PSP's Former CEO on the $9 Billion Public Service Pension Fund Surplus

On Friday, PSP investments' former CEO Neil Cunningham sent me Bill Curry's Globe and Mail article on how Ottawa could reap $9-billion from surpluses in public-service pension fund, projections show:

Ottawa could potentially reap a $9-billion boost to its bottom line over the next few years, federal documents show, thanks to a growing surplus in the pension fund for public servants, prompting a standoff with unions over what should be done with the windfall.

Treasury Board President Anita Anand upset the major public-sector unions earlier this week when she announced that about $1.9-billion in the Public Service Pension Fund from the previous fiscal year will be shifted to general revenues. Labour leaders say workers also contributed to the fund and should benefit from any surplus, rather than having the money go toward other priorities such as new spending or reducing the size of the deficit.

The minister said the change is because the size of the surplus in the $186.4-billion fund has exceeded allowable levels.

However, in an analysis to be released Friday by the Public Service Alliance of Canada (PSAC), the union points out that new federal records show the government is projecting changes totalling $9.2-billion through 2028.

The figure is contained in a table from a special actuarial report that was also released this week showing that if the existing surplus continues to grow as projected, the federal government could partly pause its contributions to the fund in 2025, fully pause them the next two years and have a partial pause for 2028.

“I was quite shocked and disappointed that the government flat out omitted one major point: that they plan to give themselves the biggest holiday present,” said Sharon DeSousa, national president of PSAC, which is the largest of the unions representing federal public servants.

Ms. DeSousa said in an interview that rather than shifting funds out of the pension plan, PSAC would prefer to see changes to address an inequity in the current pension rules that requires newer workers to work more years to qualify for a full pension. She said any contribution holiday should also apply to public servants.

Ms. DeSousa said PSAC has been urging the government for months to consider such options in anticipation of a pension surplus decision. Instead, she said Ottawa is using the funds to improve its bottom line.

“They plan to do this on the backs of workers,” she said.

The special actuarial report, prepared by the Office of the Chief Actuary, said the value of the pension fund as of March 31, 2024, is $186.4-billion. The fund has a surplus of $38.8-billion over $147.6-billion in liabilities, which is a funded ratio of 126.3 per cent.

Federal rules say the plan cannot hold a surplus of more than 125 per cent of liabilities, defining such amounts as a “non-permitted surplus.”

The actuarial report said the fund’s return on investment earnings was 7.2 per cent in 2024, compared with the expected return of 5.8 per cent.

Each year that a projected surplus above the 125-per-cent threshold does in fact materialize, the government is required to take action to bring the surplus back within the limit. The actuarial report presents a government contribution freeze as a default scenario, but the government could choose to repeat this year’s practice of shifting the surplus to the consolidated revenue fund.

Myah Tomasi, a spokesperson for Ms. Anand, the Treasury Board President, said the government’s $1.9-billion transfer “will be held while next steps are considered,” in accordance with federal legislation governing the fund.

“Once this transfer is made, there will no longer be a non-permitted surplus in the pension plan, allowing the government to continue its contributions,” she said.

It is not immediately clear how these accounting adjustments will affect the Liberal government’s bottom line.

Finance Minister Chrystia Freeland has yet to announce a date for the fall economic update. The House of Commons is scheduled to sit until Dec. 17.

In last year’s fall update, Ms. Freeland pledged that the deficit for the fiscal year that ended in March, 2024, would not exceed $40.1-billion. Parliamentary Budget Officer Yves Giroux released a report in October that said it appears the government is heading toward a $46.8-billion deficit, meaning Ms. Freeland has missed her fiscal target.

Ms. Freeland has repeatedly declined to clarify whether her update will in fact show the target was missed.

Former parliamentary budget officer Kevin Page, who is now founding president and CEO of the University of Ottawa’s Institute of Fiscal Studies and Democracy, said only the $1.9-billion transfer announced by the minister this week is confirmed. The remaining amounts are projections.

“We might only know in the next federal budget whether the figures presented in the table represent a source of funds for other measures,” he said in an e-mail.

“It is the minister’s prerogative to use funds for other policy priorities as long as the fund requirements are met. Given that the increase in the funded ratio above 125 per cent is due to over-contribution by both employees and the government, one might expect that the contribution holiday could be shared by both parties.”

 As I stated, on Friday, PSP's former CEO Neil Cunningham sent me this article along with this note:

The concept of the federal government using the surplus funds in the Public Service Pension Fund (PSPF) for other purposes is, in my opinion, a good idea. But I am not supportive of the choice that the current government is making to use this surplus as a piggy bank to support their overspending on their various other priorities.

The recent discussion regarding Canadian pensions not investing sufficiently in Canada has missed a significant point regarding the difference between the PSPF and every other Maple 8 pension funds - that is that the PSPF is essentially a sovereign wealth fund wherein it is the federal government who is the plan sponsor and is on the hook for the full pension promise that is provided to its workforce. Being a federal fund with ALL Canadians participating as contributors and sponsors through our tax dollars makes this fund essentially a sovereign wealth fund, albeit with a primary purpose to pay the promised pensions.

As you well know, the PSPF investments are managed by the PSP and represents about 70% of PSP’s assets under management, the balance being the pension funds or the Canadian Army, Army Reserve and the RCMP. (What I outline here would also apply to these other pension funds managed by PSP, although the details and surpluses are not uniform). PSP has been over the long term an extremely successful investment firm and has built up the 126% funding surplus described in the article while staying within the risk limits proscribed by the Treasury Board, to whom PSP reports. This has been accomplished while maintaining a risk profile equivalent to what currently is a 58/42 equity to fixed income ratio (by comparison CPPIB’s risk tolerance expressed by their reference portfolio is currently 85/15). So what to do with the surplus?

The legislation covering the PSP specifies the 125% limit on funding levels, any excess being described as the “non-permitted surplus”. The Act provides Treasury Board with several options regarding how to deal with such a surplus that I will summarize as i) a funding holiday for the sponsor, and/or the beneficiaries, ii) an increase in benefits or iii) a lump sum withdrawal from the fund by the sponsor. I would propose an additional option which goes to the discussion on pension funds investing more in Canada.

Quite simply, Ottawa could transfer the surplus money into a separate fund that has a mandate to invest exclusively in Canada. This fund could be set up in a similar fashion to the Canada Growth Fund that was established two years ago and is managed by PSP with NO political interference in the actual investments - the government is responsible for the fund’s mandate and then getting out of the way and letting the investment professionals do their job. For various reasons, and I admit some bias here, the PSP would be the logical manager of this new Canada fund. 

And why stop there, why not increase the risk appetite of the PSPF beyond the current 58/42 to a higher but still very reasonable asset mix, like 70/30, with the expectation that the surplus would grow over time and be could be used to continue to finance this new fund?

I’ve simplified some of the details here, but I’m sure you get the idea - Canada has a terrific investment manager that charges zero fees other than paying the direct costs of running the place - why not optimize it to the long-term benefit of all Canadians that also addresses a long-standing issue of importance to Canada’s economy. 

What followed was a very interesting discussion with Neil on what can be done with the surplus to benefit the Canadian economy.

According to Neil, the Government can use that surplus at its discretion to create a new "Canada Fund" with an explicit mandate to invest only in Canada.

This new fund can be modelled after the Canada Growth Fund which the Government incorporated exactly two years ago:

Canada Growth Fund Inc. (CGF) is a C$15 billion independent and arm’s length public fund that will help Canada to speed up the deployment of technologies in its efforts to reduce emissions, transform its economy and support the long-term prosperity of Canadians.

CGF’s mandate is to build a portfolio of investments that catalyze substantial private sector investment in Canadian businesses and projects to help transform and grow Canada’s economy at speed and scale on the path to a low-carbon economy.

This CGF is managed by PSP Investments. Its President and CEO, Patrick Charboneau, is part of PSP's executive team but he answers to his own board of directors which is made up of a subgroup of PSP's board.

CGF has a clear mandate and is managed at arm's length from the government, just like PSP:

By partnering with PSP Investments, CGF benefits from PSP Investments’ deep investment expertise and track record across a broad range of sectors and strategies, a mature and scalable operational ecosystem and a governance framework that is independent and at arm’s length from the Government of Canada, allowing CGF to rapidly and successfully deliver its mandate. CGF Investment Management’s activities are operationally distinct from PSP Investments’ pension investment mandate, and the assets of CGF and of PSP Investments are not commingled.

Neil told me the expected long-term return of CGF is zero, its investment activities focus on three key sectors:

CGF is funded by the federal government (C$15 billion) with a clear mandate and it's actively ramping up its investments to meet that mandate (read latest interim report here and see their latest news here).

The best way to think of CGF -- even though it's not exactly like this -- is a clean technology venture capital fund but they are not looking to shoot the lights out in terms of returns and their investment mandate is broader.

Neil Cunningham followed up on our conversation stating this:

As a follow up to our conversation yesterday it occurred to me that it might to useful for me to differentiate between the Canada Growth Fund (CGF) created a few years ago and my suggested Canada Fund (CF). 

CGF as you know was created by the federal government in 2023 with a mandate to make investments that take on higher risk than what the private sector will invest in to fill the funding gap on innovative investment in Canada that are expected to reduce emissions, preserve Canadian IP in Canada, create long-term employment in Canada and leverage our natural resource assets. It has a venture capital element to it, but the long-term target return of the fund is to break-even - which would be considered a success if the other objectives were achieved. It’s funded by a specific $15 billion commitment by the federal government, its mandate being in line with current federal government objectives, especially on climate. 

The CF in contrast would be funded by the excess returns generated by the PSPF (and potentially the other funds managed by PSP) and therefore would not have any impact on Canada’s annual deficit or national debt. Its mandate would be to invest exclusively in Canada - the mandate and target return to be established but could be similar to the CGF but with a broader range of industry sectors. I would suggest that it have a focus on early to mid-stage Canadian companies that often have to look to the US or elsewhere for the capital required for the development of their IP and to move their business to the next level. 

The similarity of the two funds would be the governance structure wherein the federal government sets the mandate but is NOT in any way involved in the actual investing decisions, both funds to be managed by an independent investment manager. 

By having a long-term funding source that is independent of future government finances, the CF would be a permanent source of capital to promote strategic Canadian private sector investment.

Now, I like Neil's idea of setting up a Canada Fund to invest exclusively in Canada where the governance is exactly like the Canada Growth Fund, namely, it would operate at arm's length from the government which funds it and sets the mandate.

What are other possibilities? I've long argued we need to set up a Canada Healthcare Fund which has the same governance as PSP and CPP Investments with a clear mandate to invest and meet the growing healthcare expenditures of our growing population.

Since the feds handle healthcare expenditures, they can easily set up such a fund and grow it over time to make sure we have enough money to pay for growing healthcare costs as the population ages.

To be honest, this should have been done years ago, but we don't have much foresight when it comes to thinking long-term in this country.

Another idea for that C$9 billion surplus similar to my Canada Healthcare Fund is to start the Canada Disability Fund which is a fund that will pay benefits to Canadians living with a disability.

Why do we need a Canada Disability Fund? Simple, the recent passage of Bill C-22 creating the Canada Disability Benefit (CDB) isn't enough, the disability benefits fall short of what the government promised and we need to rectify this to take care of our most vulnerable citizens who have been living in poverty for far too long.

As I stated many times, if the Government of Canada handed out CERB payments of $2,000 a month to every eligible Canadian during the pandemic, then why are Canadians with disabilities expected to live on half that amount or less in 2024 after a significant rise in inflation. It's a travesty and they know it.

Again, our policymakers make political choices that suit their agenda but how about they start making intelligent choices that fix our healthcare and boost disability payments to those that need them?

Lastly, I enjoyed my conversation with Neil because he's a sharp guy with a lot of experience and it shows.

We discussed compensation at Canada's large pension funds and he told me that at PSP, they implemented a total fund compensation system where the vast majority of every employee's compensation is based on PSP's long-term results (only a small portion based on individual and team results). 

In this regard, PSP is ahead of its peers since their compensation is based a lot more on total fund results (have to verify this to see if there are important differences with other funds that also claim their comp is largely based on total fund long-term performance).

Neil told me the idea came at an offsite and there was "buy-in from all the investment teams." 

What else? Neil explained how platforms mean different things for private market asset classes:

• For real estate, you have joint ventures 50/50 splits with funds developing and acquiring properties
• In private equity, platforms are built on strategic relationships with PE fund to gain co-investments and reduce fee drag. The same goes in private credit.
  
• In infrastructure, you have operating companies owned by pension funds that buy toll roads, airports, ports, etc.

Neil told me given the reputation risks of owning platform companies in infrastructure that are sole operators of an asset, it might make sense for several large pension funds to invest together in the future and compete with the ever growing mega billion private equity infrastructure funds.

On separating alpha and beta, he gave Eduard van Geldren, the former CIO, all the credit for setting geographic diversification and then figuring out where it makes sense to go after alpha and where it makes sense to stick to beta.

For example, in fixed income, private credit has added important alpha but in Hong Kong, it makes more sense to have beta exposure through public markets and so on and so on.

Admittedly, I am oversimplifying here and I would prefer if Eduard wrote a nice research piece on how to properly separate alpha and beta a large pension fund since he did this successfully at PSP.

Alright, before I wrap this up, I did ask Neil if he'd be interested in running this Canada Fund he is proposing and he said he's retired now and might help them as part of the board but he's not interested in heading up this fund.

He's advising Sagard and enjoying that and enjoying retirement in the Eastern Townships.

I personally can't think of a better board member to have on a large pension fund board, he has tremendous experience and knowledge and can bridge existing gaps (you need someone like that on the board of CPP Investments or other Maple Eight funds, except PSP since he was the CEO there).

Alright, that's a wrap, time to grab some dinner and put my little guy to sleep.

I thank Neil Cunningham for another great conversation and sharing his thoughts on the surplus at the Public Service Pension Fund.

Below,I urge you to watch this clip on the hidden costs of Canadian healthcare. This video was made by McMaster University students Muskaan Natt, Ali Mohammad, Asiya Ali, and Jasiya Janjua in collaboration with the Demystifying Medicine McMaster Program.

And Canada is taking an important step towards launching a long-awaited national disability benefit. The new measure was unveiled in April when the federal budget was presented and payments are expected to begin at in July 2025.

The Liberals say the program is meant to help lift Canadians living with disabilities out of poverty, but as Global News' Mike Armstrong reports, critics say the funding isn’t even close to what’s needed. 

As I stated many times, a society shows its character by how it takes care of its most vulnerable citizens. In my opinion, we are failing in this regard and need to properly fund disability benefits to Canadians that need them. Same in healthcare, we are not planning for a better future.

Update: PSP's former CIO, Eduard van Gelderen, shared this with me after reading this comment:

Herewith a quick reaction on your "conversation with Neil" blog comment. I fully support Neil's suggestion and argumentation. 

Just shaving off the surplus above 125% to reduce the debt position is not particularly creative nor productive. 

But, there is another argument to make here. Over the years, CEOs like Gordon, Andre and Neil have created a professional and successful asset manager based on the principles of the Canadian model. The performance in the past has been significantly higher than the discount rate and this is likely to be the case going forward. Hence, the 'problem' of the non-permitted (excess) surplus will reoccur over and over again. 

There are three solutions:

1. Make sure that the surplus will never go beyond 125%. For example, by changing the risk profile and/or the asset mix. But, this has potentially serious negative implications for PSP as an asset manager. For example, it might mean downsizing the internal private markets investment teams. In essence, it breaks down what the previous CEOs carefully built up. 
2. Go the "Neil" route. Shave off any surplus >125% over time. You keep the organization intact and there is a clear incentive to continue to perform well. 
3. Create a formal off-balance pension plan for government employees and get rid of the non-permitted surplus rule. In this case the Canadian government cannot claim any surplus, but also doesn't need to cover a potential deficit. This forces them to come up with a clear risk-sharing protocol and a Board taking decisions and responsibilities (similar model as, for example, OTPP). Clearly, this implies that the members carry some of the risks too and is not put in place overnight.

The 'Neil' route is probably the best option to protect PSP as a professional investment organization.

I want to thank Eduard for sharing his suggestions with my readers and since he and his team were the liaison with Treasury Board Secretariat of Canada which oversees SP, he is well suited to comment on this issue.

Also, Alison Loat, Senior Managing Director, Investments at OPTrust shared this with me after reading this comment:

Very interesting set of ideas. On your disability idea, you might want to look at Australia's National Disability Insurance Scheme (NDIS), the assets of which are managed by the Future Fund (Australian government's wealth fund). Notably the Future Fund also manages a fund for medical research. It'd be great to have this kind of long-term thinking and programs in place in Canada, and appreciate the contribution you and Neil are making to the discussion.

Alison spent much of her career in Canadian public policy and long-term investing (and was on the founding team of FCLT). She told me "the discussion you’re stimulating is so so important." 

I thank her for sharing this with my readers and fully agree with her.