Fe­lix Pereira

Many com­pa­nies spon­sor de­fined ben­e­fit pen­sion plans for the pur­pose of pro­vid­ing re­tire­ment ben­e­fits to their em­ploy­ees. One fea­ture of this type of plan is that the em­ploy­er as­sumes all of the in­vest­ment risk and un­der­takes what amounts to a guar­an­tee that the em­ploy­ee will re­ceive a cer­tain lev­el of pen­sion ac­cord­ing to a pre­scribed for­mu­la.

This plan has at least five vari­ables. They in­clude the lev­el of con­tri­bu­tions, the length of ser­vice with his em­ploy­er, in­vest­ment re­turns, in­ter­est rates and life ex­pectan­cy.

The lev­el of con­tri­bu­tions is di­rect­ly tied to an em­ploy­ee's earn­ings. Many plans har­monise the em­ploy­ee's rate of con­tri­bu­tions to the ceil­ing of the Na­tion­al In­sur­ance Sys­tem (NIS). This al­lows the em­ploy­ee to pay a low­er con­tri­bu­tion rate for the amount of his earn­ings that falls un­der the NIS ceil­ing and con­tribute a greater per­cent­age to the ex­cess that is above the NIS ceil­ing.

For ex­am­ple, em­ploy­ees may con­tribute four per cent of their earn­ings up to the cur­rent NIS ceil­ing of $8,300.00 per month; earn­ings above this fig­ure would at­tract a con­tri­bu­tion rate of say six6 per cent. The in­tent of this har­mon­i­sa­tion is that the em­ploy­ee would re­ceive a to­tal pen­sion (com­pa­ny and NIS com­bined) amount­ing to two-thirds of his fi­nal salary, as­sum­ing, say, 30 years of con­tri­bu­tions.

(Af­ter the Car­ni­val fes­tiv­i­ties, in March 2013, the NIS in­come ceil­ing is ex­pect­ed to in­crease to $10,000 per month and the con­tri­bu­tion rate (em­ploy­er and em­ploy­ee) will go to 11.7 per cent. In March 2014, the new ceil­ing ris­es to $12,000 per month and the con­tri­bu­tion rate would then move to 12 per cent.)

The length of ser­vice that an em­ploy­ee gave to his em­ploy­er is al­so a con­tribut­ing fac­tor in de­ter­min­ing the fi­nal em­ploy­ee ben­e­fit. In most cas­es, af­ter five con­sec­u­tive years of ser­vice and con­tri­bu­tions, the em­ploy­ee's en­ti­tle­ment to a pen­sion ben­e­fit be­comes vest­ed or se­cure.

If he leaves his cur­rent em­ploy­er, he may be able to trans­fer his plan to an­oth­er em­ploy­er; this, how­ev­er, is sub­ject to agree­ment be­tween the trustees of both plans. In oth­er cas­es, if he leaves, he may be able to get a re­fund of his con­tri­bu­tions plus in­ter­est, but mi­nus a tax penal­ty. Of­ten, his best op­tion might be to leave the funds in the plan and col­lect a small pen­sion when he reach­es the el­i­gi­ble age.

Both in­ter­est rates and in­vest­ment re­turns are in­ter­re­lat­ed. In the­o­ry, low in­ter­est rates should re­duce busi­ness costs, spur in­vest­ment, mar­shal ex­pan­sion plans, cre­ate jobs and boost prof­its, etcetera. Re­cent eco­nom­ic his­to­ry has con­fused the re­la­tion­ship be­tween these two forces. While good in­vest­ment re­turns are still very pos­si­ble, they re­quire much more work to fer­ret out these pearls of good for­tune. With in­ter­est rates cur­rent­ly so low, one might be for­giv­en for think­ing that sav­ing is a form of slow-mo­tion tor­ture!

Longevi­ty

Thir­ty or 40 years ago, a re­tiree might be ex­pect­ed to live any­where from five to 15 years, then pass on to the great be­yond peace­ful­ly. Based on that as­sump­tion, com­pa­nies of­fer­ing pen­sion plans could af­ford to be gen­er­ous as the re­tiree was not ex­pect­ed to live very long.

Mod­ern ad­vances in health care have re­versed this trend. When an em­ploy­ee re­tires at age 60 or 65, an as­sess­ment has to be made as to whether he will sur­vive for an­oth­er 25 or 40 years. This is, in­deed, a very long time. It means that what­ev­er funds have been ac­cu­mu­lat­ed in the em­ploy­ee's pen­sion fund have to last for a much longer time. Per­sis­tent­ly low­er birth rates fur­ther com­pli­cate ac­tu­ar­i­al cal­cu­la­tions and as­sump­tions. As a prac­ti­cal mat­ter and, fac­tor­ing in low­er in­vest­ment re­turns, this sug­gests a low­er fu­ture pen­sion pay­ment.

How do all these vari­ables af­fect the com­pa­ny?

Since, in the de­fined ben­e­fit arrange­ment, the com­pa­ny as­sumes all the in­vest­ment risk, it has to be in a po­si­tion to be able to ho­n­our its com­mit­ments for a very long time. In ad­di­tion, giv­en the cur­rent dif­fi­cult in­vest­ment en­vi­ron­ment, the com­pa­ny has to in­vest a larg­er amount of mon­ey in or­der to gen­er­ate the same lev­el of in­come to fi­nance its fu­ture com­mit­ments.

The RBL ex­am­ple

Some com­pa­nies, for ex­am­ple, Re­pub­lic Bank Ltd (RBL) are in the for­tu­nate po­si­tion where the as­sets in their pen­sion plans, based on cur­rent dis­count rates and mor­tal­i­ty as­sump­tions, com­fort­ably ex­ceed the present val­ue of their fu­ture oblig­a­tions. In RBL's case, as at the end of Sep­tem­ber 2012, its plan as­sets ex­ceed­ed its oblig­a­tions by $1.22 bil­lion.

Over the past five years, the on­ly year that RBL's plan's sur­plus fell be­low $1 bil­lion was in 2009; in that year, the sur­plus was "on­ly" $723 mil­lion. In fact, be­cause of RBL's pen­sion plan con­tin­u­ing sur­plus, it has not been re­quired to make a con­tri­bu­tion to the plan since 1999.

Look­ing again at its 2012 re­sults, we note that, in that pe­ri­od, due to the sur­plus earn­ings on its pen­sion fund, RBL's staff costs were re­duced by al­most $31 mil­lion for that year alone.

Aside from its prof­itabil­i­ty, con­ser­v­a­tive man­age­ment and oth­er at­trib­ut­es, this pro­longed pen­sion sur­plus makes Re­pub­lic Bank a more de­sir­able in­vest­ment.

RBC Roy­al Bank

We might con­trast this sit­u­a­tion with that of RBC Roy­al Bank (T&T) Ltd. For its 12 months end­ed Oc­to­ber 2012, RBC Roy­al Bank's post-re­tire­ment ben­e­fit ex­pense in­creased to $72.6 mil­lion from the $10.1 mil­lion in­curred in the 2011 pe­ri­od. This rise, to­geth­er with an in­crease in its pro­vi­sion for bad debts by al­most $128 mil­lion, were two of the ma­jor fac­tors that con­tributed to RBC Roy­al Bank in­cur­ring an af­ter-tax loss of $33.9 mil­lion for 2012.

If this bank were still a pub­lic com­pa­ny, this would be a sig­nif­i­cant fac­tor that could neg­a­tive­ly in­flu­ence its share price. How­ev­er, RBC Roy­al bank is a sub­sidiary of RBC Fi­nan­cial (Caribbean) Ltd, which, in turn, is owned by the larg­er and stronger Roy­al Bank of Cana­da. This fact alone would be a mit­i­gat­ing fac­tor in help­ing it over­come its short-term pen­sion chal­lenges (and eas­ing any con­cerns that pen­sion­ers or em­ploy­ees may have).

So, aside from such ob­vi­ous num­bers such as sales and prof­its, cash and debt ra­tios and prospects for growth, in­vestors should be more dili­gent in dig­ging for hid­den chal­lenges that a com­pa­ny might be fac­ing, ei­ther cur­rent­ly or in the medi­um term.

As com­pa­nies be­gin to come to terms with their de­fined ben­e­fit pen­sion oblig­a­tions, they would be look­ing for ways to ex­tri­cate them­selves from these bal­loon­ing and pos­si­bly un­quan­tifi­able li­a­bil­i­ties. Prob­a­bly, many have be­gun to of­fer less oner­ous, but still at­trac­tive al­ter­na­tives.

Among the pos­si­bil­i­ties are two that could be quite ac­cept­able to both em­ploy­ees and em­ploy­ers. A prof­it shar­ing plan is a rel­a­tive­ly pain­less and sim­ple form of em­ploy­ee ben­e­fit.

As the name im­plies, if the com­pa­ny does well, then so do its em­ploy­ees; they ben­e­fit by re­ceiv­ing shares in the com­pa­ny, ac­cord­ing to cer­tain rules and with ap­pro­pri­ate re­stric­tions. This plan is of­ten con­sid­ered as an em­ploy­ee ben­e­fit, rather than a pen­sion plan, which has a more pa­ter­nal­is­tic con­no­ta­tion.

De­fined con­tri­bu­tion plan

An­oth­er al­ter­na­tive is the use of a de­fined con­tri­bu­tion plan. Un­der this arrange­ment, each em­ploy­ee has an in­di­vid­ual pen­sion ac­count. The sums con­tributed by both em­ploy­ee and em­ploy­er are shown sep­a­rate­ly to­geth­er with any al­lo­cat­ed in­ter­est and earn­ings.

The em­ploy­ee re­ceives an an­nu­al state­ment show­ing the progress of his hold­ings. The ex­tent of the em­ploy­ee's pen­sion is based pri­mar­i­ly on the earn­ings of his iden­ti­fi­able pool of as­sets, but sub­ject to pe­ri­od­ic ac­tu­ar­i­al re­view and ad­just­ment. The em­ploy­er pro­vides on­ly a lim­it­ed guar­an­tee as to what any em­ploy­ee would re­ceive.

Nat­u­ral­ly, in this sit­u­a­tion, the em­ploy­er does not have an "open-end­ed" li­a­bil­i­ty to pay a spec­i­fied sum for an in­de­ter­mi­nate pe­ri­od. This fea­ture se­vere­ly lim­its the un­cer­tain­ties for the em­ploy­er in con­trast to the more open-end­ed de­fined ben­e­fit pen­sion plan arrange­ment.

As so­ci­ety's age and "spec­tac­u­lar" re­turns from in­vest­ments be­come less fre­quent, more com­pa­nies would seek to re­strict ac­cess to their ex­ist­ing de­fined ben­e­fit plans.

In­creas­ing­ly, they would want to en­cour­age less oner­ous de­fined con­tri­bu­tion schemes and prof­it shar­ing arrange­ments. Oth­ers might sim­ply pre­fer to con­tribute a spec­i­fied sum to an em­ploy­ee-owned de­ferred an­nu­ity con­tract; this op­tion re­quires very min­i­mal ad­min­is­tra­tion. These grad­ual de­vel­op­ments would help re­duce the pen­sion risks that some com­pa­nies might cur­rent­ly face, thus mak­ing own­er­ship of their shares more de­sir­able to in­vestors.