Friday, August 30, 2013

Dispelling Public Pension Plan Myths

Helen Fetterly, chair of Healthcare of Ontario Pension Plan (HOOPP), wrote an article for Benefits Canada, Dispelling public pension plan myths:
I’ve been involved with the Healthcare of Ontario Pension Plan (HOOPP) for 17 years now, and in 2013, am serving my second term as board chair. Recently, HOOPP created a two-part white paper with The Gandalf Group called The Emerging Retirement Crisis. In my first column based on this data, I looked at why the DB model, of which HOOPP is one, works.

Some of the key findings in the second part of the white paper relate to the fact that 64% of Canadians don’t believe Canada has a good workplace pension system. Seventy-three percent of those say that employers aren’t offering sufficient pension plans.

Yet, continually, on the HOOPP board we hear that DB pension plans—common in the public sector and unionized private sector workplaces—are gold-plated and not sustainable. Nothing could be further from the truth.

The average HOOPP member receives a pension of under $17,000 a year after a long, hard career. That’s an adequate pension, but not gold-plated.

Critics of public sector DB pension plans say that they should be replaced by “cheaper” DC plans. But with DC plans, there are no guarantees. A lower percentage of earnings, typically 3% to 5%, is set aside on payday, but it’s up to the individual member to decide how to invest it. The member usually gets to choose from a family of mutual funds. Those funds charge very high fees, up to 2% a year, whether the investments are up or down. So a DC pension is far less than even the modest pensions HOOPP and other DB pension plans provide. And worse, it’s again up to the member to decide how to turn that savings into income.

That’s why, rather than cutting DB pension plans, we should look at ways to ensure they can continue to contribute to the well-being of retirees. And we should look at improving the retirement system for those who lack DB coverage.

CUPE and other groups such as the Canadian Labour Congress, many provincial premiers and other retirement industry observers see the answer for those without adequate coverage in the expansion of the Canada Pension Plan (CPP), through small, gradual contribution increases over time. That would double its modest benefit of $12,000 a year maximum to more like $24,000.

Ontarians are telling us that they are willing to pay more into their employer-sponsored pension plans. They aren’t critical of public sector pension plans—in fact, in reading their responses in the white paper, you can see that they would like to see the bar raised for everyone. Seventy-seven percent of Ontarians said they would like to be part of a DB plan, and an equal number (77%) want to see the CPP expanded.

Rather than discarding the pillars of the system that work, we should look at those that are not working with an eye to improving them.
I've long argued that we need to expand the CPP and bolster our defined-benefit plans. HOOPP's former CEO, John Crocker, made the case for boosting DB plans right here a couple of years ago. I recently commented on the benefits of Canada's top ten and think it's worth remembering that Canadians are blessed with some of the best pension plans in the world.

Ms. Fetterly is right, there are too many myths regarding public pensions. The media loves focusing on abuses but the reality is many members pay a lot for the privilege of a DB plan and the alternative, a DC plan, falls short, leaving people exposed to the vagaries of the market.

Importantly, a DC plan is not a real pension; there is no pension promise attached to it like a DB plan. It places the responsibility on members to choose the right funds. Also, the fees attached to mutual funds are astronomical, further reducing the pension pot of those in a DC plan. Moreover, unlike Canada's top ten, mutual funds cannot invest in the best public and private market managers across the world or make direct investments in private equity, real estate and infrastructure. Simply put, the alignment of interests are much better at DB plans than DC plans.

But I'm tired of beating the drum on this issue. Think tanks like the C.D. Howe Institute are at it again, pushing for pooled registered pension plans, as if they will make a difference. If you want to know why DB plans are much better, read this Financial Post article below from a 40-something Canadian soldier, ‘Spend, spend, spend’: Living (happily) with a defined benefit pension:
It all started when I turned 18 years of age. This was in 1984; I had done a fair amount of research in conventional investment options during my last year in high school. As I pondered post secondary education, I realized that my childhood dream of becoming a pilot was not possible under my current financial reality.

I was 18 with a grade twelve education, unemployed, and my parents were doing all they could to stay afloat. So what the heck, I joined the Canadian Forces and worked towards my goal and became a military pilot. For ‘young investors’ the most critical start to any investment strategy is to ensure you choose a profession that you will love for a very long time, this will assure stability and consistency in investment discipline.

Today, I happen to be very well situated financially and yet I have absolutely no personal investments; all of my income is dedicated to living for today, anything that is left at the end of the month goes towards the next month of fun.

In researching investment strategies during my last year of high school, I also delved into the realm of pension plans and the variety of options available at the time; remember I was 18 and had my whole life ahead of me. So I came across the topic on public service pension plans and let me tell you, my eyes lit up.

Not only that but at the time, the Canadian Forces had a defined benefit pension plan that would allow me, upon completion of 20 years service, a non-penalized pension equal to 40% of my salary. Simply stated; join the military, fly awesome aircraft all over the world and retire at the ripe old age of 38 years old with a $35,000 pension.

Additionally, as soon as I turn 60 (not for another few years, I’m currently in my late 40’s), my pension will be adjusted for cost of living, after which I will realize an annual cost of living increase for as long as I’m around. This means that my pension will increase by approximately 40% on the day I turn 60 years old and increase onwards and upwards annually going forward. It will just keep on giving; you can’t stop it!

Yes it is true that in this day and age, one cannot live on $35K per year especially with my kind of zest for life; remember, the only investment I believe in is to buy a home; everything else spend, spend, spend and enjoy life.

So the day that I retired from the military, I competed for an inspectorate position with the federal government. It’s completely above board and here comes pension number two!

Assuming I work until 55; I will be able to accumulate an additional 30% of pensionable service in addition to the original pension that I started receiving when I retired from the Canadian Forces.

In a nutshell; here’s the investment strategy that has worked and will work for me:

20 years in the Air Force as a military pilot: $35,000 pension for life, starting at 38 years of age;
  • At 60 years of age, the $35,000 military pension automatically increases by an additional 40% (approx);
  • At 38 years of age; change careers, but remain within the public service, this allows you to build on a second defined benefit pension plan;
  • Since I still love my career, I will work until 60; hence will realize a combined pension portfolio earning $70,000 per year indexed for life
How much would one need to save to assure a lifetime annuity of $70,000 per annum, not to mention the annual increase to cost of living?

Answer: approximately $2 million!

So, just to recap; join the military and fly awesome planes until your first eligible retirement year; get back into the public service and complete a second pension. In the meantime spend all you make, every month and live life as though it will be your last day.
That sounds like one happy camper and his military and federal government pensions are both managed by PSP Investments, which recently reported exceptional four-year gains in their latest annual report. He will earn a very decent pension -- one that most people in the private sector can only dream of -- without worrying about the stock market or low interest rates.

But as discussed above, public sector pensions are much more modest than this example and public sector workers pay a lot for the privilege of a DB plan. They work hard, are forced to save and their pensions are managed by well-governed pension plans, allowing them to retire with a modest income which they can count on in their golden years. This isn't rocket science; it's good pension policy and we need to expand this coverage to more Canadians.

Below, Jim Leech, President and CEO of the Ontario Teachers' Pension Plan, describes several advantages of the defined benefit pension model. And clips from last year's Walrus/ HOOPP Great Pension debate. Listen to Jim Keohane, President and CEO of Healthcare of Ontario Pension Plan, explaining why the current system is failing far too many Canadians. Luckily this isn't the case for HOOPP or OTPP's members because their DB plans are the best pension plans in the world.