Thursday, February 16, 2012

Drummond Report Goes After Pensions?

Tim Kiladze of the Globe and Mail reports, Reduce pension benefits, don't increase contributions:

Just weeks after the federal government announced plans to reduce its pension burden, the Drummond report poked the same hot button issue by recommending an end to lucrative provincial government pension benefits.

For the most part, economist Don Drummond did not go into much detail about possible reforms to save money. He notes generally that when closing the gap between how much goes into public sector pensions and how much retirees get, the objective should be to “reduce prospective benefits rather than increase the contribution rate beyond current levels.”

However, he does recommend ending “gratuity benefits,” or lump-sum bonuses, paid to teachers upon retirement. Many school boards have already done away with them.

That Mr. Drummond touched the pension file demonstrates more concern over meeting payment obligations as Canada’s population ages and stock and bond returns remain weak. Earlier this year, the federal government proposed increasing the age of eligibility for Old Age Security to 67 from 65, noting that OAS costs are expected to triple by 2030.

The report calls on the McGuinty Liberals to act boldly if unions won’t compromise: “The government may need to consider legislative options should negotiations with plan sponsors be unsuccessful.”

The Ontario Teachers’ Federation said it has taken steps to fix funding shortfalls by increasing the amount teachers pay in – precisely what Mr. Drummond rejected. Yet federation president Francine LeBlanc-Lebel suggested her group is open to discussions on issues such as teachers’ eligibility for full pensions at age 55 if they have worked for 30 years. “This might be something that will be addressed in the next few years,” she said.

Linda Haslam-Stroud, president of the Ontario Nurses’ Association, said the Healthcare of Ontario Pension Plan has “reasonable benefits.”

“Our nurses are exhausted from the heavy workloads, the heavy lifting, and there are looking forward to a retirement that they have paid into dearly,” she said.

Ontario nurses are lucky. Their pensions are managed by the Healthcare of Ontario Pension Plan (HOOPP), one the best DB plans in the world. Its members retire with excellent benefits and the plan remains fully funded, a point underscored by John Crocker, HOOPP's former President and CEO:

The "next big thing" in social policy will be ensuring retirees have enough to live on, says John Crocker, outgoing President and CEO of the Healthcare of Ontario Pension Plan.

Crocker, who is ending his 30-year career in pension investments and 10-year term as HOOPP CEO on Dec. 31, says efforts should be made to improve workplace pension plans, boosting the number of defined benefit plans, rather than focusing on introducing cheaper alternatives.

"With pensions, the less you pay in, the less you get out – it's as simple as that," he says. In Australia, he says, a nation-wide switch away from defined benefit plans has led to widespread senior poverty. "Half of Australian seniors live below the poverty line, and two-thirds run out of pension income by age 75. Is that what we want here?" he asks.

"When you're designing a retirement plan, you should start by looking at what you want to get out of it – what you need for an adequate retirement. That's the beauty of defined benefit. You know in advance what you'll get out of it. Not many people in other types of plans realize that you need to save $500,000 to provide yourself with an annual pension of $25,000, but that's the reality. We owe it to people to help them get there – we need to make workplace pensions better, not worse."

Leaving Canadians without plans – to cope on their own – is not an answer, he adds. The average Canadian has saved just $60,000 in his or her RRSP by retirement age. "It's just not enough – you can't live on that for 20, 30 years," he says.

HOOPP, a fully funded defined benefit pension plan, shows that DB can work, he says. "With good governance, professional investors, a sound investment strategy, and mandatory contributions by members and employers, you can get there," he says. The average HOOPP pension starting in 2010 was $18,400 – meaning that after 25 years, a retiree will have received $460,000 in pension payments, he explains.

Crocker says he's confident that HOOPP will show solid results, and most importantly, be in a sound funded position, when it reports its 2011 results in the spring of 2012.

Crocker has spent much of his time in recent years speaking up for defined benefit plans. He's authored numerous columns, given speeches, and has lent support to a blog dedicated to retirement income adequacy, found at ariapensions.ca. He feels this is a critical issue.

"It's important for us to demonstrate that DB can still work. There is no more efficient, more effective way to deliver pensions to people than the DB model," he says. Other types of plans, he adds, "simply download the responsibility for retirement onto the shoulders of the average working person. Very few among us know investing well enough to know when to buy, when to sell, or when to hold – it's not fair to force busy people to try and figure this out by themselves."

James Pierlot wrote a comment in Benefits Canada, outlining the Drummond report’s pension recommendations:

On Feb. 15, 2012, the Commission on the Reform of Ontario’s Public Services released its report. Chaired by noted economist Don Drummond, and announced in the March 2011 Ontario budget, the commission was given a mandate to review Ontario government spending.

A key motivator for creating the commission is the province’s worsening fiscal position. With no change to current fiscal policies, the report projects that Ontario’s deficit could grow from an expected $16 billion in fiscal 2012 to more than $30 billion in fiscal 2018, and its accumulated debt from 35% to 50% of GDP in the same period.

In its 20 chapters and 562 pages, the report makes more than 360 recommendations intended to improve program delivery and reduce costs, with a view to balancing Ontario’s budget by 2018 and transforming Ontario into a province that “provides the best public services, delivered in the most efficient manner, in the world.” According to the report, balancing the budget by 2018 would require that total program spending grow by no more than 0.8% per year—an annual per-capita decline of 2.5% from current spending.

Public sector pensions
The report makes a number of recommendations on public sector pensions, as summarized below.

Containing pension costs
The report recommends that the Ontario government cap employer contributions at current rates and deal with future funding deficits by reducing benefits reductions “on a prospective basis,” particularly with respect to inflation indexing and early-retirement benefits. It also suggests that the government should “accelerate work” on pension plan design to contain benefit costs as part of “compensation negotiation.”

Administrative consolidation
Noting that there are currently 29 pension plans for Ontario’s 23 universities and colleges, the report recommends that the province establish a single administrator for post-secondary institutions and look for opportunities across the public sector—particularly in the energy sector—to consolidate “fragmented” pension administration and achieve economies of scale through asset pooling and consolidation of administrative functions.

Compensation benchmarking
The report recommends that a “comprehensive and transparent” compensation benchmarking system be implemented for the entire public service that reflects the full cost of compensation, including pension benefits.

Managing, funding and reporting pension liabilities
The report recommends that the Ontario government develop its own, publicly accessible “liability management assessment report” for public sector pension liabilities, develop a plan to contain “fiscal risks” of pension plans and clarify who has financial responsibility for funding pension deficits.

Noting that the Ontario government discounts pension liabilities at nominal rates of 6.25% to 6.75% under Public Sector Accounting Board rules, the report suggests that these rates may be too high and that more conservative assumptions regarding future rates of return “could reveal significant funding deficiencies.”

To address this risk, the report recommends that the government’s assessment of the financial health of public sector plans should include a sensitivity analysis that considers the probability of discount rates being “higher or lower than assumed.”

Transparency
Noting that current financial reporting practices make it difficult to determine the Ontario government’s total pension expense, the report recommends that the government disclose the government’s pension expenses more clearly in the Public Accounts and other financial statements, to contribute to a better understanding of total value of public sector compensation.

Pension Benefits Guarantee Fund (PBGF)
Noting that Ontario is the only “sub-national jurisdiction in the world” with a guarantee fund for private sector pensions, the report states that significantly higher assessments would be required to “insulate the PBGF from catastrophic claims” to update coverage. Citing an independent study of the PBGF from 2010, the report states that PBGF premiums would have to increase 1,000% to provide the coverage levels recommended in the 2008 Report of the Expert Commission on Pensions, and that PBGF risks are not “spread according to insurance principles” because there are only 1,600 plans contributing to the PBGF and coverage is concentrated in specific industries.

The report concludes that the PBGF is not sustainable and exposes the province to a “large fiscal risk” in the event of an economic downturn. It recommends that the PBGF be wound up or transferred to a “private insurer.”

Conclusion
As noted in the report, pension assets and liabilities reflected in the province’s financial statements are about $180 billion and $200 billion, respectively. Given the relative importance of pension expenses to the Ontario budget, it is perhaps not surprising that more than 10 of the report’s recommendations relate to the administration, funding and reporting of public sector pension benefits.

The report is as notable for what it does not say about pensions as for what it does. For example, there is no suggestion that Ontario should abandon its current model for delivery of public sector pensions by converting to DC plans. Rather, the report’s focus seems to be to manage costs, improve reporting and make public sector DB plans sustainable over the longer term through greater leverage of the economies of scale now realized by Ontario’s largest public sector plans.

I completely disagree with James Pierlot on abandoning the current model and converting public sector pensions to DC plans for the reasons John Crocker cited above, namely, this will only guarantee and accelerate pension poverty.

[Editorial note: James sent me an email stating he does not advocate and never advocated converting public sector pension plan to DC. Moreover, he told me he's a solid supporter of the public sector pension model in terms of delivering good pensions and managing money with low administrative costs. This certainly did not come out in the last paragraph of the article above.]

I like the Drummond report's recommendations on administrative consolidation, more transparency and compensation benchmarking. They should also look into containing operational costs at public pension funds and how senior pension fund managers are being compensated and whether the benchmarks they use reflect the risks they're taking.

While Ontario has some of the best public pension plans in the world, the Drummond report didn't recommend ways to improve their operations and cut costs. It didn't look at best practices around the world to improve pension governance. For example, I'd like to see publicly available board minutes from every single Canadian public pension fund. Who voted on what and why. Don't give me nonsense that this is "corporate sensitive material". That is total rubbish.

Of course, pension reforms are only part of the Drummond report. It was about tackling Ontario's mounting debt. I admire Don Drummond, former chief economist at TD, and think he's outlined some important recommendations to get Ontario back to a balanced budget.

My biggest concern in Ontario is exploding health care costs. The report offers 105 different ways to tame health care in Ontario. It's a disaster and unless they get a hold on these costs, they're heading for fiscal crisis -- not a "Greek-style crisis", but a fiscal crisis which will hurt taxpayers and Ontario's social services down the road. Below, a couple of reports from Global News, including an extended reaction from Ontario's Finance Minister, Dwight Duncan.

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