What Pension Funds Can Do to Avoid Financial Affliction (w/ Jim Keohane)
ED HARRISON: I was looking at your website, and you talk about advocacy at HOOPP. And there were five drivers of that. And I think maybe this is a good framework for thinking about this conversation. The five drivers you talked about were savings, fees and costs, which we already mentioned, investment discipline, fiduciary governance, which is what you were just mentioning. And then risk pooling. I want to go through those one by one and then get a sense of how much that makes a different in terms of how much I as an individual need to save if I were to be with a defined benefit plan like HOOPP versus if I would try to replicate that on my own. JIM KEOHANE: Yeah. ED HARRISON: So let's talk about the savings and how people save. And why that's one of the five. JIM KEOHANE: It's one of the big items, actually-- savings patterns. And what we see-- so if you're in our plan, it's taken out of your paycheck every two weeks. And it's automatically done. So people don't even notice it. So they just live off their take home pay, and it's automatically taken off, and they don't have to think about it. And the other thing is it's locked in. You can't take it out. ED HARRISON: Right. JIM KEOHANE: What we see in individuals trying to do it on their own is it becomes an afterthought. They are dealing with their kids' education, cars, paying for their house. And at the end, do I have any money left to save? If I do, I'll put some aside. And here, we have an instrument called a registered retirement savings plan, which is similar to your IRAs, right? So the deadline is February 28. People rushing in February 27 to the bank and put whatever it is and by the flavor of the day, right? And so it's no real thought given to what should put the money, and they put in wherever they happen to have at the time, which is usually very inadequate to provide you with a decent pension. And the other thing you see is that when they have a crisis, a financial crisis in life, they withdraw that money. So essentially, when you just look at the stats that people have in individual savings accounts, most of them have actually no money at the time of retirement. So it's so not just they don't save enough-- they don't save at all. And so unless people are in workplace pension plans-- and it doesn't necessarily have to be a DV plan, but in a workplace pension savings vehicle, they don't save it all. And so unfortunately, what we've seen in the last few years is this trend away from workplace savings plans. And we need to think about ways to stem that tide and move things back in the other direction. ED HARRISON: Even though I want to go through these step-wise, that when you mentioned the fact that we've seen this move away, the immediate thing that I think about is the what you told me about the accounting issues and why this happens. I want to go straight to the solutions thing here, because basically, the solution is defined benefit is my understanding And what we're already talking about in terms of savings on a regular basis. But the reality is that in a private company, it's not on an accounting basis, a good thing to have that on your balance sheet. Like, you mentioned GM in particular as an example of that. JIM KEOHANE: Yeah. And this goes back to the Sarbanes-Oxley legislation, which happened after the Enron and WorldCom bankruptcies, where they had always off balance sheet entities that masked a bunch of risk that was there. And so that legislation essentially said you have to put all these things back on your balance sheet, which included the defined benefit plan. So in the past, a defined benefit plan was one line-- was off the balance sheet. But just if you get swings in interest rates, you can get very material swings. And you've got 50 year assets there that very small changes in interest rates for example, can change a lot. So once you get that back on the balance sheet in the [indiscernible], it creates a huge amount of noise. And so companies have big pension plans and GM is an example of that. I think the pension plan is about five times the size of the company. The pension plan affects your earnings more than anything. And so the joke in the financial markets was that GM is a pension plan that makes cars and it's true, in a sense. And also, if I put my investor hat on and I want to invest in a car company, I look at GM and think, well, I'm going to get too much exposure to its pension assets, so I'm going to go buy some other car company instead. So it's a huge amount of pressure from shareholders for GM to get out of the pension business. So that's where it comes from. If the accounting was not bad, if you went back to the previous accounting, that probably would alleviate that issue. So employers are looking to have defined contribution account. In other words, all they have to put in their earnings statement is the contribution they make in the employee's account that year. And then any future risk is the employee's, actually. ED HARRISON: Right. JIM KEOHANE: So the risk doesn't go away. It just got shifted off the company's books to the employee's book. ED HARRISON: You used defined contribution accounting, though. JIM KEOHANE: Yes, our employers do. The reason is that HOOPP is a different structure. So we don't just manage the money on behalf of the employers. The obligation for the pension is actually HOOPP's obligation, not the hospital's obligation. So in effectively, we not only take on that management money, that pension is guaranteed by HOOPP-- it's not guaranteed by the hospital. ED HARRISON: Right. JIM KEOHANE: So from the hospital's point of view, they really just make a contribution into the plan. And the only future obligation it could have is we could raise the contribution rates. ED HARRISON: Right. JIM KEOHANE: But they have no obligation in the future to fund it. If we had gotten into a situation where we're underfunded or something, they have no future obligation that way. So their accounting is DC accounting. So our structure, actually, it's an interesting structure that could be brought into the private sector that may encourage employers to get back into something that looks more like a defined benefit. ED HARRISON: Right. And so you're talking about governance right there. So let's unpack that a little bit, because we have on the one hand, the fact that you can have your constituents have defined contribution accounting. And that takes away this whole accounting issue. But at the same time, they have no control over the governance of how the plan works. How do you achieve that? JIM KEOHANE: Well, they do have some control in the sense of our board is constructed of-- so the trust- - so the HOOPP is is a trust. And so it was originally created by and agreement between the Ontario Hospital Association, the employer, and four county unions, which is OPSEU, QP-- OPSEU is Ontario Public Service Employees Union, public employees, SEIU, Service Employees International Union, and Ontario Nurses Association. So that's the five founders of the trust. And so the employer side appoints eight board members in each [indiscernible] point 2. So it's half union, half management, if you will, at the board table. So they do have some level of control over it. Trust law requires, though, that they all check our hats to the door and they do things that are in the interest of the members of the trust. ED HARRISON: And who are these individuals in terms of their competence from a financial perspective? What do they do, what is their knowledge about pensions and things of that nature? JIM KEOHANE: So it's mixed. So we have some people that I would consider financial experts on the board and some people that are senior members of unions, for example. And it's a good mix, because the sense that the union-- people represent the interest of the members. And so you get to understand things from the members' point of view. And plus, we have some financial experts that sit on the board that can provide expertise at the table. And we also have hospital CEOs, for example, on the board that represent the interest of the employers. So it's a good mix there. And it does lead to good decision making. I think most people call our board a lay board. That's a bit of a misnomer, because they're all very intelligent people, well-educated. And their day job-- in all cases, they're not in the financial services sector. But a lot of them have been on the board for a long time. They're familiar with the issues. They're up to speed. And decisions do get made in the best interest of the members of the plan. So it all works. And you think that maybe you'd have all the union line up on one side of the table and management on the other side. That's never happened. So we have a dispute resolution mechanism that's never used-- it's never even been close to being used. So people do actually do act very much in the interest of the members. So I say to people, if you were a fly on the wall of our board meeting, I think you'd have trouble telling who is the union rep and who is the management [indiscernible], which is how it should work. ED HARRISON: Right. And the key for me in terms of that is the ability for these hospitals-- even though they're not necessarily publicly traded companies-- to use defined benefit, defined contribution accounting. Because legitimately, if you take that issue away, then the opportunity for private companies to use defined benefit solutions increases. Instead of what you were saying, that we're actually moving away from that, you could actually have people move towards that because suddenly, they can offer that to their employees, and that's a safety net that people would want. JIM KEOHANE: Yeah. Again, it moves away from the-- we're training much very much more towards the individual managing their own plan when it's much more effective to have collective plans. And you want to try to move the trend back in that direction.