Module 11: Implementing the Capital Accumulation Plan Investment Policy Flashcards
Outline the steps in the capital accumulation plan (CAP) investment cycle.
Steps in the CAP investment cycle are:
(1) Develop investment policy
(2) Select service provider
(3) Determine specific investment alternatives
(4) Provide investment information to members
(5) Monitor performance on an ongoing basis.
Describe the general responsibilities of CAP investment decision makers as they relate to CAP investments.
The investment decision makers are responsible for:
(a) Complying with legislative requirements associated with the investment of the pension fund (for a CAP that is a defined contribution (DC) pension plan).
(b) Clearly communicating the investment risks inherent in CAPs to the members
(c) Ensuring that each member has sufficient education and tools to make an informed decision on the investment of their funds
(d) Deciding whether to retain a service provider for the purpose of providing plan members with investment advice.
Explain how the CAP investment cycle differs from the defined benefit (DB) pension plan investment cycle.
The major differences in the investment cycles of DB pension plans and CAPs flow from the responsibility for investment risk. DB pension plan investment returns substantially contribute to the magnitude of a pension fund and, in turn, impact the level of contributions required to meet pension standards requirements. In most cases, the DB plan sponsor bears all the risk of the impact of lower-than-expected investment returns on the contribution levels.
In a CAP, the plan sponsor bears no investment risk since contribution levels are fixed by the terms of the plan. Instead, the members assume the investment risk. CAP investment decision makers’ responsibilities introduce a need for member education that is not required in DB pension plans or in non-CAP defined contribution (DC) pension plans.
Identify the primary considerations that CAP investment decision makers should undertake when developing investment policy, Step 1 of the CAP investment cycle.
CAP investment decision makers should consider the following when developing investment objectives and constraints for the CAP:
(a) Purpose of the CAP (e.g., long-term retirement savings, tax-efficient compensation, profit sharing, short-term savings). The defined purpose strongly influences member expectations regarding outcomes of the plan and the implications of whether the expected outcomes are achieved.
(b) CAP investment decision makers’ ability to periodically review the investment options
(c) Diversity and demographics of CAP members.
Describe the various types of investment objectives and constraints that may be included in a CAP investment policy during Step 1 of the CAP investment cycle.
CAP investment decision makers should ensure that a range of investment options is made available, taking into consideration the purpose of the CAP. The CAP’s own unique circumstances will influence its investment objectives and constraints. A CAP investment policy may include the following investment objectives and constraints:
(a) Number of investment options to be made available
(b) Degree of diversification among the investment options
(c) Level of risk associated with the various investment options
(d) Styles of investment management to be included among the investment options (i.e., active vs. passive management, equity management styles, etc.)
(e) Need to accommodate different member investment approaches
(f) Type of default investment option to be provided to members who do not make a choice
(g) Criteria for assessing investment options and their managers and a description of the assessment process
(h) Approach to payment of plan expenses and fees and confirmation of fees paid by each CAP stakeholder
(i) Roles and responsibilities of all CAP stakeholders as they relate to plan investments.
Explain the concept of a “default” investment option and describe the pros and cons of some investment options used as a CAP’s default investment option.
A “default” option is an investment option designated by the plan investment decision makers for plan members who fail to elect an investment choice at the time of their enrolment. By definition, a default is intended as a short-term “parking spot” until the plan member makes an informed investment decision but, in reality, plan members may be invested in the default investment option for an extended period of time.
Investment options that have been used as default options, and their associated pros and cons, include:
(a) Money market fund. Money market funds have a very low-risk nature. However, CAP members who leave their plan monies invested in a money market fund for the long term will earn very low investment returns.
(b) Balanced fund. Balanced funds offer members professional management of the asset-mix decision, and a diversified approach investing in fixed income, stocks and cash. Asset mix is normally static, which may not be appropriate for certain plan members due to their investment time horizon or appetite for risk.
(c) Target-risk fund. This special type of balanced fund allows members to invest in a diversified portfolio with a specific and defined investment risk profile. A drawback is that the investment risk level chosen for the default fund may not be appropriate or all members.
(d) Target-retirement-date fund. Another special type of balanced fund which offers members a diversified portfolio with a dynamic asset mix that becomes more conservative as the member approaches their expected date of retirement. One drawback is that when used as a default option, the fund’s maturity date may not match the member’s planned retirement age.
Explain how CAPSA Guideline No. 3, Guidelines for Capital Accumulation Plans (CAP Guidelines) addresses default investment options.
The CAP Guidelines are silent on what is an appropriate default investment option. In the absence of legislation, there is no right or wrong answer for default selection by the CAP sponsor; however, the requirement for prudence and fiduciary responsibility guides its decision. Annual communication with plan members and documentation of rationale are critical to mitigating risk. An effective default policy addresses the reasons members use the default fund, and it reiterates that plan members are responsible for their investment choices (or nonchoices).
Describe one of the first considerations that influences the service provider structure of a CAP.
Investment decision makers must determine whether there is in-house expertise and capabilities to undertake such main CAP activities as:
(a) Trustee and/or custodial services
(b) Recordkeeping and administration, including reporting to members and the plan sponsor
(c) Investment management
(d) Communication to members, including the provision of decision-making tools and investment and retirement planning education.
When such in-house expertise is not available, one of the first decisions to be made is whether to use a bundled or unbundled approach.
Describe the selection criteria that CAP investment decision makers who have selected a “bundled” approach can use when selecting service providers.
When a bundled approach has been selected, the CAP investment decision makers can consider use of the following selection criteria:
(a) Whether the service provider can offer investment managers that offer all the types of investments required in accordance with those chosen in Step 1 of the investment cycle. Some CAP investment policies identify specific types of investment options that are to be made available. These can include stock issued by the plan sponsor, Guaranteed Investment Certificates (GICs) of varying duration and other types of market-based funds. If the investment policy specifies the need for any of these other types of investment options, or for specific types of pooled funds, it is important for the plan sponsor to identify whether the service providers being considered provide access to those types of investment options. If all service providers meet the requirements of the investment policy, then administrative and fee considerations may take precedence in the selection of the service provider.
(b) Administration requirements. Investment decision makers need to satisfy themselves that the package of services meets the following criteria:
Compliance with all legislative requirements
The unique needs of the plan sponsor and employee group, given the purpose of the CAP and the investment objectives and constraints established in Step 1
(c) Fee structures available through providers that offer bundled CAP arrangements.
Identify the factors that the CAP Guidelines recommend CAP investment decision makers consider when establishing criteria for selecting service providers.
Factors CAP sponsors consider when establishing criteria for selecting service providers:
(a) Level of professional training and experience
(b) Specialization in the type of service to be provided
(c) Cost of the service
(d) An understanding of employee benefits, pension legislation and related rules
(e) Consistency of service offered in all geographical areas where members reside
(f) Quality, level and continuity of services offered.
Identify factors that the CAP Guidelines recommend CAP investment decision makers consider when establishing criteria for selecting service providers to provide investment advice to members.
Factors CAP sponsors consider when establishing criteria for selecting service providers to provide investment advice to members include:
(a) Criteria used to select service providers (i.e., professional training; experience; specialization in the type of service to be provided; cost of the service; understanding of employee benefits, pension legislation and other related rules; consistency of service offered in all geographical areas where members reside; and quality, level and continuity of services offered)
(b) Any real or perceived lack of independence of the service provider relative to other service providers, the CAP sponsor and its members
(c) Any legal requirements that individuals must meet before they can provide investment advice
(d) Any complaints filed against the advisor or their firm and any disciplinary actions taken (if known).
Describe the fees associated with a CAP that has elected to use a bundled approach to plan operation.
When the CAP sponsor uses a bundled approach for services, it is also common for the plan fees to be expressed in a bundled manner.
In this situation, some or all of the fund management, investment transaction, custody, and other investment administration and plan administration fees are combined into a bundled fee. In CAPs, it is common for insurance company providers to provide all those services under the umbrella term “investment management fees.” In addition to the investment management fees, Goods and Services Tax/Harmonized Sales Tax (GST/ HST), segregated fund operating expenses and fund manager operating expenses are normally charged. It is not usual for the insurers to disclose the specific composition of the investment management fees, and there is no requirement that the fee bundle be transparent.
Describe how fees are assessed for CAP investment managers.
While the typical activities of CAP investment managers are similar to those of DB pension plan investment managers, when a CAP operates on a bundled basis, the assessment of fees for those activities is different. The assessment of fees includes:
(a) Investment management fees. In CAPs, investment management fees are typically asset-based (i.e., percentage of assets). When the investment manager operates outside of the service provider (e.g., an insurance company can contract with an institutional or mutual fund manager to include its products within the insurers’ product offering), the level of investment management fees reflects the fee arrangement between the service provider and the investment manager. As a result, it is common (but not universal) for those investment options that are proprietary to the service provider to have a lower level of investment management fee than a similar fund managed by an outside investment manager. Sometimes fees for active investment management scale down with the asset-level ranges (e.g., size of the investment). For example, a fee schedule that starts out at 100 basis points on the first dollar of plan assets may be as low as 15 basis points on each dollar of plan assets over $100,000,000.
(b) Segregated fund operating expenses and fund manager operating expenses. These fees apply to service providers’ (e.g., insurers’) investment products. They include trading expenses, custody fees, accounting fees, consulting fees, legal fees or other related fees incurred by the fund managers. They are charged separately and expressed by the service provider as the percentage of fund assets that they represented in the previous calendar year.
(c) Administration fees. For a bundled CAP, the selected service provider incurs costs related to the maintenance of plan member records and reporting to plan sponsors and members. Often the service provider’s fees for these services are “bundled” into the total investment fees, or sometimes there is a separate fee for these services. It is common for certain transactional expenses (e.g., a fee for processing an in-service withdrawal from a Group Registered Retirement Savings Plan (Group RRSP)) to be charged directly to the member making the transaction.
Describe criteria typically used by CAP investment decision makers when selecting specific investment alternatives in Step 3 of the CAP investment cycle.
The selection of specific investment alternatives is based on the plan’s investment objectives and constraints determined in Step 1 of the investment cycle. It is possible that the selected service provider will offer a number of investment alternatives that, on the surface, appear to meet the CAP sponsor’s objectives (e.g., it offers more than one actively managed Canadian equity fund that follows a growth style of equity management). In this case, an analysis of each investment alternative is required to identify the option that is most appropriate for the CAP. This generally involves obtaining information about the respective fund managers, the composition of each alternative fund, relative fee levels and the managers’ respective success at meeting their investment objectives for the investment funds.
Outline the primary responsibilities of CAP investment decision makers relating to the provision of investment information to members in Step 4 of the CAP investment cycle.
Step 4 of the CAP investment cycle (Provide investment information to members) calls on CAP investment decision makers to fulfill the following responsibilities:
(a) Ensuring that each member has sufficient education and tools to make an informed decision about the investment of their funds
(b) Clearly communicating the risks inherent in CAPs to the members.
Outline factors recommended by the CAP Guidelines that CAP investment decision makers should consider when establishing criteria for the periodic review of service providers and investment options.
Factors CAP investment decision makers should consider when establishing criteria for the periodic review of service providers and investment options are:
(a) The criteria used to select the service provider and investment option
(b) The frequency of and/or triggering events for the review.
Outline factors that the CAP Guidelines recommend CAP investment decision makers consider in deciding what action to take if a service provider fails to meet established criteria.
Factors that CAP investment decision makers should consider when deciding on what action to take if a service provider fails to meet established criteria are:
(a) The length of time that the criteria have not been met
(b) Any complaints arising from members (if applicable)
(c) The effects that taking a particular course of action will have on members
(d) The availability of alternative service providers.
Describe Step 5 of the CAP investment cycle, monitor performance on an ongoing basis as it relates to the plan’s investment options.
The investment policy and constraints established in Step 1 set out the review requirements for the investment options and fund managers. The CAP Guidelines suggest reviewing investment options at least annually, which for DC pension plan CAPs is consistent with statement of investment policies and procedures (SIPP) requirements.
The objective of investment performance monitoring is to provide plan fiduciaries with accurate, comprehensive measurements that provide a basis for decision making and allow more effective discharge of plan governance responsibilities. The process of monitoring an investment option is similar to any monitoring process where objectives are determined and policy and process are established for monitoring results and adjusting actions as required. The key to effective performance evaluation is having an evaluation framework (i.e., knowing the objective, the appropriate measures and the performance benchmarks) and then consistently reviewing the actual performance using consistent standards. The same metrics used to measure investment performance for DB pension plans can be applied to CAPs. A CAP investment decision maker is concerned with the same quantitative and qualitative factors since they apply to each of the CAP investment options.
Investment decision makers must consider the impact of unsatisfactory performance of investment options upon plan members and determine appropriate action, including in the area of employee communication as outlined in the CAP Guidelines.
Outline factors CAP sponsors consider when deciding on action to take when investment options no longer meet established review criteria, according to the CAP Guidelines.
Factors outlined in CAP Guidelines for CAP sponsors to consider when deciding on action to take when investment options no longer meet established review criteria include:
(a) Length of time that criteria have not been met
(b) Any other deficiencies in how the investment option operates
(c) Complaints arising from plan members
(d) Effect that taking such action would have on members; for example, whether there would be tax consequences
(e) Remaining investment options available in the CAP
(f) Availability of equivalent investment options.
Describe OSFI’s requirements for inclusion of investment option information in a standardized information booklet for a member of a DC pension plan that allows members to make investment choices.
OSFI expects that the following information about investment options be included in a standardized information booklet for a DC pension plan that allows members to make investment choices
(a) A description of how members make their investment choices
(b) The investment tools available to assist in decision making
(c) A statement that account balances reflect the investment performance of the investment option, less fees
(d) A statement that members should obtain investment advice from an appropriately qualified individual
(e) A description of the plan’s default investment option.
Describe the investment information that the federal pension legislation requires to be included on members’ annual statements in a pension plan that allows members to make investment choices.
Federal pension legislation requires that the following information be included on a CAP member’s annual statements:
(a) A description of each investment option available to the member that indicates:
Its investment objective
Type of investment and the degree of risk associated with it
Its ten largest asset holdings by market value, each expressed as a percentage of the total assets
Performance history
That its past performance is not necessarily an indication of its future performance
The benchmark that best reflects its composition
Fees, levies and other charges associated with it that reduce return on investment expressed as a percentage or a fixed amount
Target asset allocation
(b) A description of how the member’s funds are currently invested
(c) An indication of any timing requirements that apply to the making of an investment choice.
Outline information that the CAP Guidelines recommend CAP investment decision makers include in the performance report given to each plan member for each investment fund.
The CAP Guidelines recommend that the performance report for each investment fund include:
(a) Name of the investment fund for which performance is being reported
(b) If applicable, the name and description of the benchmark for the investment fund. If the benchmark is permitted by law to be composed of several indexes, this should be explained.
(c) If used, corresponding returns for the benchmarks
(d) Performance of the fund, including historical performance for one, three, five and ten years (if available)
(e) Whether the performance is gross or net of investment management fees and fund expenses
(f) Identification of the method used to calculate the fund performance return calculation, along with directions on where to find a more detailed explanation
(g) A statement that past performance of a fund is not necessarily an indication of future performance.
Outline information that the CAP Guidelines recommend CAP investment decision makers provide to members if there are significant changes in investment options.
The CAP Guidelines recommend that CAP sponsors provide advance notice to CAP members when there are significant changes in investment options. The notice to members includes:
(a) Effective date of the change
(b) Brief description of the change and the reason for the change
(c) How the change could affect the member’s holdings in the plan (e.g., if the change affects the level of risk of an investment option, this should be described)
(d) Manner in which assets will be allocated to new investment options—where applicable
(e) Details of any penalties or special transaction fees that may apply to the change
(f) Summary of the tax consequences that may arise because of the change
(g) Where to get more detailed information about the change
(h) Details on what the members must do (if action is required) and the consequences of not taking action
(i) A reminder to members to evaluate the impact of the change on their current holdings in the CAP.
Outline factors that impede retirement planning for CAP members that can be addressed by the inclusion of lifecycle funds as a CAP investment option.
Factors that impede retirement planning for investors that can be addressed by the inclusion of lifecycle funds as a CAP investment option include:
(a) Member motivation/desire for professional oversight. Many members want to feel they are benefiting from professional oversight.
(b) Choice overload. Members can be overwhelmed by being asked to choose from too many funds.
(c) Member knowledge. Many members have limited knowledge of basic investment concepts.
(d) Member attitudes. Many members have little interest in investment issues or in monitoring their investments.
Outline characteristics of lifecycle funds.
All lifecycle funds share a common foundation—They are based on two fundamental tenets of investing: Diversify to reduce risk and invest for a particular time horizon. They are driven by top-down asset allocation methodologies, where asset allocation is the most important decision in portfolio construction. Most lifecycle vehicles use a fund-of-funds approach to achieve the required level of diversification, i.e., an investment strategy of holding a portfolio of other investment funds rather than investing directly in stocks, bonds or other securities.
Describe the characteristics of target-retirement-date funds in the areas of assumed risk profile of members, asset allocation shift, asset allocation monitoring and time horizon.
The risk profile of target-retirement-date funds assumes that members who share a retirement date have similar objectives and risk tolerance. The fund’s manager automatically changes the asset allocation over time to make the portfolio more conservative as the member’s target retirement date approaches. All asset allocation changes occur within the fund; the member has no need to rebalance. A change in a member’s personal time horizon or investment objectives warrants a review of the portfolio. The time horizon is predetermined based on the fund’s target date.
Describe the characteristics of target-risk funds in the areas of assumed risk profile of members, asset allocation shift, allocation monitoring and time horizon.
With target-risk funds, members typically assess their own risk tolerance by responding to a questionnaire. The fund manager periodically rebalances the fund to maintain its stated asset allocation. The member decides when and how to shift to a more conservatively allocated fund as retirement draws nearer. The member monitors the fund to ensure its asset allocation continues to match their risk profile as time and life changes occur. The time horizon is not predetermined.
List the three approaches used by Canadian investment managers when constructing lifecycle funds that are funds of funds.
Three approaches used by Canadian investment managers when constructing lifecycle funds that are funds of funds are:
(1) Underlying funds entirely passively managed index funds or products
(2) Underlying funds managed by a single fund manager
(3) Underlying funds managed by a number of different fund managers (multi- manager approach).
Describe CAPSA’s recommendations for the distribution of information about retirement products to DC pension plan members who are approaching the payout phase.
CAPSA Guideline No. 8 recommends that CAP investment decision makers provide information regarding all regulated retirement products available to plan members, including:
(a) Locked-In Retirement Accounts (LIRAs)
(b) Locked-In RRSPs
(c) Locked-In Retirement Income Funds (LRIFs)
(d) Life Income Funds (LIFs)
(e) Life annuity contract
(f) Prescribed Registered Retirement Income Funds (pRRIFs)
(g) Variable benefits.
The Guideline also recommends that members be given information that assists them to make informed decisions with respect to their retirement options. Along with the retirement statement, information provided should include details regarding the level of fees payable by the member or through the member’s account, including asset-based fees that are payable with respect to each investment held in the account. As well, if the retirement statement provides retiring members with an option to move funds out of the plan and into investments with a current service provider, then the fees related to those investments should also be made available. Members should be provided with information regarding any unlocking options that may be available at the time of retirement.
Explain the only circumstance where the plan investment decision makers are responsible for providing ongoing communication to DC pension plan members during the payout phase.
The only circumstance in which ongoing communication is required during the payout phase is when the payout product is a variable benefit. Where a variable benefit is permitted, pension standards legislation details the information to be provided to a variable benefit owner. In the case of other retirement products, information provided to the plan owner is stipulated by the institution holding the funds (according to legislative requirements).
