Labour Code Lowdown: Retirement Benefits
by Adam Stauffer, CFA, Offshore Investment Advisor
After 35 years without revision, the territory enacted a new labour code, Labour Code 2010 on October 4, 2010. As with most change, the new code is not without critics. One controversial section on Retirement Benefits has scared many employers. Their fears are warranted, given the gloomy state of the economy and slow pace of recovery. However, there are steps employers can take to minimize the impact to their bottom line.
With the average life expectancy steadily increasing, retirees find themselves in the bittersweet position of having to make their savings last longer so they can enjoy their longer lives. The retirement benefits section is one way to address the issue. However, it is by no means an end all—everyone should have a retirement strategy in writing and save accordingly.
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Although many questions still remain, employers can follow several steps to ensure they are prepared to meet the sixmonth implementation deadline in march 2011. First, what are an employer’s financial obligations? determining pension obligations can be tricky. Employers should not only estimate their vested benefits obligations (VBO)—the amount due to vested employees (individuals that have been with the company for greater than 10 years) at current salaries—but also estimate the projected benefits obligation (PBO). PBO is an all-encompassing estimate of the future amount due to vested and non-vested employees at future salaries. In order to calculate this, employers must estimate future salary levels as well as the amount set aside for each employee going forward. The code is vague on this amount, but according to the Code’s author, Clive pegus, the minimum for permanent employees is around 3.46% of the employee’s annual salary.
Next, what plan structure best suits the business? employers appear to have a choice between defined benefit and defined contribution plans. In defined benefit plans, retiree benefits are a fixed amount, employer contributions depend on promised benefits to the retirees and the employer bears the investment risk. Conversely, in defined contribution plans, employer contributions are defined, retiree benefits depend on fund performance and the retiree bears the investment risk. on the surface, the pros and cons of each seem obvious. in fact, over the last few decades there has been a shift away from defined benefit toward defined contribution in the private sector. However, defined contribution plans may not be right for all employers or fit best with the requirements of the new code. Before making this decision, which may be impossible to reverse, employers should closely examine the two options and align their plans with their businesses’ structures. In doing so, they will reduce future headaches and minimize near and long-term financial obligations.
Finally, how is the business going to meet these new obligations? As a result of the dot-com bust and the credit crisis, investors have shied away from equities and have hidden in assets like Cds and bonds. but with rates as low as they are now, holding assets in Cds and low interest bearing
accounts could do more harm than good—when the rate of inflation is above the rate of interest, investors realize a negative rate of return and lose money. Instead, investors need a diversified allocation to equities, fixed income and commodities designed to match their future obligations.
An important closing note: there is a provision in the code that states “where an employer is unable to pay retirement benefits…by reason of exceptional financial hardship, the employer may appeal to the minister for variation of the obligation.” So the sooner employers determine their obligations, the more time they will have for submitting requests before the march deadline.
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Once the dust settles, and the regulations are put into writing, employers who have a well thought out retirement benefits strategy will experience the least disruption to their business and minimized impact to their bottom line.
