Hi. My name is Sheryl Smolkin, and today I’m interviewing Randy Bauslaugh for a savewithspp.com podcast. Randy is a partner at the McCarthy Tétrault law firm, where he leads the national pensions, benefits, and executive compensation practice. He has been involved with many of the leading pensions and benefits cases over the last 30 years, and he is also a member of the Saskatchewan Pension Plan.

Welcome, Randy. I’m so glad you could make time for us in your busy schedule.

Thanks. I’m happy to give back to the SPP.

That’s terrific. Randy has recently written an article titled Dumb and Dumber: Individual Investment Choice in DC Plans. That’s what we’re going to talk about today. 

Q: Randy, that’s a very provocative title for an article. Tell me about the independent research supporting your thesis that giving investment choice to plan members in defined contribution RPPs is riskier from a legal perspective and a bad idea from a financial performance perspective.
A: Sure. The research comes from various sources – research institutions, academics, news articles and a lot of that relates to the financial performance side. Also, on the legal side, I had a student a few years ago take a look, and there were 3,500 class actions relating to defined contribution plans particularly in the US and those were just relating to DC plan fees.

I think you can pick up any standard textbook on pensions and it will tell you that defined benefit plans have a low legal risk but potentially fatal financial risk. That’s because they guarantee the retirement payments. However, they always say DC plans have low financial risk, because the employer just contributes a fixed amount, but very high legal risk, because there are so many different ways of getting sued.

Q: Then why do DC plan sponsors typically provide a broad range of investment options for plan members?
A: Well, I don’t really know. I have some theories. Before the mid-1980s, most plans did not provide choice, and then it sort of became trendy. I think a lot of employers just believe that choice empowers their employees, or maybe it’s just because after all, who wants just one TV channel.

I also know for a fact that aside from individual empowerment or incentives for the financial industry, there are a lot of plan sponsors out there who think either they have a legal obligation to provide choice or they are somehow reducing their legal exposure if they do provide choice when exactly the opposite is true.

Q: What legal risks does offering multiple investment options raise for DC plan sponsors?
A: Well, one thing a client once said to me is, “Well, what about the (Capital Accumulation Plan) CAP guidelines? I need to provide choice to comply with the CAP guidelines.”  Financial market regulators put out something called Guidelines for Capital Accumulation Plans. Take a look at the table of contents and you’ll find a whole lot of ways of being sued under a DC plan that offers choice. I’ve got a slide presentation that just identifies 48 different ways in which plan members have sued their employers only over fees.

The other thing people should do is read the second paragraph of those guidelines. It says it applies where you’re giving two or more choices, so it doesn’t apply if you’re not giving any choice.

Q: Is providing only one investment option, such as a balanced fund, a set-and-forget strategy for plan sponsors, or do they still have active management and monitoring responsibilities?
A: They still have the active management and monitoring responsibilities. It’s definitely not just “let’s turn it on and forget about it.” Ideally, a DC plan should be managed like a defined-benefit fund. You may do a profile of what your current particular employee group looks like and then the investments can be shaped to that group’s profile, but you still need to manage it on a regular basis.

One of the advantages of a single fund is that you get professional management of the whole fund, not members making their own investment choices for their own little pots. Once you set it up, you should still review it every month or at least every quarter just to make sure that that fund has got an appropriate mix for your group.

Q: Why is a one-fund approach less expensive from a fees perspective for both plan sponsors and plan members?
A: Well, usually you can get economies of scale that will keep the fees down, because you’ve just got one big pot and not multiple little pots. I know that recently a lot of DC fund providers have dramatically reduced their fees for, say, balanced funds and other investment vehicles but some of the other esoteric funds are still pretty expensive. When you’ve got all these little individual accounts, you still have lots of transaction and other fees that are tied to those accounts. That tends to make them a bit more expensive than a pooled arrangement.

Q: Doesn’t having one or more investments managed by several investment managers better diversify a DC plan member’s portfolio and promote better overall returns?
A: Well, you can get that in a no-choice plan, as well, because you could have many managers that are managing different parts of the bigger pool. But the difference is you now have scale, and you’ve got professional management of the money.

Most plan members are not good at investing. In fact, only 7% or so of DC members can actually beat the rate of return of the average DB plan. One of the more interesting statistics that came up in the research was that only 3% of their professional advisors can beat the average rate of return of the average DB plan.

Q: What is a default fund, and what percentage of DC plan members typically invest in the default fund?
A: About 85% of the members in DC plans don’t make any choice at all. If they don’t make a choice, they end up in the “so-called” default fund. It’s a fund that you get into in default of making an election. Employers have to keep track of who is in the default fund because it’s not really clear whether it is just as a result of a decision or simply putting off investment of their money. It may actually be the plan member’s choice to go into the default fund.

In some surveys many members have said  that they thought the default fund must be the best fund because that’s the one the sponsor set up for people who don’t make decisions. Increasingly, what we’re seeing out there today, though, is people defaulting into what’s called a target date fund.

A target date fund is based on your age when you go into it, and as you start getting close to your retirement age, it will move your portfolio from largely stocks to largely bonds. That’s not a bad idea, because once you retire, the theory is you don’t have the capacity to make more income, so a loss just before retirement is undesirable.

One of my clients actually allows employees to choose their target date funds, and  they found that a number of people were choosing three of these target date funds because they weren’t sure if they were going to retire at age 55, 60 or 65. So they put a third of their money in each in case they retire early or later, which is probably the absolute worst thing they could do.

Q: How long have you been a member of Saskatchewan Pension Plan, Randy?
A: Probably about 10 years. I was at another firm some years ago, and they had a pension arrangement, and then when I came to this firm and they don’t. I just think SPP is a great idea.

I  know a lot of people … Even my own professional financial advisor questioned how I got into the SPP and asked whether I was born in the province. No, I wasn’t. It’s open to anybody, and it works just like an RRSP. Anyway, every year I just keep moving the maximum amount from my RRSP to the SPP, and I make the maximum contribution every year. I’m glad to see it’s gone up.

*This is the edited transcript of a podcast recorded in April 2018.

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Written by Sheryl Smolkin
	Sheryl Smolkin LLB., LLM is a retired pension lawyer and President of Sheryl Smolkin & Associates Ltd. For over a decade, she has enjoyed a successful encore career as a freelance writer specializing in retirement, employee benefits and workplace issues. Sheryl and her husband Joel are empty-nesters, residing in Toronto with their cockapoo Rufus.