MONTREAL – A corporate wave to abandon defined benefit pension plans gained strength Friday when Canada’s largest bank announced plans to end its long-held system for new hires.
The Royal Bank of Canada (TSX:RY) will shift to a defined contribution pension plan in January in a bid to ensure predictable long-term pension costs.
Although the new pension system will be required for all new employees, the enhanced plan will also be open to existing workers who want to switch.
“The changes are a responsible way for RBC to better manage the retirement program by ensuring more predictable pension costs in the future,” said spokeswoman Elyse Lalonde.
“This will enable RBC to continue to provide retirement benefits that reflect current market trends.”
The bank said the defined contribution plan will be improved with an automatic RBC contribution, higher matching contributions and higher annual bank contribution limits as of July 1.
Royal Bank is just the latest Canadian company to shift its pension system since the last recession struck in 2008 and interest rates dropped, eroding the value of many corporate pension plans.
Many plans have large unfunded liabilities, challenging the financial ability of companies to make higher pension payments as they face other costs and tougher competition in their markets.
In the United States, IBM, Verizon, Lockheed Martin, Motorola and many other blue-chip American companies opted for less costly defined contribution plans.
In Canada, nickel giant Vale Inco closed its (defined benefit) plan to new hires despite a lengthy strike by 4,000 miners and refinery workers. US Steel continues to lock out Hamilton steelworkers in an attempt to close its defined benefit plan for 900 active members and new hires.
Air Canada (TSX:AC.B) also wanted to move all new hires to less costly defined contribution plans as it struggles with a $2.2 billion solvency deficit.
But an arbitrator’s ruling is forcing the airline to shift to a hybrid system composed of both systems.
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Newly hired customer service workers and flight attendants will be subject to the new system, which CEO Calin Rovinescu described Thursday as “a step in the right direction.”
A shift towards the cheaper pension system can be bad news for workers. Unlike a defined-benefit plan, where employees know their benefits on retirement, the only certainty in a defined-contribution plan is what the worker contributes. After the money is invested it can grow or shrink depending on the stock markets, which have been volatile for years.
Canadian Labour Congress president Ken Georgetti said he’s troubled and disappointed by the trend, which he said will increase the retirement security risk of Canadian workers.
“Everybody would like to do it because it’s an easier way out for them and it’s a trend that’s running through North America,” he said from Vancouver.
But the shift hurts workers and the competitiveness of companies by making it more difficult for companies to attract and keep increasingly scarce talent.
Corporations are attracted to defined contribution plans because it’s easier to write a cheque than maintain plans through proper funding and projections, Georgetti said.
The labour group says the government should instead shore up the Canada Pension Plan to ensure retirees have a base pension “equal to or better than the bottom edge of the standard of living in Canada.”
A larger pension model like CPP has lower administrative costs and better spreads the risks, which would benefit both workers and employers.
Several other Canadian banks contacted say they are watching Royal’s move but have no immediate plans to make the switch themselves.
“We look at many factors when we review our programs and Royal’s decision would be only one of many factors,” said Gabriella Zillmer, senior vice-president, Performance Alignment and Compensation for the BMO Financial Group. (TSX:BMO).
The National Bank of Canada (TSX:NA) also said it regularly reviews its compensation package, including pensions, but a change to its fully funded plan “is not currently considered.”
TD Canada Trust (TSX:TD) and CIBC (TSX:CM) said they too have no current plans to switch pension systems.
Quebec-based Laurentian Bank (TSX:LB) switched from a defined benefit to hybrid system for its unionized employees three years ago. It also has a defined contribution system for non-union workers.
Observers believe Canada’s banks will eventually shift their stances.
“The wave is already well established within many organizations in North America now and so this is just the continuation of the wave, it’s just moving into the financial sector with bigger corporations,” says University of Toronto economics professor and demographer David Foot.
In 2010, there were roughly 11,000 defined benefit plans and an estimated 6,000 defined contribution plans in Canada, according to Statistics Canada.
In 2006 – well before the recession hit – there were about 2.1 million members of defined benefit plans, but that has since dropped to about 1.7 million.
Meanwhile, defined contribution members rose from 737,000 to 820,000 between 2006 and 2010.
Foot believes a shift away from defined benefit plans will reverse a trend of the last 30 years that cut the poverty rate among seniors.
“From a society’s point of view this has ominous implications for poverty among seniors 15 or 20 years from now,” he said in an interview.
Defined benefit plans provide retirees with a predictable income, but they expose employers to additional costs if their pension funds can’t pay promised benefits.
With defined contribution plans, the company’s contribution is limited to a set, negotiated amount, generally a cheaper option for employers.
It also shifts the risk from employer to employee, who often don’t have the required investment expertise and face higher management expense ratios that will eat away at returns.
Royal Bank said eligible employees who have not yet joined the retirement program by June 30 will be automatically enrolled in the enhanced DC plan.
Full-time employees will be able to join the defined contribution after six months of service.
Royal Bank (TSX:RY) earned $5.2 billion last year, up 35 per cent from 2009.
Canada’s five biggest banks brought in $19.41 billion in profit, soaring above the $13.52 billion reported in 2009 when the economic downturn ravaged results.
On the Toronto Stock Exchange, Royal Bank’s shares gained 88 cents to $44.82 in Friday trading.
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