Wednesday, December 29, 2010

US Public Pensions Up 6.2% in Q3

Kenneth Barry of Reuters reports, Assets of public pension funds up 6.2 percent in Q3:

The value of assets held by the 100 largest U.S. public pension funds rose 6.2 percent in the third quarter from the prior quarter, reaching their highest level in two years, a report by the U.S. Census Bureau said on Wednesday.

The value of the assets held by the state and local pension funds also rose 5.2 percent from the same period a year earlier, marking their fourth consecutive year-over- year quarterly increase, the report said.

The report said the value of the investments, whose returns help pay for the pension benefits of millions of retired public-sector workers, was more than $2.5 trillion last quarter.

Public-sector retirement systems across the nation have been clawing their way out of deep financial holes created by the recession and turbulent financial markets, and at the same time have been facing increased scrutiny about their current and future costs.

The California Public Employees' Retirement System, the biggest U.S. public pension fund, for instance, saw the value of its assets fall to as low as $160 billion during the financial meltdown from a peak of $260 billion. The pension fund's assets currently stand at about $221 billion.

The recent losses by public pension funds and the size of their projected liabilities are fueling debates in statehouses and local government chambers across the nation over requiring public employees to contribute more to their pensions and reducing benefits for future public-sector workers.

Some officials are also calling for doing away with traditional defined-benefit pensions altogether for government workers and offering government employees retirement accounts similar to 401(k)s common in the private sector.

San Diego Mayor Jerry Sanders, for instance, is planning to ask voters in California's second largest city to approve a measure for a such shift to lower its costs.

"It's pretty unrealistic to think that we're going to have defined-benefit plans, at least on a local level," Sanders told Reuters in a recent interview.

You can download the report by the US Census Bureau by clicking here. The results are not surprising given that the S&P 500 gained 11.3% in Q3 2010. In other words, public pensions rode the beta wave higher in Q3 but still underperformed the broad market index (understandably so since they're not just invested in stocks).

What remains to be seen whether public pension funds can continue riding the beta wave higher in 2011. As a friend of mine told me today, "when everyone is bullish on stocks, they're usually wrong". My thinking is that this year will be all about alpha, with some beta juice in a few sectors. I'm recovering from Lasik eye surgery but will try to post my outlook 2011 this week.

Monday, December 27, 2010

Pension Pioneers?

Bruce Johnstone of the Regina Leader-Post reports, Pension Pioneers:

The province that introduced medicare and public auto insurance to Canada -- could soon be leading the way in pension reform as well.

The Saskatchewan Pension Plan, which has been around since 1986, may well be the model for the pooled pension plans that the country's finance ministers proposed last week in Kananaskis, Alta.

The federal and provincial finance ministers agreed to introduce legislation to allow the creation of pooled registered pension plans (PRPPs), targeted to employees of small-and medium-sized businesses.

The PRPPs would be 'low-cost' private pension plans that would be available to employees without a company pension plan or even an employer, in the case of self-employed people. Employee participation would be mandatory, unless the employee opted out of the plan.

The closest thing we have to a PRPP in Canada today is the Saskatchewan Pension Plan (SPP), a voluntary pension plan to which employees, self-employed individuals and/or their spouses can contribute up to $2,500 annually.

Originally designed for homemakers or self-employed people without access to a pension plan, in less than 25 years, the SPP has grown to more than $268 million in assets and 31,000 members.

"We're the 26th largest defined- contribution pension plan in Canada,'' said Kathy Strutt, general manager of the SPP, in a recent interview.

"We don't have the billions that the public employees pension plan or the co-op superannuation plan have. We're small compared to other government plans, but we're not small when you look at the DC (defined-contribution pension) world.''

Not bad for a pension plan based in Kindersley, where the SPP was relocated in 1990, with no sales force and, until recently, a $600 a year contribution limit.

Strutt said the changes announced earlier this month should help increase the profile and public participation in the SPP, which was developed and introduced by the Devine PC government.

With the increased contribution limit to $2,500 a year, participants could potentially save $100,000 over 30 years, based on an average six per cent rate of return, she said.

The SPP, which has an independently managed portfolio of stocks, bonds, real estate, mortgages and T-bills, has generated an average return of 8.4 per cent (12.7 per cent in 2009).

The $100,000 savings in the SPP could be turned into an annuity, which could pay $668 a month, or just over $8,000 per year, Strutt added. Participants can also roll the money into a registered retirement income fund (RRIF) or locked-in retirement account (LIRA).

In addition, the SPP payments are now eligible for the $2,000 federal pension income credit, which tax shelters the first $2,000 in annuity income. In addition, the SPP allows for income splitting between spouses.

"Spousal contributions are allowed,'' Strutt said. "That's not a huge part of our (pension plan business), but we do have 700 or more members who do make a spousal contribution.''

Strutt said the changes will benefit current plan holders, who have an average of $30,000 to $40,000 in their plans, but the real beneficiaries are those participants who are just starting out.

"Even at $2,500 (a year), it's not going to be a full work-based (income) replacement from some people ... But it's still a supplement and time is the best friend of a savings program.''

Dave Wild, chairman of the Saskatchewan Financial Services Commission, participated in the discussions in Kananaskis between the federal government and other provinces on the issue of PRPPs. And he agrees that the SPP could be the model for the roll-out of PRPPs across Canada.

"I think the SPP was heavily influential in developing the framework for the pooled (registered pension plan) arrangements,'' said Wild, who's also the province's superintendent of pensions.

In fact, Wild has been involved in a working group on "pension innovation" since June to demonstrate how pooled pension plans, similar to the SPP, could provide benefits to individuals without a company pension.

"Saskatchewan Pension Plan is broad-based," Wild said. "Any employer and any employee can participate."

Specifically, the SPP can cover employees of small and medium-sized businesses or self-employed individuals, who otherwise wouldn't have a company pension. "The SPP was developed to serve a niche that was not being well-served by the pension industry."

Of course, there are differences between pooled pension plans and the SPP, Wild added. Namely, pooled plans would tend to be privately operated by insurance companies, mutual fund managers, banks and other financial institutions, while the SPP is a public sector, non-profit organization, albeit operating at arm's length from government.

"They left the door open to other third-party administrators, which is where the SPP would fit in. But I don't think the finance ministers had a particular model in mind that was government-administered,'' Wild added.

"I don't know if we'll see something exactly like the SPP set up in other jurisdictions, but it's very close to the vision of the ministers -- to have a broad-based pooled arrangement, very easy for people to participate, very low cost,'' he said.

"Saskatchewan Pension Plan has got a number of features that the ministers found very attractive and would like to see replicated.''

Not everyone is convinced that PRPPs are the answer to the Canada's pension problems, however.

Deputy Liberal Leader Ralph Goodale said the concept of PRPPs is fine as far as it goes, but reform of the Canada Pension Plan (CPP) is still required.

"(PRPPs) provide a relatively small portion of the solution ... There are several other things that are bigger and more important," the Wascana MP and former federal finance mininster said last week. "Certainly, expansion of the CPP is the core piece."

Goodale note the previous Liberal federal government fixed the CPP in 1997 with changes to contribution limits and investment management functions, with the creation of the CPP Investment Board. But he conceded more changes are needed to bring CPP benefits in line with pensioners' current and future income needs.

While the CPP is actuarially sound and well-managed, most experts agree that CPP should be expanded, by raising the yearly maximum pension earnings (YMPE) to $60,000 or $70,000, or increasing the income replacement rate from 25 per cent to 30 or 35 per cent.

Currently, the maximum payout from the CPP is about $11,800 per year, which is roughly one-quarter of the average industrial wage of $48,000.

But even an expanded CPP would still need to have supplemental plans, like PRPPs and the SPP, that fill in the cracks the system. And the pooled pension plans provided a way forward for the finance ministers on pension reform, where the proposed CPP reforms did not.

"I really don't know where CPP reform will go,'' Wild said. "It's a bigger step (to reform the CPP) in that it's a mandatory program. (With) the pooled pension arrangements, there will be an encouragement of participation, but certainly it's not a requirement. No one can opt out of the Canada Pension Plan.''

"The pooled pension arrangement is more flexible, which I think is what allowed ministers to move forward on it, where they want to move a little more cautiously on CPP reform. It's a more serious decision, a complicated decision.''

Wild said the pooled pension plans also offer a lower cost alternative to CPP reform or private investment plans. "There will some interesting discussion around how we encourage low-cost pooled arrangements," Wild said.

"SPP is clearly a low-cost alternative in Saskatchewan. Whether the insurance industry or mutual fund industry will offer similar low-cost products is a point of debate.''

Is the Saskatchewan Pension Plan (SPP) the way forward? It has some advantages over private pooled registered pension plans (PRPPs), but I still think it can't compete with expanded CPP (or other large defined-benefit plans) in terms of fees, performance and governance. Importantly, the biggest drawback to this system is it's based on voluntary contributions. At a time when Canadians aren't saving enough for retirement, it's ridiculous to think that any defined-contribution plan will make a significant difference in bolstering the retirement system. I still maintain that bolder steps need to be implemented or we risk falling well short of meaningful reforms to our pension system.

Saturday, December 25, 2010

Dan Wallrath's Christmas Message

Christmas is a time for family and friends. It's also a time to reflect on how fortunate and blessed we are and to give to those who are less fortunate.

Last year, I wrote about Katie Piper's Christmas message. This year, I was touched by the kindness of a man called Dan Wallrath, one of the CNN heroes who builds free homes for wounded vets:
Alexander Reyes' boyhood dream of a military career ended when he was hit by an improvised explosive device during a patrol two years ago in Baghdad.

"Laying in that hospital bed ... sometimes I felt I'd rather [have] died," Reyes said. "My life came to a complete halt."

Reyes sustained severe blast injuries that led to his medical discharge; he's on 100 percent medical disability. Like many soldiers wounded in Iraq and Afghanistan, Reyes, now 24, found the transition to civilian life difficult.

But he and a handful of other injured veterans are getting help from what may seem an unlikely source: a custom home builder in Houston, Texas.

Dan Wallrath recently presented Reyes and his wife with an unexpected gift: a home built especially for them, mortgage-free.

"Thank you. That's all I can say," Elizabeth Reyes said, sobbing and clutching her stunned husband's arm as Wallrath surprised them with the house.

For Wallrath, giving wounded veterans a place to call home is his way of saying thanks. Since 2005, his organization has built four houses. Five more are under construction, and he's expanding his idea into a national campaign called Operation Finally Home.

Wallrath spent 30 years making upscale clients' dream houses a reality. But he found a new mission in 2005 when he met with Steve Schulz about a very different type of project.

Schulz's 20-year old son, a U.S. Marine, had been gravely injured in Iraq. Schulz desperately needed to remodel his house to accommodate his son's wheelchair.

"I had no idea how I was going to pay for it," Schulz said. "I just knew that I had to get it done."

Wallrath went to advise Schulz on remodeling his house as a favor to a friend. It was a meeting that changed Wallrath's life.

He remembers Schulz showing him photos of his son Steven.

"He was a big, strapping Marine," Wallrath said. But the pictures he saw of Steven taken after his injury told a different story.

"He was ... half his size. It was so sad," he said. "It dawned on me that people are facing this all over the U.S."

Wallrath mobilized an army of carpenters, plumbers and suppliers who took on the remodeling job for free. They widened doorways, built a ramp to the back door and made the bathroom handicapped-accessible.

"Anything that needed to be done, Dan said, 'We'll take care of it,' " Schulz recalled. "It was just a huge, huge relief."

When the work on Schulz's home was complete, Wallrath realized he was just getting started.

"It really broke my heart to think [about] these young men and women," he said. He decided the best way he could help wounded veterans was by doing what he knew best: building them homes.

"It was like someone hit me upside the head with a 2x4. ... I just felt like this is what God wants me to do."

He took his idea to his local trade group, the Bay Area Builders Association, and convinced members to start a home-building program for wounded veterans.

With donations from suppliers and contractors, Wallrath said, the group can build a $300,000 house for $25,000 to $50,000. Each house is fully furnished and customized to meet the needs of each family and is mortgage-free. The group also covers the taxes and insurance for two years.

Wounded veterans or their spouses often have to find a new career or go back to school, making it hard to make ends meet, Wallrath said.

"If you can alleviate a financial burden off these young kids where they can concentrate on rebuilding their lives, you can really make a difference," he said.

Lt. Erasmo Valles is one such story. As a Marine, he was injured by an IED in Iraq in 2004 and ultimately had one of his legs amputated. Returning to civilian life was hard, and his family rapidly burned through its savings.

"We'd saved money for rainy days, but ... it was raining," Valles said.

Receiving a home from Wallrath in November 2008 turned their fortunes around. Valles, 34, is now studying for his doctorate in public safety; his wife earned her master's degree and is now a special education teacher.

"It saved us," he said. "We're moving on and moving forward. ... For someone to think about me and my family ... to build a home -- wow. That's a hero."

Wallrath is determined to help as many families as he can. He's trying to enlist builders' associations across the country to join his crusade, with the goal of building 100 homes. His program got tremendous interest at an industry event in January, and it soon hopes to break ground on a house near Chicago, the first outside of Texas.

Considering the industry was hard-hit by the recession, Wallrath says he's been heartened by the response.

Now retired, Wallrath dedicates about half of his time to this effort without pay. He says it's the least he can do to repay some of the more than 30,000 troops who've been wounded in Afghanistan and Iraq.

"These kids ... they're doing it for me and you," he said. "So we're the ones that need to step up and do something."

Here is to Dan Wallrath and others who "step up and do something" for those in need. You don't need to be Bill and Melinda Gates to give back to your community. All it takes is a good heart, dedication to a cause you believe in and lots of selfless perseverance. I wish you all a Merry Christmas and Happy Holidays full of love, health and happiness.

Thursday, December 23, 2010

An Irrevocable Right to Benefits?

Lisa Fleisher of the WSJ reports, New Jersey Pension Gap Grows:

New Jersey's pension gap grew to $53.9 billion in the last fiscal year, up from $45.8 billion, thanks to market losses and a lack of state funding, according to figures released Thursday by the state.

The looming pension burden, largely ignored by the state for the past decade, has ballooned into a nearly unmanageable problem that will push state and local finances into a corner in coming years, dropping large bills in the laps of already strained taxpayers.

Gov. Chris Christie's administration said the gap, which reflected the state's investment positions as of June 30, highlighted the need for proposed cuts to current public workers' pensions.

The new calculations mean the state has 62% of the money it needs to pay retirement benefits promised to roughly 720,000 state and local workers over the next decade, down from 66% a year earlier. But the state is using an annual 8.25% rate of return, which critics say masks the problem by being overly optimistic

"As all states, they're getting it wrong," said Eileen Norcross, a George Mason University researcher who has studied New Jersey's budget and pensions. Using a 3.5% rate of return, she had estimated the previous liability at $173 billion.

For most of the past decade, New Jersey politicians from both parties have skipped required payments to the pension fund while giving increases in benefits to workers. Faced with a tight budget, Mr. Christie skipped a $3.1 billion payment this year, which experts said all but guaranteed a higher gap next year.

Mr. Christie, a Republican, wants to reverse a 9% pension bump workers received in 2001 under a Republican administration. A spokesman for Senate President Stephen Sweeney said he would work on changes that would "ensure workers who have been promised a pension get one," adding the governor needed to fund the pensions.

Unions argue their members have an irrevocable right to benefits they have earned, and the governor has said he will meet the unions in court. Public workers pay into their pensions at various rates—8.5% of salary for police officers and firefighters; 5.5% for teachers, state and municipal workers; and 3% for most judges.

"Once again, the Christie administration wants to make middle-class retirees pay the price for the disastrous consequences of reckless speculation and financial malfeasance on Wall Street, and for the legislature's continuing failure to fund the pension," said Bob Master, political director for the New York-area Communications Workers of America.

Mr. Christie in March signed a slew of pension and benefits changes pushed by Democrats but said they didn't go far enough. In September, Mr. Christie unveiled further proposals targeting current workers, including raising the retirement age to 65, requiring all workers to contribute 8.5% of their salaries to pensions, and eliminating cost-of-living increases.

In a statement, state Treasurer Andrew Sidamon-Eristoff said Thursday, "Unchecked, the cost of this impossible burden will fall not just on the taxpayers of today, but on future generations of New Jerseyans."

Average annual pensions for new retirees as of July 2009 were roughly $39,500 for state workers, $46,400 for teachers, $73,500 for police officers and firefighters, and $105,600 for judges.

So who is right, unions or the Christie administration? At this point, it doesn't matter. Yes, Wall Street's elite made off like bandits, squeezing the middle class once again. But Governor Christie, who spoke with 60 Minutes this past Sunday, is right when he says public sector workers and retirees will get little sympathy from private sector workers who saw their 401K plans implode in 2008. Moreover, with state budgets deep in the red, there is no money left to pay for public works projects, let alone generous public pension benefits. All stakeholders need to make concessions or risk deeper cuts down the road.

If I were the unions, I would use this as an opportunity to push for better governance at the large state public plans. And by better governance, I mean make sure that alignment of interests are there. As for state governments, they have little choice but to raise the retirement age, cut benefits, and partially or fully remove inflation protection on public sector pensions. They should also revise their rosy investment assumptions for state plans.

This may seem unfair and unreasonable to public sector workers, but to quote a strategist who I spoke with yesterday, "deleveraging sucks". You can't have pensions apartheid between the private and public sector. And there are no "irrevocable rights to benefits". Just look at the mess Greece and Ireland are in right now. When the money runs out, cuts are guaranteed.

That's one of the reasons why I was disappointed with the meetings at Kananaskis. A lot of people are looking at politicians with gold plated pensions asking themselves why couldn't they expand CPP and provide Canadians with a more secure retirement? I know, the critics will holler: "it's just another payroll tax". They're wrong and shortsighted and I'm embarrassed to say this is the best Canada could come up with -- another giveaway to banks and insurance companies. And who's going to end up bailing out PRPPs when they flop? Who else but Canadian taxpayers!

There was a time when Canada led the way in terms of health, education and social economic policy. Our leaders need to rethink expanding CPP. If you do it right, you'll bolster the private and public sector. But if you do it wrong, or introduce half-baked measures, you're better off not doing anything at all. I'm serious, I'd rather see no change than reforms that are doomed to fail.

***Update***

Read Mish's excellent comment on this subject.

Wednesday, December 22, 2010

Let's Be Creative With CPP?


Bob Baldwin, an Ottawa-based pension consultant and author of Pension Reform in Canada: A Guide to Fixing our Futures Again, writes in CTV, Let’s take the CPP – and be creative:

The outcome of this week’s Kananaskis meeting of finance ministers was not as clear as the Rocky Mountain air but more like a fog one might associate with the Prince Edward Island venue of the previous gathering. While a modest enhancement to Canada Pension Plan benefits is still on the table, it’s less clear now than in June what direction it will take.

There are two dimensions to the problem plaguing Canada’s retirement-income system: inadequate incomes of the future elderly relative to their working-life earnings, and inefficiency of the available means to save individually for retirement. Of the two, income inadequacy is the bigger issue, and research undertaken since the Whitehorse meeting of finance ministers in December of 2009 has improved our understanding of it. A study released last week found that more than 40 per cent of today’s 25- to 30-year-olds risk a significant reduction in their living standard after retirement.

That bigger issue must be addressed through initiatives that aren’t purely voluntary on the part of employers and individuals – that is, some form of compulsion or automatic participation must be involved. No experience in any OECD country suggests that we will significantly improve retirement savings or the coverage of employer pensions through voluntary means.

It’s not clear yet how compulsory the “framework for Pooled Registered Pension Plans” will be. Official statements and press accounts vary on this point. But it seems key details remain to be determined.

At this point, public statements by federal Finance Minister Jim Flaherty suggest that PRPP contributions won’t be designed to achieve a particular level of retirement benefit. It will be important to see whether individual participants in PRPPs can make preretirement withdrawals. Finally, weaknesses in managing investments by individual investors are well-documented, and the nature of the investment choices open to those enrolled in PRPPs remains to be seen. It also will be important to see what mechanisms are in place to ensure that the interests of the plan managers and plan participants are aligned.

Even if they were compulsory, it’s hard to imagine how the proposed PRPPs will achieve the administrative efficiencies of the CPP. It’s also unlikely that PRPPs can offer the degree of predictability of benefits provided by the CPP. The PRPP proposal looks more sensible as a supplement to a modest increase in CPP benefits rather than a substitute for it.

The huge advantage of using the CPP’s legal and organizational structure is that it can provide pension benefits to whatever portion of the employed and self-employed one wants to reach. Simply increasing the CPP benefit rate and/or ceiling is rather blunt, and less well-targeted than a CPP reform should be. In a study published by the Institute for Research on Public Policy last week, I suggested we should develop a second tier of the CPP that should apply to earnings over $25,000 and extend beyond the current ceiling of $47,300. Tier 2 should only be compulsory – or feature automatic participation with the right to opt out – for those employees not already belonging to a workplace pension plan that meets some minimum standards.

Virtually all proponents of pension reform want reforms to be fully funded. If ministers further delay pension reform, it will be increasingly difficult to meet retirement-income objectives in a timely way on a fully funded basis since phasing-in new benefits will take a very long time. Also, until the fate of the CPP is clearer, it will be hard to advise Canadians on whether participation in a PRPP makes sense.

This is an excellent editorial. Bob Baldwin has been a board member at PSP Investments for over ten years. I had the pleasure of meeting him on several occasions and he understands the core issues around pensions and why Canada desperately needs pension reform.

Others have raised concerns. Jim Murta wrote an excellent comment on his actuarial blog which he appropriately titled The Pension Gift. Jim also sent me the press release from the Canadian Institute of Actuaries (CIA) which "regrets that expectations for the meeting of finance ministers in Kananaskis were not achieved". It truly was another squandered opportunity and it will end up costing Canadians billions down the road.

Tuesday, December 21, 2010

'Career Average' to Replace Final Salary?

The BBC reports, Public pension schemes 'should be career average':

Lord Hutton's review of public sector pension schemes has been urged to recommend they be changed to career average schemes.

The National Association of Pension Funds (NAPF) says such a switch would be the best way to keep the schemes going in the face of rising costs.

It would also protect the interests of lower-paid workers, the NAPF said.

Most public servants are in better final-salary schemes, whose costs are rising due to increasing longevity.

Review

Lord Hutton indicated he would recommend this policy when, in October, he published his initial findings on the future of the pension schemes.

His independent commission, set up by the coalition government, covers staff in the civil service, NHS, local government, education, police, armed forces and fire service.

Lord Hutton's first recommendation was that members of most of these schemes should pay higher contributions.

The government has said it will adopt this policy, with contribution rates likely to go up by an average of 3% of salary.

"Career average pensions are the most promising option for providing a sustainable, affordable and fairer public sector pensions system," said Joanne Segars, chief executive of the NAPF.

"While it will reduce the costs of public sector pensions, it will also protect lower-paid workers who don't usually have significant salary spikes late in their careers," she added.

The idea was supported by the London Pension Funds Authority (LPFA), which runs the local government pension scheme for councils in London.

"The conclusion we have drawn is that there is a need to share risk more effectively between members and employers," said the association's chief executive Mike Taylor.

"We believe the CARE [career average] system is the most appropriate solution to achieve this."

Cheaper

A final-salary scheme pays a pension based on both the number of years for which a worker makes contributions, and their final salary at retirement.

A career average scheme is fundamentally different.

A worker's pension builds up as a proportion of each year's salary during their employment.

In most cases, this means the pension paid out will be significantly lower than in a final-salary scheme.

As such, career average schemes are much cheaper for employers to finance, which is why Lord Hutton, and now the NAPF, have come out in favour of them.

At the moment, the only significant career average scheme in the public sector is the one that has been open since 2007 for new recruits in the civil service.

The universities' scheme - not part of the Hutton review - is currently considering making a similar change for new staff.

Lord Hutton will publish his final report in time for the 2011 Budget and has received 137 submissions.

In October, he acknowledged that the future cost of paying for the public sector schemes - all of which are paid out of taxation, apart from the local government scheme - had already been cut by as much as 25%.

Among the typical changes already in place have been the introduction of a higher pension ages for new recruits.

The government is also about to enforce a lower level of inflation-proofing for all public schemes by moving from the use of the retail prices index (RPI) to the slower rising consumer prices index (CPI).

I'm not going to debate the pros & cons of final salary versus career average pension schemes, but it's obvious that policymakers in Britain are looking to make cuts to pensions and this, along with the switch to CPI, are all part of the measures they're introducing now.

The US is also taking note as many states are struggling to cope with their own ballooning pension costs. CBS's 60 Minutes had a segment on the municipal bond market this past Sunday which took a close look at the financial mess plaguing many states (see videos below or click here).

Will a collapse in the municipal bond market be the next major hurdle? Who knows? But I can guarantee you the Fed and the US government will do whatever it takes to avoid any collapse of the municipal bond market. In the meantime, pension reforms will continue around the world, and many policymakers will be looking at Britain to see how their reforms are working out and whether they can bolster their pension system now that the day of reckoning has arrived.

Part 1:


Part 2:

Monday, December 20, 2010

Canadian Pensions Still Treading Water

Jonathan Chevreau of the National Post reports, Flaherty leans toward pooling:

Finance Minister Jim Flaherty has surprised pension reformers by dashing hopes for an expanded CPP in favour of Pooled Registered Pension Plans. While modest expansions to the almost universal CPP may yet be in the cards, PRPPs are aimed squarely at the 3.5 million middle-income private-sector workers and self-employed who lack employer-provided pensions.

In principle, the idea of “pooling” pensions among multiple small employers makes sense. PRPPs are in essence group RRSPs or Defined Contribution RPPs but relieve employers of the administrative burden, says Fred Vettese, chief actuary at Morneau Sobeco. The burden shifts to a third-party administrator.

One reason only a third of private sector workers now have employer pensions is the complexity of set-up and administration. Classic Defined Benefit (DB) plans are notoriously complex because providers must deal with solvency issues, surpluses and onerous regulations. No surprise that small businesses and entrepreneurs often choose to provide no pension at all, leaving workers to make their own RRSP contributions or — just as likely — no contributions at all.

Smaller firms that take the plunge are confronted with high-cost solutions, similar to what RRSP investors face buying mutual funds. One benefit cited by Finance’s draft, Framework for Pooled Registered Pension Plans, is “enabling more people to benefit from the lower investment management costs that result from membership in a large, pooled pension plan.” If annual fees are lower by 1%, resulting pensions will be 20% higher, Vettese says. Thus, PRPPs “have the potential to change the pension landscape more dramatically than one might think.”

There are major differences. CPP is compulsory and provides a DB-style pension that gives workers a known future income. The PRPP is voluntary and Defined Contribution in nature, meaning market risks are borne by workers if stocks fall.

There’s room for both, says Mercer partner Malcolm Hamilton. A small gradual rise in CPP contribution rates over five years wouldn’t do much harm if imposed on workers rather than employers, he says: “If we want Canadians to save more for retirement we must accept that they will have less to spend.” But to the extent the PRPP encourages more workers to participate in low-cost retirement savings plans, it too is “worth trying,” he says.

There are “major challenges” either way, says Towers Watson senior consulting actuary Ian Markham. Both build on existing efficient frameworks. Ideally, PRPPs will be established through a single federal legislative framework. Markham worries about the higher CPP premiums employers or employees (or both) might face under an expanded CPP. He says there’s only so many extra deductions employers can load onto payrolls before they look to cut back on employee pay — including existing DB or DC pension arrangements.

One benefit cited by Finance is portability of benefits. Another is the “fiduciary” duty for pension administrators. In theory, that should provide peace of mind to employees that their interests are being put ahead of the firms managing the money.

Employers still have a major role. If they choose to offer PRPPs, they can make “direct employer contributions to the plan,” the draft document states, “along with remitting contributions from the employee.”

That doesn’t sound more onerous than the payroll function firms of all sizes must in any case provide. Doug Carroll, vice president of tax at Invesco Trimark Ltd. says this may help investors save who otherwise might not: “Automatic payroll deductions keep cash out of sight and out of mind,” while pre-tax payroll deductions let the gross amount of contributions be invested every pay period. By contrast, lump-sum RRSP deposits are often made with after-tax dollars after tax returns are filed.

The biggest drawback is PRPPs are voluntary for both employers and employees. Pension consultant Keith Ambachtsheer says “both empirical evidence and common sense tell us the purely ‘voluntary’ uptake of these PRPs will be minimal.” He views the initiative as less than serious reform and more a “PR exercise/financial services sector business opportunity.”

Susan Eng, vice president of advocacy at CARP says it’s is better than nothing because it does “a few good things.” Large pooled funds provide better returns than individuals can achieve on their own and the massive marketing likely to accompany it may encourage more Canadians to save. But she’s skeptical banks and insurance companies will keep fees as low as they suggest, or that they’ll truly do what’s best for clients (as required by a fiduciary standard).

Ottawa previously resisted such plans, Eng says, because RPPs cost the treasury tax revenue. But the more Canadians save inside such plans, the less they can contribute to RRSPs so to some extent it’s a wash.

Add the PRPP to either an existing or expanded CPP as well as the new Tax Free Savings Accounts launched in 2009 and Canadians who fail to save for retirement will have only one party to blame: Themselves.

I also have my doubts on the ''fiduciary standards'' of PRPPs and I agree with Keith Ambachtsheer, this was a less than serious reform to our pension system and just another giveaway to the banks and insurance companies.

Don't get me wrong, I got nothing against banks and insurance companies, but let's get serious on pensions. Like healthcare and education, I consider pensions a public good. I truly believe that policymakers should implement changes that try to cover as many Canadians as possible so they can retire with a secure pension. You simply can't compare RRSPs, defined-contribution (DC) plans or PRPPs to a well run defined-benefit (DB) plan.

What would have been a better solution? I had a discussion with a colleague and he mentioned that they could have used the insurance companies' and banks' distribution to offer products from large DB plans. ''After all, that's all that banks and insurance companies really have: distribution.''

Bill Curry and Karen Howlett of the Globe and Mail report, New pension plan would require employers to offer it but allow opt-out:

Canada and the provinces endorsed a new Pooled Retirement Pension Plan Monday, promising to address concerns about yet another voluntary savings option by forcing employers to offer it to their workers.

Finance Minister Jim Flaherty also agreed to keep talks alive on enhancing the Canada Pension Plan – which involves mandatory contributions – and promised an update in June.

Quebec and Saskatchewan agreed to the extended talks on CPP reform, leaving Alberta as the only province that is solidly opposed to the idea.

Advocates of enhancing CPP benefits through a phased-in increase in premiums have recently argued that it is the only way to ensure those who aren’t saving enough for retirement will start putting money away.

The criticism of the pooled system was that it was voluntary, and therefore unlikely to make much more of a difference to retirement savings than existing savings programs such as RRSPs.

But Mr. Flaherty argued that by forcing employers to offer the new PRPP – without forcing them to contribute – and by forcing employers to automatically enroll workers into the system with an opt-out provision, millions more Canadians will start putting away extra cash for retirement.

But employees, who under CPP must match employer contributions to the plan, would be under no obligation to contribute to PRPP.

“The real benefit of it will be seen many years down the road,” said Mr. Flaherty. “We think the PRPP will, to a significant extent, address the savings issue.”

Quebec’s Finance Minister Raymond Bachand noted his province has offered multi-employer savings plans for years, but the mandatory aspects of the PRPP will make a big difference.

“This will increase participation by an enormous amount,” Mr. Bachand said.

While Mr. Flaherty and Mr. Bachand stressed the mandatory parts of the plan, not all provinces have agreed to those details. That will be worked on over the coming months, with the expectation that a final plan will be ready in the “short term.”

The PRPP is aimed at workers who – either because they are self-employed or because they work for a small company that does not offer a pension – do not currently participate in a payroll-based pension plan.

Proponents expect that through regulations and new federal and provincial laws, governments can ensure that the private sector firms offering the pooled pensions will offer lower management fees than those currently available. The hope is that these workers will then be able to take advantage of the investment benefits that came with participating in a large pension fund. Ministers also said the pension will be portable when workers change jobs.

Ontario Finance Minister Dwight Duncan said he supports the PRPP but was pleased to see talks will continue on CPP enhancements.

“We don’t think that’s the whole enchilada,” he said of the PRPP. “We need more.”

Susan Eng, VP Advocacy at CARP, brought to my attention that there is no auto-enrollment requirement in the federal proposal forcing mandatory contributions. It's odd that Minister Flaherty emphasized this requirement. (Read CARP's statement, Pension Opportunity Missed).

Moreover, I strongly doubt PRPPs will make a significant difference in the savings rate down the road. And I repeat, PRPPs cannot compete with the large defined-benefit plans that already exist. The latter exhibit better performance, their fees are lower and their governance standards are way better.

The point on fees was made in Paul Vieira's article in the National Post, Pension rule changes may be key to success:

The debate among country’s key policymakers over what measures would best secure Canadians’ retirement income may be missing one key point.

Ottawa and the provinces discussed the merits of an expanded Canada Pension Plan over a pooled registered pension plan (PRPP), recently pitched by Finance Minister Jim Flaherty as the way forward. At the end of a full day of meetings on Monday in Kananaskis, Alta., there was a tentative agreement to study the benefits a pooled scheme can deliver.

There was little talk, though, about possible changes to pension rules that would make it easier for Canadians to contribute for retirement.

Experts suggest unless such changes are on the table — they would, in essence, remove limits to annual contributions, place less restrictions on what type of income can go into a retirement savings vehicle and help level the playing field between RRSPs and gold-plated defined-benefit plans — then all the pension-reform talk might be for naught.

“Structurally, there is nothing wrong with the pooled pension arrangement. And there could be an expansion of CPP along with that. But this is absolutely not a solution to the pension saving problem in Canada,” said James Pierlot, a Toronto-based lawyer and pension consultant who proposed in a 2008 paper the private pooled scheme Mr. Flaherty is now championing. “This is a rearranging of the deck chairs on the Titanic.”

Mr. Pierlot recommended pooled pensions, to be managed by banks and life insurers, as part of a larger package that included amendments to pension tax laws. For instance, tax rules don’t allow individuals to choose how much of their total annual compensation they will allocate to retirement saving (capped at 18%) and when - in essence penalizing workers when they make big income gains in a particular year.

But such changes are not under consideration, at least not yet. Mr. Pierlot said that’s because governments would sustain a short-term hit to cash flow as the incentive to save improves.

“If you have a budgetary deficit do you really want to solve the pension problem, which would necessarily see a lot more deductible contributions going into these plans? This is the elephant in the corner of the room,” he said.

Even though there was a tentative agreement to look at the pooled pension scheme, no final decision on how to proceed with pension reform is expected for years. And the debate still rages on after years of blue-chip panels, and myriad recommendations via academics and think-tanks.

Still, pension watchers, such as William Robson, president of the C.D. Howe Institute, and Jack Mintz, head of the public policy school at the University of Calgary, said an eventual combination of private pooled management and “some” improvement to the CPP — by, for instance, making defined-benefit arrangements more available — could help address future retirement-income needs.

“There’s no reason why you can’t do both,” Mr. Mintz said.

Six provinces, led by Ontario, have pushed for an enhanced CPP, and Mr. Robson noted that’s to their benefit because it would remove political responsibility to do something.

Still, any plan to boost CPP comes with consequences. Certainly it will lead to higher contributions from employers and employees, or an increase in payroll taxes -- a risky move in a decade most economists argue will be dominated by slow growth.

“One way or another the mechanics have to work through into wages, or else there is going to be job losses,” Mr. Robson said. “And the money has to come from somewhere.”

In addition, increased contributions would disproportionately penalize lower-income earners, as they would be left with less disposable income and the income they could draw at retirement could conceivably be clawed back.

As for the pooled scheme, the biggest criticism is relatively high management fees charged by banks and insurers will eat into returns. And Mr. Pierlot said data from recent years indicate the returns from defined-contribution plans and RRSPs have lagged those of large defined-benefit plans, whose fees tend to be “much lower” than those charged by financial institutions.

Finally, just to underscore the challenges we face with pensions in Canada, CTV reports, Pension plans treading water:

Canada’s pension plans are “running in place” and struggling to return to financial strength despite two years of strong market returns that have bolstered the value of their holdings.

The culprit is falling interest rates, which are offsetting – even outpacing – the improvement in investment returns on pension plans’ assets.

The result, pension experts say, is that many major plans are still grappling with significant financing deficiencies at the end of 2010, and companies are still facing new obligations to put more cash into their plans, more than two years after stock markets fell sharply in 2008.

“Pension plans are running in place,” said Paul Forestell, senior partner at pension consulting firm Mercer. “As interest rates go down at the same time assets go up, the funded position doesn’t move.”

Federal and provincial finance ministers wrestled with similar issues affecting government pension plans in a meeting in Kananaskis, Alta., and have agreed on a framework for a pooled private-sector pension plan for small firms and the self-employed.

Many of Canada’s biggest companies are coping by plowing cash into their pension funds to make up shortfalls. Some payments are being made ahead of the required schedule for eliminating shortfalls because companies have available cash.

BCE Inc., for example, announced this month that it will make a voluntary $750-million payment to its employee pension plan, on top of a regular required payment this year of $500-million. The company, parent of Bell Canada, said its estimated pension solvency deficit of $2.4-billion at the end of 2010 will be reduced to $1.6-billion as a result of the special payment.

BCE’s chief financial officer Siim Vanaselja told analysts that the company decided it makes sense to speed up funding of the pension plan, given the sustained low interest-rate environment in Canada.

“We believe it’s prudent to address permanently our pension deficit,” he said. “By making what should be a final special contribution, we’ve set a clear path to eliminating altogether any deficit funding obligations for Bell by the end of 2014.”

Canadian National Railway Co. has similarly said it will put $430-million into its pension plans this year – including a $300-million additional voluntary contribution above required levels. The company said it wanted to strengthen the financial condition of its primary employee plan.

The ongoing funding problems are linked directly to falling bond yields.

Pension plans have two sides to their funding equation. One is the value of the plan’s assets, which are investments made to finance pensions for retirees. On that front, plans have posted strong returns for the past two years. In 2009, for example, a typical plan earned returns of 16 per cent. In the first 11 months of 2010, plans earned about 7 per cent on average.

The problem lies on the other side of the equation with the pension liability, or the estimated cost of financing the plan’s future benefits. Those liabilities are calculated using bond yields, and are highly sensitive to even small changes in interest rates. As rates fall, more money needs to be in the pension plan to cover future costs, because it is assumed long-term returns will be lower.

Pension specialist Ian Markham at consulting firm Towers Watson says a one-percentage-point drop in interest rates typically causes a plan’s liabilities to rise by about 15 per cent – creating a huge hole in a plan’s funded status.

He estimates that a typical plan earned a return on its investment portfolio of about 7 per cent in the first 11 months of 2010, while plan liabilities have climbed about 15 per cent on an accounting basis for financial statement reporting.

That means many companies are going to be reporting a bigger pension deficit at the end of 2010, and will face increased funding costs from a financial statement perspective.

Companies also measure pension liabilities on a so-called solvency basis, which measures how much money is needed to be in the pension plan under the assumption that the company would go out of business immediately and freeze pension contributions.

On a solvency basis, Mr. Markham said liabilities have climbed about 7 per cent so far this year, which means the funded ratio of a typical plan is not worse, but has also not improved in 2010, despite better market returns.

Either way, the decline in interest rates is whipsawing companies who are trying to budget for future pension-plan costs.

“These are very dramatic changes that are taking place,” Mr. Markham said. “Unfortunately, the trend has been toward lower and lower long-bond yields, as the markets believe that inflation is going to remain relatively low.”

While statistics for 2010 are not available yet, numbers for 2009 compiled by Mercer show that the 111 companies with defined-benefit plans in the benchmark S&P/TSX composite index contributed a total of $8.5-billion to their pension funds last year. They still had pension shortfalls totalling $13.6-billion at year’s end.

Mr. Forestell said that while companies are looking at longer-term solutions such as changing their investment strategies or closing their plans to new members, in the short term, most must put even more cash into their plans to address immediate funding problems.

“The only thing that will fix the problem quickly is an increase in interest rates,” Mr. Forestell said. “But I always tell my clients that will fix your pension problems – but what does it do to the rest of your business?”

What worries me is that funding problems will only get worse and many companies will be forced to cut defined-benefit plans altogether. And then what? PRPPs to the rescue? I guess we're going to have to learn the hard way that when it comes to pensions, the private sector solution is really not a long-term solution at all. It's a shame that our policymakers squandered yet another opportunity for meaningful pension reform. Canadians deserve much better than these half-baked measures.

Sunday, December 19, 2010

Provinces Call for CPP Expansion

The Globe and Mail reports, Provinces call for CPP expansion ahead of finance ministers' meeting:

Federal Finance Minister Jim Flaherty is expected to face resistance over pension reform when he meets with his provincial and territorial counterparts Monday, with a group of six provinces calling on Ottawa to reverse course and expand the Canada Pension Plan.

Mr. Flaherty said last week he won't be proposing any expansion to the CPP because not all provinces were on board. Instead, he'll be pushing a new private-sector plan allowing small firms, employees and even the self-employed to pool resources on new, low-cost pensions.

But the finance ministers of B.C., P.E.I., Nova Scotia, New Brunswick, Manitoba and Ontario issued a joint statement Sunday asking Flaherty to keep CPP expansion on the table.

“Making progress on a moderate expansion of CPP is important for the long-term adequacy of Canada's retirement-income system,” B.C.’s finance minister, Colin Hansen, said in the statement.

“We need to keep moving forward in determining what that expansion should look like.”

The provinces said the federal government should phase in a “modest,” fully-funded expansion to the CPP, and make changes to provide more Canadians with low-cost pensions.

They said they weren't opposed to Mr. Flaherty's private-sector proposal, but insisted it shouldn't preclude Ottawa from also improving the CPP.

Mr. Flaherty's comments last week have prompted criticism from opposition parties, provincial governments and the labour movement.

The president of the Ontario Federation of Labour, Sid Ryan, has described Flaherty's comments as a “last minute betrayal.” On Friday, Ryan was among a group of protesters who occupied Flaherty's constituency office in Whitby, Ont.

Ontario's finance minister, Dwight Duncan, said last week that not expanding the government-backed pension system was a “serious mistake,” and he noted that Alberta appeared to be the lone holdout in supporting such a move.

In Sunday's statement, Mr. Duncan said Ottawa shouldn't choose between the CPP and private-sector pension reform.

“The CPP provides a secure, fully indexed, defined benefit pension to virtually all working Canadians,” he said. “While we fully support more private-sector pension innovation, it should not be used as a reason not to make progress on CPP.”

Mr. Flaherty wasn't immediately available for comment on Sunday to the provincial news release.

The federal finance minister has described the proposed private-sector pensions as a “Pooled Registered Pension Plans,” which, at the earliest, could be in place by the end of 2011.

Under the federal proposal, the pooled, low-cost plans would be based on defined contributions. They would be available to any type of employee, as well as the self-employed.

Ottawa and the provinces have been discussing how best to reform the country's retirement income system for well over a year.

Last June, the provincial and federal governments said they would look at a three-pronged reform: financial literacy, regulatory changes to give the private sector more freedom to offer low-cost savings options, and gradually enhancing the CPP.

I agree with Mr. Duncan, all Canadians should enjoy the benefits of a secure, fully indexed defined-benefit plan. Also, it's important to note that the federal government does not have the final say on CPP expansion. The provinces collectively have a say on changes to the Canada Pension Plan.

Finally, the Calgary Herald reports that Alberta Finance Minister Ted Morton will also be pushing for Ottawa and the other provinces to drop investment taxes he says have unfairly been levied on Albertans:

In a number of recent letters, Morton has asked federal Finance Minister Jim Flaherty to suspend both the GST and other provinces' harmonized sales tax (HST) on investment management services.

Since the HST came into effect for financial services in both Ontario and British Columbia last July, he said Albertans - who have no HST or provincial sales tax - are at times being forced to pay another provinces' taxes as they save for retirement.

"Taxes being levied in Ontario are being collected from Albertans," Morton said. "We will not accept Albertans having to pay provincial sales tax ... when they're purchasing services here in Alberta."

In letters, Flaherty has told Morton residents of Alberta - or Canadians from other non-HST provinces - are not included when determining the amount of HST charged on a mutual fund, and "investors in non-harmonized provinces are not unduly affected."

However, Morton said in many cases mutual funds take a "blended" approach, flowing their HST costs out to all investors in the pool equally. At times, Albertans and other non-HST provinces are lumped in with HST-province investors, particularly Ontario where most of Canada's investment management services companies are headquartered.

He said examining the situation for Albertans made him realize it's not a wise course to charge any consumptive tax on services meant to spur Canadians to save more. It's contrary, he said, to the whole push to boost the retirement income of Canadians.

"Why the heck are we turning around and then levying a tax on financial services which Canadians use to build savings?" Morton said.

It's unclear what support the Alberta minister will receive among his counterparts and Flaherty today - he acknowledges it's a non-issue for those provinces that have an HST.

However, his plan will likely garner broad support in the financial services industry.

Patrick Farmer of EdgePoint Wealth Management Inc. said his company has already established specific no-HST series funds for people in non-HST provinces, including Alberta, Saskatchewan, Manitoba, Quebec and Prince Edward Island. He said it makes the cost of investing significantly less in those provinces.

Farmer said that Morton's plan to cut the taxes is a good idea.

"At a time like this, when investors over 2008 had a very difficult year, and many of them are closer to retirement, the last thing you want is to be taxing savings," he said.

While Morton intends to bring the HST/GST debate to the table, today's meeting in K-Country will likely be dominated by discussions over Flaherty's surprise announcement last week to move to establish a new private-sector pension system. Flaherty also quietly dropped his earlier strategy in addressing what many believe is a looming retirement-income crisis for Canadians, which was to expand the Canada Pension Plan.

The move toward defined contribution Pooled Registered Pension Plans (PRPPs) has outraged unions and other public sector advocates.

On Sunday, the Alberta Federation of Labour held a protest outside the Delta Calgary Airport hotel as the finance ministers left to Kananaskis for the federal-provincial summit. Dressed as Santa, president Gil McGowan and a couple dozen others urged the ministers to reject the "lump of coal" plans for the private pension plans.

But the plan has been welcomed by financial and investment institutions, as well as Alberta, which has long been pushing for a private, targeted solution for the self-employed and middle income earners without pensions.

"We think again that any increase in the CPP is unnecessary," Morton said. "Anything you add to the CPP in terms of benefits obviously entails increasing payments. And not just employee payments, but employer payments."

Morton argues that companies, who can choose whether they offer PRPPs or not, will choose to participate to retain employees.

"If employees have a choice between working for companies that have some type of registered pension plan and ones that don't, other things being equal, most of them would take the registered pension plan."

But the debate hasn't died down.

Ontario's Finance Minister Dwight Duncan has said he approves of Ottawa's private plan, but is worried it will come at the expense of a "modest" expansion of CPP to ensure financial stability for Canadians in retirement.

Simon Fraser University professor Jon Kesselman, who focuses on public policy and finance, said the new federal plan ignores the fact that many businesses have already been eliminating or downsizing their company-sponsored pension plans.

"If it's a competitive advantage, why aren't they (companies) doing it now?" Kesselman said. "It puts it all back on the worker."

Kesselman said even though the PRPPs will be available to individuals on their own, most people don't know how much they need to save for retirement, don't have the investment skills, and using conventional approaches, find there's a big drag on returns due to Canada's high investment management fees.

"The returns for the individual investor are much less than the returns for the market as a whole, I presume meaning that it's the institutional investors and the wealthy individuals who do better than average," Kesselman said.

On the other hand, the CPP has lower operating costs, skilled managers and can invest anywhere in the world, he said.

In his letter to provincial ministers, Flaherty noted that today's meeting will also address provincial progress on accommodating the needs of potential Registered Disability Savings Plan (RDSP) beneficiaries with intellectual disabilities who lack contractual competence, and are prevented from opening a plan because they don't have a legal guardian.

I have my thoughts on the Registered Disability Saving Plan. They should increase the limit to $500,000 and make them more available and more flexible, forcing all financial institutions to advertise them so clients with disabilities or parents with disabled children are aware of this saving plan. For example, older parents with a disabled teenage or adult child should be able to transfer money out of the RRSPs right into a RDSP without any penalties instead of being forced to transfer it into a RRIF account. Even better, just have CPPIB or some other plan like HOOPP manage RDSPs for disabled Canadians so that they don't have to worry about managing this money (same problem as defined-contribution plans!).

Friday, December 17, 2010

Backlash Grows Against Pension Proposal

Following up on my last comment on the showdown in Kananaskis, Richard J. Brennan and Les Whittington of the Toronto Star report, Backlash grows against Flaherty’s pension proposal:
Two dozen protestors barged into Finance Minister Jim Flaherty’s office in Whitby on Friday as a backlash against his latest pension proposal gathered force.

“We’ve been betrayed,” Ontario Federation of Labour President Sid Ryan said as labour and community figures occupied Flaherty’s constituency office.

Ryan said the labour movement was angered by the Harper government’s surprise decision to opt for a private sector solution to the country’s pension problems rather than enhancing the Canada Pension Plan, as Flaherty had previously proposed.

Unlike the CPP, the new Pooled Registered Pension Plan, or PRPP, would be a voluntary scheme administered by the financial industry.

Ryan said the voluntary plan unveiled Thursday would do little to help solve a situation in which nearly one-third of Canadian families lack any pension savings.

“What Flaherty is proposing is a glorified savings plan — a gimmick to get the issue of pensions off the front pages,” Ryan said in a telephone interview.

Neither employers nor workers would be required to pay into the PRPP, Ryan said. “It will not deliver income security for Canadians the way an expansion of the CPP will,” he said.

Flaherty was in St. John’s for pre-budget consultations and, after several hours at the office, Ryan said the protestors were about to leave to ensure there would be no confrontation with police.

“We’ll be back,” Ryan said. “This will be the first of many protests across the country.”

The fractious issue of pensions has been gathering steam for more than a year and is likely to come to a head when Flaherty meets with his provincial counterparts in Kananaskis, Alta., on Sunday and Monday.

After studying Flaherty’s pension proposal for a day, Ontario Finance Minister Dwight Duncan on Friday lashed out at the federal government, accusing the Conservatives of misleading the country on a matter of importance to all Canadians.

“We just think this is a terrible decision for Canadians and a bad decision overall,” Duncan told the Toronto Star Friday.

“The real story here is that they (the federal Conservatives) are clearly flip-flopping and breaking the commitment they made (in June).

“They basically misled us.”

Last summer, Flaherty said he agreed with a majority of provincial governments that a slight increase in CPP premiums would be the best way to help Canadians save more for retirement.

Duncan said Flaherty can expect trouble if he asks the provincial finance ministers in Kananaskis to endorse his new pension proposal.

Duncan said he had been in touch with other provinces and “I can tell you that a number of provinces are surprised” that Ottawa has turned its back on CPP enhancements.

Ontario and other provinces “are going to continue to fight for enhancements to the CPP,” said Duncan, who suspects pressure from the business community forced Ottawa to abandon its promise.

Flaherty’s proposed PRPP would provide a lucrative new source of business for life insurance companies and other financial institutions.

Ontario and most other provinces have recommended a “modest” increase to CPP premiums over a period of time, but Prime Minister Stephen Harper rejected that out of hand Thursday.

Canadian Labour Congress President Ken Georgetti said he was astonished and disappointed with Flaherty’s new proposal.

“Everybody knows that the best way to ensure the retirement security of Canadians is to enhance the CPP,” Georgetti said. “There is overwhelming evidence that the private sector, voluntary system of saving for retirement has failed us for over 40 years and won’t work now.”

Susan Eng, vice-president of advocacy for CARP, an advocacy group for older Canadians, said its members welcome any moves to provide a long-awaited improvement in pension security.

But she said Flaherty, in exchange for providing a new source of business to financial institutions, must demand commitments not to gouge pension savers through high administrative fees. To protect the public, there should also be guarantees to ensure benefit adequacy and ethical performance by administrators, she said.

“You’re about to hand some billions of dollars in business over to a monopoly” of banks and insurance companies, Eng said in an interview. “So, before you hand over all this business, let’s talk about some regulations.”

Susan Eng forwarded me CARP's response to the new pension proposal. Most of CARP's members are worried about their retirement, and rightfully so.

The Montreal Gazette reports that in the shifting alliances of Canadian federalism, Quebec is siding with Alberta and the federal government in opposition to higher pension benefits to be paid by the Canada and Quebec public pension plans because that would also mean raising payroll deductions for taxpayers:

Ontario and the remaining provinces want improved Canada Pension Plan benefits, and on another federal-provincial front, Alberta and Quebec stand opposed to the federal Finance Minister Jim Flaherty’s proposal for a Canada-wide securities regulator.

On Sunday, the issue of the single securities regulator will be on the agenda when finance ministers from the 10 provinces and three territories gather in Calgary.

Then on Monday in Kananaskis, west of Calgary, pension reform, renewal of the equalization financial transfers from Ottawa to the provinces, as well as efforts to return to a balanced budget and monetary policy will be on the agenda when Flaherty joins the 13 provincial and territorial ministers.

“For Quebec, the renewal of the federal transfers in 2014 must be based on the facts to establish federal transfers that adequately meet the objectives of all partners in the federation,” said Quebec Finance Minister Raymond Bachand.

The federal government has hinted that balancing its budget could mean lower federal transfers.

In his budget for the current year, Bachand can count on $15.3 billion in federal transfers, including $8.6 billion in equalization payments.

On the pension issue, Quebec is proposing that “more work is needed” on finding ways to improve the retirement income of Canadians, sharing the concern of Alberta that higher contributions of the Quebec pension plan would have a negative impact on the economy.

The Régie des rentes du Québec, Quebec pension plan, is the equivalent of the Canada Pension Plan in the other provinces, paying generally the same benefits and charging similar premiums.

In Kananaskis, Quebec will side with the federal government on its proposal to encourage the creation of private-sector, multi-employer pension plans, meant for small businesses and the self-employed, who now have no private pension plan.

Bachand is calling on the federal government change its legislation and financial regulations to allow the creation of large-scale multi-employer pension plans, to assure lower costs for the participants.

“That will send a clear signal of its willingness to improve rapidly the system of pension income in Canada,” Bachand said.

I'm all for larger scale multi-employer plans, but again, they simply cannot compete with large defined-benefit plans like the CPPIB or the Caisse. Not in fees, not in performance and more importantly, not in governance. Both Mr. Flaherty and Mr. Bachand will enjoy the benefits of a secure pension managed by the Public Sector Pension Investment Board (federal government employees) and the Caisse de dépôt et placement du Québec (Quebec civil servants). Why shouldn't hard working Canadians from all provinces enjoy the same benefits?

Finally, Jonathan Chevreau of the Financial Post reports that on Friday, the C.D. Howe Insitute released a 21-page study entitled Canada’s Looming Retirement Challenge: Will Future Retirees Be Able to Maintain Their Living Standards upon Retirement? (Click here for full report):

It finds Canada’s retirement system “has supported post-retirement consumption relatively well, especially for lower-income individuals and those who reached retirement age in the last 20 years.” However, it is more worried about the prospects for the prospects of younger workers once it’s their turn to retire. It says “the proportion of retirees without the financial resources to replace three-quarters of their pre-retirement consumption could rise sharply – from about one in six currently to more than two in five – over the next 40 years.

In it, Kevin D. Moore, C.D. Howe president William Robson, associate director Alexandre Laurin and Statistics Canada’s Kevin Moore highlight the differing retirement outlooks for Canadians of various age and socio-economic groups, as revealed by a Stats Canada simulation tool called LifePaths.

“A key question in Canada’s pensions debate is whether Canadians will be able to maintain their living standards in retirement, and if policy needs to respond to the risk that some will experience painful declines,” said Mr. Robson.

I fear that most Canadians from my generation and especially younger Canadians will not enjoy the same standard of living. It's not just pensions. The world is becoming much more competitive and the truth is North Americans are lagging behind. But we can do something to improve our pension system building on our existing public pension plans which are among the best in the world. Why squander yet another opportunity to improve our pension system? And if you do it right, both the private sector and and the public sector will come out ahead.

Thursday, December 16, 2010

Showdown at Kananaskis?

Bill Curry of the Globe and Mail reports, Provinces to push Ottawa on CPP improvements:

Provinces are planning to fight for enhancements to the Canada Pension Plan at a key meeting on Monday, setting up a showdown with the Harper government over how Canadians will fund their retirements.

Just days before federal and provincial finance ministers meet in Kananaskis, Ottawa made a surprise move to reject CPP enhancements for now in favour of a new privately run savings vehicle.

The shift in federal priorities on pension reform comes as the Bank of Canada heightens its warnings that Canadians are borrowing too much and saving too little, putting some households at risk when interest rates inevitably climb back from near-record lows.

Ottawa’s critics insist long-term pension problems must be tackled now and premium increases can be phased in, but the Harper government is aligning itself with Alberta in arguing the economy cannot absorb a new hit on the take-home pay of Canadians.

“I think all are agreed that while we will continue to look at improvements, now is not the time for CPP premium increases,” Prime Minister Stephen Harper said Thursday in the House of Commons in response to objections from the NDP.

Ontario Finance Minister Dwight Duncan said as far as he knows, Alberta is the only province that opposes CPP enhancements. He said provinces are working the phones Thursday planning to push the CPP option on Monday.

“It’s just not acceptable in our view to put this discussion off,” said Mr. Duncan in an interview. “A number of us, the provinces, have talked over the course of the last number of hours and there’s still very substantial support for moving forward [on CPP].”

Insurance companies, business groups and the Alberta government praised Ottawa’s proposal for a Pooled Registered Pension Plan (PRPP) as a targeted response. One insurance firm, Sun Life, called it a “historic milestone” that could expand pension coverage to millions of Canadians.

But other provinces, national labour unions and federal opposition parties insist another voluntary savings option will not address the fact that millions of Canadians are not saving enough to maintain their current living standard in retirement.

While the recession exposed the harsh realities of high household debt, particularly in the United States, it also exposed inadequate protection for workplace pensions in cases like the bankruptcy of Nortel. Critics of Ottawa’s latest plan are concerned the new pool of savings managed by the private sector will not have the same level of protections as the CPP.

When Ottawa and the provinces last discussed pensions in June, Mr. Flaherty was a surprise advocate of a “modest” increase to CPP premiums and benefits as a way of ensuring, through a mandatory policy, that Canadians save more for retirement.

For the past six months, officials at both levels of government were assigned to study both a CPP enhancement and a private-sector option for people who do not have workplace pensions. Mr. Flaherty said there is simply not enough provincial support right now to move ahead with CPP reform.

“It's a multi-jurisdictional challenge to get a consensus on CPP. It's clear that we do have broad support for the private-sector solution,” he told reporters on Parliament Hill Thursday.

Changing the CPP requires the support of two-thirds of the provinces representing two-thirds of the population. Even if that threshold could be met, it would be politically and technically challenging to accomplish a major CPP change over the objections of individual provinces.

Canadian Labour Congress president Ken Georgetti praised Mr. Flaherty in June for supporting CPP improvements. Now he’s furious.

“Voluntary systems don’t work,” he said. “I guess a couple of lunches with the insurance and the banking industry have more effect on this government than Canadians’ public opinion. It’s just absolutely unacceptable in our view.”

The PRPP would be administered by regulated private-sector institutions, such as insurance companies, and Mr. Flaherty suggested the rules may require companies that do not currently offer a plan to offer the PRPP to their employees. In that scenario, the employees may be automatically enrolled in the plan and would have to specifically opt out should they not want to participate.

The minister says the plan should appeal to small business owners who may not have the expertise or resources to set up a workplace pension. The PRPPs will pool contributions from many individual companies and workers, allowing them to take advantage of the investment advantages of large retirement funds.

Keith Ambachtsheer of the Rotman International Centre for Pension Management has been following the technical negotiations closely. He said Ottawa appears to be taking the simplest option with the PRPP. “I think there’s considerable evidence that something stronger than this is required to solve the problem,” he said.

Keith Ambachtsheer and Ken Georgetti are absolutely right. These Pooled Registered Pension Plans (PRPP) are a joke -- a dead giveaway to the private sector. What's the problem? For one, they're voluntary and second of all, they are not defined-benefit plans, just another defined-contribution plan. This will leave many vulnerable to the whims of the market.

But Sun Life calls PRPP a "historic milestone". Of course it is, for their bottom line. The only problem is if we compare the performance and fees of these PRPPs to that of the Canada Pension Plan Investment Board, I'd rather have my pension money managed by CPPIB. Not only are their fees lower, they can invest in public and private assets all around the world and outperform most private sector plans over the long-run.

In Ottawa, these concerns were raised by NDP leader Jack Layton who said the plan will only benefit investment bankers and give less to middle-class Canadians, because private-sector financial fees dwarf those for the public sector.

I'm not going to get political here because pensions are far more important to me than politics. I am however surprised that the Finance Minister came out before meeting with his provincial counterparts. If I were them, I'd be pissed off. Pensions are one of the most important political and economic issues facing our country, and to bend over and hand the private sector freebies is simply wrong. Mark my words: PRPPs cannot compete with CPPIB, the Caisse, Ontario Teachers, OMERS, AIMCo, bcIMC, and other large public pension plans. And they certainly can't compete with HOOPP which is a private defined-benefit plan providing pensions to Ontario's healthcare community.

Unfortunately, and much to my disappointment, Ottawa is short-changing Canadians on pensions. All those consultations just went out the window. It didn't have to be this way, but I can guarantee you this isn't the end of it. There's going to be a showdown in Kananaskis next week and we haven't heard the last of expanding CPP -- not by a long shot!

Wednesday, December 15, 2010

No Surgery Needed?

Timothy Inklebarger of Pension & Investments reports, Proposals target Canadian corporate plan funding:

Canadian corporate pension plans will be able to negotiate funding arrangements with participants and retirees when restructuring their plans as part of the proposals announced Tuesday by Canadian Finance Minister Jim Flaherty.

The proposals would amend the 1985 Pension Benefits Standards Regulations, according to a news release from the Canada Department of Finance.

Among the proposals were the following:

• allow plan sponsors to secure letters of credit in lieu of making funding payments to the pension fund, up to a limit of 15% of plan assets;

• require corporate plans to be fully funded before being terminated; and

• void any amendments to a pension plan that would reduce the plan’s solvency to below 85%.

The proposed changes are a federal initiative and would not apply to provincially regulated pension plans.

“These changes will help pension plan sponsors to better manage their funding obligations while providing additional protection to plan members and retirees,” Mr. Flaherty said in the release.

Annette Robertson, spokeswoman for the Finance Ministry, could not be reached for further details.

Following a 30-day public comment period, the proposals will go to the government for further consideration.

I discussed these proposals with some contacts and here is what they shared with me:

This is just a reprise of the announcements made earlier in the year – now with regulations in place. None of the govt’s pronouncements in any form give solace to the Nortel pensioners nor to anyone like them. The only impact is in preventing pension fund deficiencies in the future by strengthening the rules – yet they still don’t prohibit contribution holidays and risky investments – which as you have said are the main causes of fund deficiencies – even in good economic times and a major disaster in bad economic times.

...

That is correct...it only applies to federally regulated pension plans (banks, Air Canada, Bell Canada...<10%)....and I am not sure it buys them much either... clearly our current government still plans no pension reform of any substance, see today's article by the government's mouth-piece on the subject, Jack Mintz entitled "No Surgery Needed".

I read Jack Mintz's editorial below (bold comments are mine):

Facts keep getting in the way of those who push for big changes to our retirement income system. Most Canadians have sufficient replacement income in retirement years and have generally paid down most of their debt by 65 years of age. (Really? Then why is pension poverty growing and the Bank of Canada sounding the alarm on our growing debt?)

Canadian household net wealth per dollar of income has already surpassed the earlier 2000 peak and is approaching 2007 levels. Unlike the U.S., Canadians have experienced no decline in housing equity, which is now close to $1.9-trillion. (Ah yes, the great Canadian housing boom. We're due for a major correction, especially in some of the frothier markets)

Housing wealth is as large as all the combined assets held in pension plans, RRSPs and CPP/QPP, although, as most Canadians know, downsizing or reverse mortgages have no tax consequences, unlike pension and RRSP withdrawals, which are fully taxed. On top of this, Canadians have more than $2-trillion in net financial and business assets that are not sheltered from tax. Modest and middle-income Canadians hold many of these assets, not just the rich. (Along with reverse home mortgage growth come increased opportunities for fraud and scams)

As recent research confirms, almost 90% of Canadians have managed their affairs quite well, taking all the assets into account. On average, most middle-income Canadians have at least 60% replacement income at retirement. While some modest-income Canadians may not be saving enough, others save more than they need in their retirement years. (Which recent research are you referring to Jack? Last I checked, the number of Canadian seniors living in poverty soared by 25%)

And, Canada has done a good job in protecting the elderly from poverty. Even with the recent uptick in poverty, with a loss in financial income — which is a concern — Canada’s poverty rate is one of the world’s lowest. With Old Age Security, the Guaranteed Income Supplement, CPP, medicare, provincial support programs and tax breaks for the elderly, most low-income Canadians maintain their consumption after retirement. Focus instead should be directed where poverty rates are highest, such as single-parent working families.

Some proponents of pension reform argue that Canadians will earn poorer returns in the future than in the past. Actually, returns on investment, once adjusted for inflation, were quite poor in the 1970s and in the past decade. Those with defined contribution plans or RRSPs would find a large variation in retirement incomes depending on their years of investment, which is why plans with at least minimum guarantees are less risky.

The average annual return on assets has been 5.5%, which is just as likely to be the case in the coming decades as in the past. The system is performing well — we certainly don’t need major surgery. (How do you conclude 5.5% is "just as likely" when US 10-year bond yields are 3.5% -- and this after a huge recent spike in yields?!? We'll be lucky to see anything close to 5.5% in the coming decades, even with emerging markets leading the way).

Some nips and tucks could help, though, to remove regulatory and tax barriers that undermine the efficiency of retirement income markets. For example, smaller and medium-size businesses have difficulty pooling resources in multi-employer pension funds, since only the employer or a union sponsor such plans. Broadening sponsorship to include financial institutions could make it easier to develop cost-efficient multi-employer plans. (MEPPs are full of governance issues -- just look at the problems that Canada's largest MEPP is going through. But instead of broadening sponsorship, let's just give the assets to public pension funds).

Then there’s discrimination against the use of group RRSPs. At present, employer contributions to registered pension funds reduce the payroll tax base for calculating CPP, QPP, Employment Insurance and workers’ compensation payments. But this is not the case for group RRSPs, which can be a cost-efficient mechanism to provide retirement income to workers (and a flexible plan for employees who change jobs frequently). (RRSPs stink! Most Canadians are better off having their retirement money managed by public pension plans!)

The decline in defined-benefit arrangements in the private sector is also a concern since these options enable individuals to pool risks optimally with employers or financial institutions. Unlike defined-contribution plans and RRSPs, defined-benefit plans and annuities allow Canadians to share longevity risk by pooling across the population. Defined-benefit arrangements also enable many workers to know better their income at time of retirement, since employers or financial institutions absorb a significant share of the risk.

In the past, both regulatory and legal obstacles have made it more difficult for employers to offer defined-benefit arrangements. Some employers prefer to keep defined-benefit plans for workers as a competitive edge in labour markets. Recently, federal and provincial governments have improved the treatment of defined-benefit plans, such as enabling greater surpluses to be generated in the good years to offset declines in bad years. However, more still needs to be done, such as dealing with an inappropriate sharing of risks and surpluses in face of partial windups.

And those on disability insurance need to be assured that employers facing bankruptcy cannot have access to trust funds that are meant to cover their benefit payments. (Yes, the disabled always get screwed. Just listen to this interview with Jackie Bodie, a disabled Nortel employee who lost her LTD benefits)

This leaves whether CPP should be expanded. The Canadian Labour Congress proposes the doubling of the current earnings limit of $47,200 in seven years’ time, resulting in an estimated sharp hike in payroll taxes from 4.95% to 7.95% each for employees and employers (almost a 60% increase).

The virtue of the CPP is that contributions are pooled to reduce both investment and longevity risks, which for some workers is the only defined-benefit arrangement available to them. CPP pools risks best since it is a mandatory savings plan, forcing all Canadian workers to save more or reduce holdings of other assets.

Nonetheless, a CPP expansion has consequences. Some young Canadians prefer to put their money in a home, business or other financial assets rather than the CPP. Small businesses will find it more costly to hire workers. As an anti-poverty measure, CPP is less effective than the Guaranteed Income Supplement, since the latter is available to all seniors, whether they have worked sufficient years in the past or not.

More important, a CPP expansion could result in a large transfer of wealth from workers to retirees. For this reason, governments are considering a fully funded CPP expansion to avoid inter-generational transfers — a hard sale since payroll taxes would rise before benefits would be received.

Some modest increase in CPP to provide more defined-benefit arrangements makes some sense. However, bringing in higher payroll taxes at a time when the Canadian economy is on the rocks is rather bad timing. (Businesses will ultimately be better off if we expand CPP! In fact, all businesses should worry about business, not pensions. Let public and private pension fund managers worry about pensions)

When federal, provincial and territorial ministers of finance meet just before the holidays, they should first focus on low-hanging fruit, such as regulatory changes, and put off CPP expansion until the economy is in better shape.

Bernard Dussault, former Chief Actuary of Canada had these comments to share:
There is no new issue with the CPP. It had big ones that were addressed through the 1998 reform. Its partly funded status is due to the insufficient contributions made from 1966 to 1996 and to granting full accrued benefits after only 10 years of contributions to the original (1866) cohorts of contributors, which gave rise to a huge deficit, too huge to ever be amortized. Therefore , our children, grand children, grand-grand children and so on will have to pay 9.9% (half paid by employer) rather than 5.5%. Pure case on intergenerational inequity.

The CPP is not a target benefit plan and not meant to be one. The decreased in future benefits in 1998 (the then current pensioners were not affected) was one good mean to correct errors (re: insufficient contributions) of the past. Real target plans do not allow known insufficient contributions. In 1966, it was clearly reported that the CPP 3.6% contribution rate was insufficient. It was a political decision to go ahead with the 3.6% and leave the problems to future generations.
Finally, Canadian policymakers should look at Australia who just announced reforms to their pension system, attacking fund fees:

Australia unveiled reforms to its A$1.3 trillion ($1.28 trillion) pension funds industry on Thursday, aiming to tackle high management fees in a move that could trigger consolidation in the sector.

The government, responding to a recent review of the huge but often inefficient pensions industry, said it would introduce a simple, low-fee investment product and also force funds to modernise back-office systems to further reduce costs.

The long-anticipated reforms are expected to force smaller funds to merge and trigger industry consolidation: the government estimates the measures will rip A$2.7 billion in fees out of the industry every year over the long term.

"The government is acting to reduce the unnecessary fees and charges on working Australians retirement savings, and to remove barriers to a low cost and efficient superannuation system, Assistant Treasurer Bill Shorten said in a statement.

Canadians are getting raped by fees. We have some of the highest management expense ratios (MERs) in the developed world. It's a farce, especially since most of these mutual funds underperform market indexes. All the more reason to expand CPP!