Pension Reforms: Will Canada Lead the World?

Norma Greenaway of Canwest News Service reports that pension expert proposes fix for Canada's retirement saving shortfall:
A supplementary pension plan is needed to give middle-income Canadians without workplace pensions a better crack at securing a comfortable retirement, says Keith Ambachtsheer, one of the country's leading authorities on pensions.

Ambachtsheer, director of the Rotman International Centre for Pension Management at the University of Toronto, says governments must plug the hole in the system that leaves about four million Canadians on their own to build a better nest egg than the public pension system guarantees.

Ambachtsheer says the public system provides adequate income replacement for workers whose annual incomes are $30,000 or less.

But, he says, the combined income from the Canada Pension Plan, Old Age Security and the Guaranteed Income Supplement won't finance the type of retirement envisioned by many of those earning between $30,000 and $125,000 a year.

"There are a lot of people that aspire to have a long, comfortable, pleasant post-work life," Ambachtsheer said Thursday in an interview after the release of is latest pension report.

Many have lifestyles that require $60,000 or $70,000 a year to maintain after they stop working, and "$36,000 doesn't do it," Ambachtsheer said, referring to the current maximum value of benefits a retired couple can collect from CPP, OAS and GIS if it has no other income sources. The maximum benefit for a single person is about $19,000.

Ambachtsheer called on federal and provincial governments to rally around the idea of creating a supplementary national pension plan — separate from the CPP/QPP — that would allow the three of four workers in the private sector without workplace pensions to build a better retirement cushion.

Under Ambachtsheer's preferred formula, premiums would be set to provide the equivalent of 60 per cent of pre-retirement earnings when benefits from all pensions are combined. All employers and workers without a workplace pension plan would be automatically enrolled, but they could choose to opt out.

"(This) reform is about facilitating middle-income private sector workers so that they can have a decent, enjoyable post-work period of retirement, rather than ending up (at) a cliff — where as soon as their work income stops, their incomes goes in half."

Ambachtsheer's latest appeal comes as federal and provincial finance ministers prepare for a meeting in Whitehorse next month that some participants hope will result in the players agreeing to fashion a national approach to resolving what many see as a mushrooming retirement income crisis.

Ambachtsheer's proposal for a "Canada Supplementary Pension Plan" envisions joint federal-provincial involvement, but, he says, separate provincial or regional initiatives are feasible.

The governments of British Columbia and Alberta, which are ahead of the others on exploring provincial supplemental pension plans, say they would prefer a national approach, but they are prepared to go it alone if necessary.

Saskatchewan and Manitoba say that in the absence of a national plan, they would be interested in joining a possible western regional plan.

The Harper government is playing its cards close to its chest, saying it wants to wait until it sees the results of ongoing research into the adequacy of Canadians' retirement income, and how it compared to other countries. The research findings will be presented in Whitehorse.

Analysts say the recession has shone a light on long-standing gaps in a pension system. Even those with workplace pension plans are on edge, wondering whether their expected pensions will shrink or disappear if their employer goes bankrupt or gets into financial difficulties.

The Canadian Institute of Actuaries concluded in a study released last month "two-thirds of Canadians who plan to retire in 2030 may not be saving at levels required to meet household expenses in retirement."

Ambachtsheer prepared his latest pension report for the Benefactors Lecture series operated by the C.D. Howe Institute.

Mr. Ambachtsheer's report, Pension Reform: How Canada Can Lead the World, identifies the following problems with pension rules and regulations:

  • Private-sector workers cannot participate in the kind of large-scale, pooled arrangements that serve public-sector workers well. Such restrictions should be removed (see Pierlot 2008).
  • Workers cannot participate in pension plans that are not sponsored by their employers. This restriction should be removed to facilitate the creation of cost-effective collective pension arrangements (see Pierlot 2008).
  • Current legislation and regulations foster administrative complexity and restrict employers from exercising flexibility in sponsoring and contributing to a variety of pension arrangements. These complexities and restrictions should be removed (see Pierlot 2008).
  • Pension legislation and regulations should be harmonized across the country (see Van Riesen 2009).
  • A number of quantitative investment restrictions continue to hamper pension investments and should be removed (see Puri 2009).
  • Current tax rules restrict saving for retirement in a number of important ways, including through contribution ceilings, age-restrictions, and the definition of which types of income qualify for retirement-savings-related tax-deferral treatment. All these rules need to be reviewed and brought into the twenty-first century (see Banerjee and Robson 2008; Gunderson and Wilson 2009).
  • The treatment inequities between private-sector and public-sector workers should be dealt with (see Charron 2007).
  • Current RRIF rules force seniors to run their retirement savings down too quickly (see Robson 2008).
  • The 10 percent overfunding cap in DB plans hampers prudent risk-management practices (see Banerjee and Robson 2008).

He said the following principles should guide any plan to reform Canada's pension system:

  • Pension plan designs should target a post-work standard of living that is adequate, achievable, and affordable
  • All workers should have a simple, accessible, portable opportunity to participate in pension plans that have explicit post-work income-replacement targets
  • All forms of retirement saving should receive equal tax, regulatory, and disclosure treatment across all sectors of the Canadian workforce
  • Pension management and delivery structures should be expert, transparent, and cost effective.

On the issue of governance of large pension plans, Mr. Ambachtsheer writes:

Does the lower cost of large funds translate into a direct benefit on the investment side as well? The answer is yes. In fact, here the benefits are even better: on average, for every tenfold increase in the dollar value of fund assets, risk-adjusted net returns increase by twenty-seven basis points (that is, 0.27 percent); recall that, for every tenfold increase in dollar value, unit costs decrease by only seventeen basis points. Thus, on average, larger funds outperform smaller funds by more than just their lower unit cost advantage.

What explains these findings? Research suggests that a possible answer is the generally stronger governance capabilities of larger funds. A study by Ambachtsheer, Capelle, and Lum (2008) involving 88 pension funds finds a positive correlation between risk-adjusted net returns in the CEM database and the governance quality of those funds. Higher-quality governance is associated with the following behaviours:

  • a board of governors selection process that combines both representativeness and skills/experience criteria;
  • self-evaluation of board effectiveness;
  • clarity between the respective roles of the board and management;
  • the adoption of a high-performance culture with transparent and competitive compensation policies; and
  • insource and outsource decisions that are based purely on cost-effectiveness assessments.

In empirical analyses almost ten years apart, funds that scored well on these behaviours outperformed those that scored poorly by 1 to 2 percent per annum.

This is the biggest beef I've got with Mr. Ambachtsheer's "authoritative" report on pension reforms. He shamelessly cites his own firm's research and neglects to mention that his biggest clients are the very large pension plans he is commending for "good governance".

If you've been reading Pension Pulse, you know what is really going on at each and every large Canadian pension fund. Far from having good governance, most of these large funds are governed in an ad hoc fashion which provides the illusion of good governance. The claim that "Canada leads the world" on pension governance is an outright lie which ignores serious governance gaps that still remain in our pension system.

I can destroy each and every governance point Mr. Ambachtsheer raises above. First, the board of directors at these large public pension funds are made up of political hacks and industry types who in many cases don't have a clue about proper pension governance.

If it were up to me, I would add a few university professors from the finance, accounting and economics departments who have no industry ties whatsoever. I'd love to see pension fund managers try to pull fast ones over unbiased experts.

Second, self evaluation of board effectiveness is like Wall Street and Bay Street's self-regulation. It simply does not work and only acts like smoke and mirrors.

Third, there is no clarity between the respective roles of board and management. All too often the board tries to micromanage management instead of clearly defining their role and allowable risk parameters.

Fourth, the "adoption of a high-performance culture with transparent and competitive compensation policies" is typically based on bogus benchmarks which do not accurately reflect the risks of the underlying investments (particularly in private markets where benchmark abuse is rampant).

Fifth, decisions based purely on cost-effectiveness assessments is debatable. If pension funds are not disclosing who they do business with and what are the total costs of doing business, then we can never really know if they're delivering real added value to the plans they manage.

Sixth, and most important, everything should be disclosed at public pension funds. And I do mean everything. Benchmarks governing public and private markets, minutes from each board of directors' meeting, compensation for every senior officer, departures of senior managers, turnover rates, custodians, vendors, fees to external managers, internal operational costs, expense reports for senior managers and individual groups, etc. Public monies deserve full and public disclosure.

Finally, if you want to read an excellent article on pension reforms, I suggest you read Jean-Pierre Laporte's article in the June issue of Benefits and Pension Monitor, Supplemental CPP: An Idea Whose Time Has Come (on pages 38-39).

Canada can lead the world in pension reforms, but first let's get some basic disclosure and tighter oversight on investments and compensation policies. If you pay people to take stupid risks, don't be surprised when they deliver disastrous results.