurance company.
In 1968, there were a few pension consulting firms, but none did much recruiting on campus. Instead, they relied on the insurance companies to train their future consultants.
The pension world was very simple compared to todayʼs world. Ontario had implemented Canadaʼs first pension standards act in 1965 and tax rules for pension plans were almost nonexistent.
Thatʼs not to say we didnʼt have our challenges.
The biggest one was managing data. This was a time before high speed computers – before even low speed computers. Data was collected manually and the actuaryʼs challenge – that is to say, the actuarial studentʼs challenge – was to convert it into a manageable format that allowed us to perform manual calculations that produced acceptable results.
The actuarial factors were also generated by hand – on electro-mechanical machines. This was also the time before electronic calculators. If the actuary wanted to later change any assumption, it might mean two or three days of additional work to produce new factors and another couple of days to apply them to the data – on real paper spreadsheets with pencils and erasers.
Large Amounts Of Data
Of course, the first major change in actuarial consulting was the introduction of accessible mainframe computers and the ability to manage large amounts of data that allowed us to perform complex calculations much more quickly.
By the time I joined a consulting firm in 1974, the use of computers through timesharing services was pretty common. Typically, data from a large client was delivered on big reels of magnetic tape and delivered to the service provider. The actuarial consultant wrote the program in FORTRAN or some similar mainframe computer language, accessing the computer by remote access – through a teletype-like machine that only allowed you to enter or edit lines of code one at a time. Then youʼd have to wait as the program sat in a queue along with the jobs submitted by other users until it was finally executed – sometimes the next day.
By this time, however, the pension world was starting to get a little more complicated. The tax authorities had issued Information Circular 72-13, so we had more tax rules to contend with. In addition, other provinces were beginning to introduce their own minimum standards legislation. However, it was still possible to practice and keep upto- date on all of the legislation.
It was very typical that an actuarial consultant would deal with all aspects of pension plan management. Although we always told our clients to have the documents reviewed by external legal counsel, it was still pretty rare to find a lawyer with any real pension experience. This was, after all, ʻBefore Conrad Blackʼ (B.C.).
The period After Dominion (A.D.) was quite different. The legal implications of pension plan management become excruciatingly clear following the Conrad Black/ Dominion Stores surplus removal case in 1986. No one had ever questioned the sponsor ʼs right to actuarial surplus. After all, the sponsor had to make up any shortfalls, so, of course, they should expect to receive the benefit of actuarial surpluses.
In the B.C. period, actuaries tended to be very conservative – especially by todayʼs standards. And why not? If too much money was contributed to the plan, you could always use it later to take a contribution holiday or improve benefits or, what is unimaginable today but relatively common then, to simply remove it from the plan and put it back into the companyʼs assets. The Dominion Storesʼ decision began the era of significant legal actions against plan sponsors with most litigation focusing on the use of actuarial surplus. It became clear that pension plan legal issues were becoming of major importance, so legal practices grew within actuarial consulting firms and pension practices in private legal firms.
There were plenty of other things happening on other fronts in the 1980s.
The volatility of the stock markets was important, but did not cause the same problems as it has in recent years. For most plan sponsors, the pension expense was considered to be simply the plan sponsorʼs contribution to the plan. Todayʼs complex accounting valuation rules, which can create huge balance sheet swings, were not yet in place.
In addition, cash flows were generally very positive and investments continued to be made in the bond market as interest rates continued to rise until they peaked in 1981. Finally, donʼt forget that most pension plans were conservatively funded. Valuation rates of interest crept upwards as interest rates increased but rarely exceeded eight per cent – mainly because of the regulators.
The pre-1991 system was inherently unfair. The amount of money that could be tax-sheltered on a personʼs behalf depended upon whether they belonged to a Registered Pension Plan (RPP) or Deferred Profit Sharing Plan, and whether the employee was required to contribute to the RPP. Starting in the mid-1980s, the federal Department of Finance started to float ideas on how the system could be made fairer. Although well-intentioned, the early proposals were largely unworkable but analyzing them kept pension consultants busy.
Early Tax Proposals
These early tax proposals marked the start of the consulting professionʼs boom time, which continued on for the next 10 to 15 years as the final tax changes were implemented, and then were quickly followed by additional tweaking and implementation delays.
Plan sponsors first needed to understand the potential impact of the tax proposals. Then the lobbying started. The actuarial profession, industry associations, labour organizations, and others gave their input to the Finance Department – and they listened – pretty much. During this time, the demand for pension consultants began to rise dramatically. It was difficult to find actuaries and pension consultants with enough experience to do the work. A number of senior pension actuaries chose this time to retire rather then have to learn a new system.
The arrival of the tax rules also happened to coincide with the introduction of minimum standards pension reform in many pension jurisdictions.
And donʼt forget the accountants – or the changing world of investments – and not to be outdone, the actuaries themselves began reviewing and updating their own professional standards.
Era Of Specialization
And so the era of specialization began. Gone was the time when one consultant could do all of the work required for a client. The pension consulting firms were now looking for all kinds of specialists – communications, accounting, technical and computer, administration, tax, research and librarian, international pensions, executive pensions, investment, and legal. Most work was done within traditional actuarial consulting firms, or in pension departments within law firms, but several of the accounting firms provided pension consulting services as well – until the problems with conflict of interest with audit clients forced them to trim back and focus their service lines.
Not surprisingly, all of these changes placed a great deal of stress on the Defined Benefit plan sponsor.
Much of the early reactions were with respect to the amount of administration involved in implementing the new tax rules – PAs, PARs, and PSPAs and the new registration rules. Increased amounts of calculations and reporting seemed overwhelming and many DB plan sponsors began to wonder whether DB was still the way to go.
Some reacted by looking for third parties to do the work. So began the rapid growth of third-party administration. Many of the actuarial firms invested significantly in administration systems believing that the actuarial work would likely go to the company providing the administrative services. And, to some extent that was, and is still, true. However, many larger clients adapted to the increased requirements by developing their own systems or buying them. And the pension consulting firms helped them by defining system requirements and providing actuarial factors – and keeping them up to date.
The accounting changes made life even more complicated. It was hard enough producing just funding valuations, but now accounting ones … and using the clientʼs best estimates.
Educating clients became a far more important job. In many cases, the auditors had to be educated too, as they often did not have enough experience with pension plans. Plan sponsors now had to balance cash requirements (funding) and expense implications (accounting). Chief financial officers took a greater interest in pension plans than ever before.
But if two valuations werenʼt enough, enter solvency valuations. When they were introduced in the minimum standards reforms starting in the late 1980s, they seemed pretty benign. Final average plans rarely had a problem with solvency requirements. But neither did flat benefit or career average plans. It was sufficient for most plans to do a quick back of the envelope estimate of the solvency position to be able to confidently state that there was no solvency deficiency – that is, until interest rates started to drop in the late 1990s. Then the Canadian Institute of Actuaries changed its commuted value basis to reflect improving mortality.
Around this time, the ʻtech bubbleʼ burst. DB plans were all of a sudden in deep financial trouble and the consulting community had its hands full once again. Many plans required annual valuations. Even when they werenʼt legally required, plan sponsors were keen to get estimates of the current financial status of their plans.
The sheer volume and complexity of work required to effectively manage a pension plan has had the unfortunate effect of increasing the overall cost of managing these plans. However, itʼs important to recognize two other factors that have contributed to increased hourly rates for consultants – practice protection and research.
Plan sponsors arenʼt the only ones in jeopardy of law suits. All professional firms have had to respond to an increasingly litigious environment. The accounting firms were the first to recognize the risks and one major firm has disappeared over (nonactuarial) legal problems. While Canada has not yet seen any large, public claims against any pension consulting firms, they are not immune.
Of necessity, a significant effort has been expended by the consulting firms themselves over the issue of risk management. Much of it starts with professional practice. Every major firm has developed procedures to minimize the opportunity for error and procedures have been put in place for dealing with errors if they do occur. Training also plays a key role in attracting employees and keeping them updated regarding new developments – not only in the pension world, but with respect to the firmʼs practice requirements.
With new and increasing challenges faced by plan sponsors comes increasing expectations on their consultants. They must be able to deliver a more comprehensive product, in a complex and changing environment, quickly, and at a reasonable cost. Tools must be developed which will help plan sponsors understand the implications of their decisions and help them make those decisions.
Time (and time is money in a consultant ʼs world) must be devoted not only in keeping up to date with technical changes, but in anticipating what plan sponsors are thinking (or should be thinking) and in developing tools to assist them in managing their plans. Every major firm has a significant resource centre (library) and sophisticated mechanisms to get that information to their consultants.
Finally, the service expectations have also increased dramatically.
In the early years, it took a huge amount of manual labour (and time) to produce a valuation report and mail service was slow; but thatʼs how we communicated with our clients and they with us. Then came faxes, which were very expensive initially, but which moved documents around far more quickly than mail and courier services. Remember all those yellow ʻMessageʼ notes? Voice messaging was still to come.
Now with electronic mail, cell phones, and general internet accessibility, service standards are extremely high and fast turnaround is an expectation as is quick access to the consultant.
Like most businesses, the pension consulting industry has undergone an enormous change over the past 40 years and thereʼs no indication that the rate of change will slow down. The challenge of an everchanging workforce will require employers to continually create and manage innovative and complex retirement solutions – and pension consultants will continue to be there to help them.
Randy Dutka has worked in pensions for more than 35 years and is a senior consulting actuary with Watson Wyatt Worldwide
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