Pension reform – where are we now. The seesaw drama of getting the finance ministers to finally acknowledge that Canada’s retirement system needed fixing took nearly two years. When they emerged from their shells last June, they offered a two-track solution: “modest” CPP enhancement and a commitment to have the private sector devise a product to fill the rest of the savings gap. By December, CPP-enhancement was dropped and the 'Pooled Retirement Pension Plan' or PRPP was announced.
CARP members were not impressed with a voluntary fund run by the private sector and said so in our survey - which we dutifully conveyed to the junior federal minister of finance and his officials. Such multi-employer plans are already permitted by federal law and in Quebec (they are called simplified pension plans), but there has been very little uptake over the last decade. So now the industry wants the government to do its marketing for it.
Skeptical? One of the questions at the recent PRPP consultation was whether employees should be automatically enrolled in a PRPP of the employer’s choosing. Our answer was: only if there’s a public option along with the private sector run offerings.
Why? You can already invest your money in Canada Savings Bonds or in private bonds issued by corporations or banks. It follows that Canadians should similarly have a public option for their pension savings. The antipathy towards the financial services industry shown in the polling was likely shaped by news of financial frauds, overcharging on fees and unnecessary foreclosures.
What part of “retirement security” did the federal government not understand? Even provincial premiers are calling for a CPP expansion along with federal opposition parties.
A practical solution is staring all of us in the face – allow people to buy into a separate fund run by the existing not-for-profit pension funds like the CPP, OMERS, provincial Teachers Funds and the like. With their size and experience, they can offer low-cost, reliable defined benefit pensions – which, coincidentally, is what we’ve been asking for.
Monies contributed by individuals and their employers, would be invested in a diversified fund but separated from the fund managers’ other holdings. These contributions would be pooled with those of millions of Canadians participating in such public funds and would benefit from huge economies of scale – a scale that a myriad of private sector funds would not be able to achieve. And with such economies of scale comes the advantages of lower fees and access to lucrative investment options (private equity, infrastructure etc.) that retail private funds cannot and would not be expected to offer.
A large pool also allows the administrators to purchase annuities for each beneficiary on a regular basis so that by the time of anticipated retirement, the target or promised pension benefit would be available (thanks that what insurance experts call 'risk pooling' a key ingredient for insurance markets to exist). The existing CPP makes the same promise but does not need to purchase annuities, relying instead on the actuarial predictions and adjustments that a massive fund and long term horizons offers to minimize risks.
In short, the key advantages of a true defined benefit plan would be coupled with the key advantages of knowing in advance what contributions are required. Historically, private insurers used to provide defined pensions in this manner in the 1950s and 1960s but ceased to do so because it required them to maintain regulatory capital on account of the fact that insurers were on the hook for pension promises. By transferring the underwriting risk to a large enough entity (the public funds), Canadians can have the certainty of a defined benefit promise without putting pressure on insurance companies. The key to this approach is the setting of actuarial assumptions very conservatively, thereby avoiding surprises.
B.C. and Quebec have adopted a similar model for car insurance in their provinces. This model works and Canadians in those provinces generally pay half the premiums Ontarians pay. Ironically, allowing a public alternative will introduce a healthy dose of competition for our pension dollars, something which is surely bound to benefit everyone by keeping private providers honest.
CARP isn't the only one wondering why PRPPS should only be the exclusive domain of the private sector. Greg Hurst of Benefits Canada reports, A case for allowing pension funds to manage PRPPs:
Recently OMERS CEO Michael Nobrega suggested that pension funds should also be permitted to compete with banks and insurance companies when it comes to pooled registered pension plans (PRPPs). Benefits Canada followed up with an story and online poll asking “Should large pension plans be permitted to administer the new pooled retirement pension plans?” At the time of publication, 53% of respondents say “Yes” (including me), 23% say “No” and 25% say “There’s not enough information yet.”
If OMERS or other large pension plan boards are interested in competing with banks and insurers, I would like to suggest that perhaps they need not wait for the provinces and the federal government to flesh out the PRPP framework.
The trail that’s been blazed by the Saskatchewan Pension Plan (SPP) might represent an opportunity for other large pension funds to seek “specified pension plan” status from the federal government under the Income Tax Act regulations, and thus allowing them to compete in the PRPP space.
Recent Income Tax Act amendments made for the SPP including these two changes:
- All instances of the term “prescribed provincial pension plan” were changed to “specified pension plan”. This could this be a hint that the federal government might be open to also bestowing specified pension plan status on plans without provincial government sponsorship.
- The $600 annual contribution limit was removed and RRSP limits now apply. The $2,500 limit in the SPP is now only a function of that plan, not the Income Tax Act.
Any Canadian with employment income can apply to join the SPP. Unlike PRPPs sponsored by banks and insurers, the SPP has a fiduciary framework that is focused on the delivery of retirement plan services and income to plan beneficiaries without the possibility of conflicts with shareholder interests.
Other large pension funds would offer similar fiduciary frameworks, and many can deliver at costs even less than the SPP through economies of scale already established. OMERS has demonstrated this already in very competitive pricing for their new voluntary contribution account services for their current plan members.
Even if specified pension plan status for other large pension funds is not forthcoming from the federal government, the current pension statutory framework does not preclude a willing pension plan board and sponsor from amending a pension plan to extend participation to unaffiliated employers. In this regard, it is noted that although there is a minimum employer contribution requirement for a defined contribution provision (1% of earnings), this is subject to the administrative discretion of the Minister of National Revenue. Further, such rule will have to be modified in any event, in some fashion, to accommodate the PRPP principle of voluntary employer contributions.
In addition to the advantage of fiduciary independence from shareholder interests, large pension funds as competitors to financial institution PRPPs would also have the following attractive features:
- participating employers would be relieved of any direct fiduciary obligations in respect of the pension plan (like PRPPs);
- an immediately competitive pricing regime, based on already established economies of scale;
- an established track record of investment results; and
- investment offerings that are appropriately limited for a pension plan, particularly when compared to the plethora of investments offered by financial insurers which are very confusing for most pension plan members.
Perhaps most importantly, competition from large pension funds can set a tough standard towards ensuring a pension policy objective for PRPPs of realizing benefits from economies of scale and delivering most of those benefits to better the retirement income security for Canadians covered under such plans. Utilizing OMERS new voluntary contribution account fees as an example, fund investment management fees could be as low as 0.50% per annum (and possibly less), along with a fixed administration fee of $23 per member account.
The only question large pension funds really need to ask of themselves concerning this kind of pension innovation is, “Why wait?”
I couldn't agree more, why wait? The problem is that the private sector knows it can't compete with OMERS, CPPIB, and other large Canadian public defined-benefit plans when it comes to delivering well governed, cost effective retirement funds that invest in both the public and private markets (you can add HOOPP in the mix even if it's a large private DB plan). That's why you'll never see Canadian public DB plans compete in the PRPP space. Politicians will never allow it. It's a shame because it makes perfect economic sense and despite what banks, mutual funds and insurers think, I'm sure other corporations would love to offer their employees a public option for pension security.