Monday, October 3, 2016

Long Live the CPP!!

Last week, the Department of Finance Canada released a statement, Canadians Can Count on a Stronger, Financially Sustainable Canada Pension Plan:
Helping Canadians achieve a safe, secure and dignified retirement is a core element of the Government of Canada’s plan to help the middle class and those working hard to join it. The Canada Pension Plan (CPP) enhancement agreed to by Canada’s governments on June 20, 2016 will give Canadians a more generous public pension system, which will support the conditions for long-term economic growth in Canada.

Minister of Finance Bill Morneau today tabled in Parliament the 27th Actuarial Report on the Canada Pension Plan. The Report concludes that the existing CPP is on a sustainable financial footing at its current contribution rate of 9.9 per cent for at least the next 75 years. CPP legislation requires that an actuarial report be prepared every three years to support federal and provincial finance ministers in conducting financial state reviews of the CPP as joint stewards of the Plan.

The CPP enhancement will build on this strong record of financial management: The Chief Actuary will conduct an actuarial assessment of the enhancement once legislation implementing the enhancement is introduced in Parliament.
You can read the latest triennial actuarial report on the Canada Pension Plan here. Jean-Claude Ménard, Canada's Chief Actuary, and his team did a wonderful job explaining the state of the CPP and why its on solid footing.

I agree with Bill Morneau, Canada's Minister of Finance, who sums it up well in this statement:
The CPP enhancement agreement that Canada’s governments reached in June means that Canadian retirees will enjoy a more secure retirement and a better quality of life. This Actuarial Report confirms that the agreement will build on a rock solid financial foundation. I would like to thank Chief Actuary Jean-Claude Ménard and his Office on behalf of Canadians for their hard work and dedication, and look forward to their continued efforts in helping to ensure that Canadians can count on a stronger CPP well into the future.”
Let me first publicly thank Michel Leduc, Senior Managing Director & Global Head of Public Affairs and Communications at CPPIB, for bringing this to my attention last week (click on image below to see him):

Unfortunately, I was busy last week covering why Ontario Teachers is cutting computer-run hedge funds, why these are treacherous times for private equity providing a follow-up guest comment from an insider who revealed the industry's misalignment of interests, and ended the week discussing the ongoing saga at Deutsche Bank.

But I think it's important Canadians step back and realize how fortunate we are to have the Canada Pension Plan, its stewards, and the astounding and highly qualified professionals at the Office of the Chief Actuary, as well as the senior managers and board of directors running and overseeing the Canada Pension Plan Investment Board (CPPIB).

Michel Leduc's initial email to me started like this:
If you're open to topics for your blog, the Chief Actuary of Canada's report was tabled by the Minister of Finance yesterday - looking into the sustainability of the CPP. This only happens once every three years. It is a deep dive into the program. It is a big deal and no one really places enough attention to it, remarkably.

In any event, it is astounding to see that, since the last report (2012), investment income (CPPIB) is nearly 250% above what the Chief Actuary had projected three years ago. The report indicates that this allows a lower minimum contribution rate. For those detractors of active management - this slams the misguided view that it is mere experiment.
Michel followed up by providing me some key findings from the latest triennial actuarial report:
  • Despite the projected substantial increase in benefits paid as a result of an aging population, the Plan is expected to be able to meet its obligations throughout the projection period.
  • With the legislated contribution rate of 9.9%, contributions are projected to be more than sufficient to cover the expenditures over the period 2016 to 2020. Thereafter, a portion of investment income is required to make up the difference between contributions and expenditures.
  • Total assets are expected to grow from $285 billion at the end of 2015 to $476 billion by the end of 2025.
  • The average annual real rate of return on the Plan’s assets over the 75-year projection period 2016 to 2090 is expected to be 3.9%.
  • The minimum contribution rate required to finance the Plan over the long term under this report is 9.79%, compared to 9.84% as determined for the 26th CPP Actuarial Report.
  • Investment income was 248% higher than anticipated due to the strong investment performance over the period. As a result, the change in assets was $70 billion or 175% higher than expected over the period. The resulting assets as at 31 December 2015 are 33% higher than projected under the 26th CPP Actuarial Report.
A few key points I'd like to mention here:
  • Strong investment performance obviously matters for any pension plan. The stronger the investment performance, the better the health of the plan as long as liabilities aren't soaring faster than assets, and this this translates into less volatility for the contribution rate (ie., less contribution risk).
  • Unlike HOOPP or OTPP, however, the Canada Pension Plan is not a fully-funded plan (it is partially funded) and assets are growing very fast, which effectively means the managers at CPPIB can use comparative advantages over most other pensions to take a really long view and invest in highly scalable investments across public and private markets.
  • I think it's critically important that Canadians realize these advantages and why it sets CPPIB apart not only from other (more mature) pensions but more importantly, from long only active managers, hedge funds, and even private equity funds, all of which are struggling to deliver the returns pensions need. 
  • In particular, the crisis in long only active management is a testament to why the CPPIB is so important to the long-term health of the Canada Pension Plan and more importantly, why large, well-governed defined-benefit plans are far superior to defined-contribution plans or registered retirement and savings plans. 
  • Not only this, the success of the Canada Pension Plan should make our policymakers rethink why we even allow private defined-benefit plans at all and why we don't create a new large public defined-benefit plan that amalgamates the few corporate DB plans remaining in Canada to backstop them properly with the full faith and credit of the Canadian federal government. 
In other words, I'm happy we finally enhanced the CPP but we need to do a lot more building on its success and that of other large Canadian defined-benefit plans.

I mention this because I read an article from Martin Regg Cohn of the Toronto Star, Death of private pensions puts more pressure on CPP:
It’s human nature to ignore pension tensions. Until the money runs out.

Full credit to our political leaders for coming together to expand the Canada Pension Plan this summer, recognizing that a looming retirement shortfall requires a long-term remedy.

Their historic CPP deal came just in time, for time is running out on conventional pensions in the private sector.

Long live the CPP. Private pensions are on life support, and fading fast.

If anyone still doubts the need for concerted action, or ignored the high stakes negotiations over the summer, here are two bracing wake-up calls from just the past week:

First, unionized autoworkers at GM made an unprecedented concession to relinquish full pensions (which pay a defined benefit upon retirement) for newly hired employees. The agreement, ratified by Unifor members over the weekend, marks the end of an era in retirement security.

Like virtually all other private-sector workers, new hires at car factories will be given a glorified RRSP savings account. These so-called “defined contribution” plans (I prefer not to call them pensions) get matching employer contributions but remain at the mercy of the stock market for decades to come, without the security of annuitized payments upon retirement.

It’s hard to fault Unifor for throwing in the towel after long insisting on pension parity among all workers. They were among the last major private-sector unionists to cling to full-fledged pensions that have been phased out across North America.

Why continue to burden your own employer with legacy pension costs that disadvantage them against competitors? For example, Air Canada has faced major pension liabilities in recent years, while upstart start-up airlines like Porter were free from such legacy costs and financial risks because their newly hired workers weren’t getting “defined benefit” (DB) plans backstopped by the company.

A second development last week tells the story of our pension peril from a different angle: While autoworkers were surrendering full pensions for new hires, steelworkers were fighting to rescue and reclaim their full defined benefit pensions.

But the way in which their pensions are being salvaged portends a losing battle. When U.S. Steel Canada filed for creditor protection, after taking over Stelco’s assets, it revealed a pension shortfall of more than $800 million. Upon insolvency, that liability would land in the lap of the province’s little-known Pension Benefits Guarantee Fund.

It has always been something of a Potemkin pension fund, with little to prop up its facade of protection. Like an undercapitalized bank, the pension fund could not withstand a run on its assets if too many private pensions failed — requiring replenishment by the provincial government and all other employers in the province.

That’s why Queen’s Park has long been loath to see a big bankruptcy deplete the fund. Behind the scenes, it recruited former TD Bank CEO Ed Clark to find a way to rehabilitate what remains of the old Stelco operations so that those pension liabilities could somehow be avoided.

After drawn-out court hearings and closed-door negotiations, a New York investment firm signed a deal last week with the provincial government to invest hundreds of millions of dollars to save 2,500 jobs — and prop up those pensions a little longer. The United Steelworkers union, which had been deeply skeptical of previous bidders, likes this proposal because it provides a pension infusion.

While that may sound like good news for pensioners and workers, it is surely just a stop-gap — neither a sure thing for the former Stelco workers, nor a safe bet for the taxpayers who could be on the line if it all unravels.

We don’t know how the story will end. The only certainty is continued uncertainty for private-sector pensions, no matter how much union muscle is brought to bear. Private DB pensions are dying, and our only recourse is a reliable, diversified public DB pension in the form of the CPP.

All the more reason to herald the CPP expansion agreed to this summer after nearly a decade of drawn-out negotiations and foot-dragging by the previous Conservative government in Ottawa. A strong push by Ontario’s Liberal premier, Kathleen Wynne, and national leadership by the new federal Liberal government, helped persuade other premiers to accept a pan-Canadian compromise.

Details of the CPP reform, announced this month, will take years to phase in. In truth, it is a relatively modest and staged increase after a half-century of virtual stasis since the plan’s creation.

It is a promising start. But decades from now, as more private sector plans die off and today’s young people grow older, Canadians will wake up to the need for a more robust round of CPP expansion to pick up the slack.

It’s only human.
Indeed, it's only human and I'm glad that our policymakers finally decided to enhance the CPP but a lot more needs to be done.

In particular, the Department of Finance Canada should immediately study a proposal to create a new large, well-governed public pension which will absorb the few remaining Canadian private DB plans and staff this new organization properly using the existing pool of talented pension fund managers in Montreal.

I mention Montreal, not Toronto, because Montreal is where you will find the head offices of CN, Bell and Air Canada, all of which have talented pension fund managers managing legacy and active DB pensions. And this city desperately needs a new large public pension plan (Toronto has the bulk of them).

But absent this initiative, I agree with Cohn, "long live the CPP!!!", it's our only hope to bolster Canada's retirement system and the economy over the long run.

Below, more much ado about Deutsche. Raoul Pal, RaoulGMI, says the key issue for Deutsche Bank is not the Justice Department fine but internal problems in the bank and rising LIBOR rates.

Listen to his comments and remember, these are difficult times for public and private markets which is why we want to make sure that we bolster Canada's large, well-governed DB pensions to ensure more Canadians retire in dignity and security. Long live the CPP!!

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