Canadian Pensions Still Treading Water

Jonathan Chevreau of the National Post reports, Flaherty leans toward pooling:

Finance Minister Jim Flaherty has surprised pension reformers by dashing hopes for an expanded CPP in favour of Pooled Registered Pension Plans. While modest expansions to the almost universal CPP may yet be in the cards, PRPPs are aimed squarely at the 3.5 million middle-income private-sector workers and self-employed who lack employer-provided pensions.

In principle, the idea of “pooling” pensions among multiple small employers makes sense. PRPPs are in essence group RRSPs or Defined Contribution RPPs but relieve employers of the administrative burden, says Fred Vettese, chief actuary at Morneau Sobeco. The burden shifts to a third-party administrator.

One reason only a third of private sector workers now have employer pensions is the complexity of set-up and administration. Classic Defined Benefit (DB) plans are notoriously complex because providers must deal with solvency issues, surpluses and onerous regulations. No surprise that small businesses and entrepreneurs often choose to provide no pension at all, leaving workers to make their own RRSP contributions or — just as likely — no contributions at all.

Smaller firms that take the plunge are confronted with high-cost solutions, similar to what RRSP investors face buying mutual funds. One benefit cited by Finance’s draft, Framework for Pooled Registered Pension Plans, is “enabling more people to benefit from the lower investment management costs that result from membership in a large, pooled pension plan.” If annual fees are lower by 1%, resulting pensions will be 20% higher, Vettese says. Thus, PRPPs “have the potential to change the pension landscape more dramatically than one might think.”

There are major differences. CPP is compulsory and provides a DB-style pension that gives workers a known future income. The PRPP is voluntary and Defined Contribution in nature, meaning market risks are borne by workers if stocks fall.

There’s room for both, says Mercer partner Malcolm Hamilton. A small gradual rise in CPP contribution rates over five years wouldn’t do much harm if imposed on workers rather than employers, he says: “If we want Canadians to save more for retirement we must accept that they will have less to spend.” But to the extent the PRPP encourages more workers to participate in low-cost retirement savings plans, it too is “worth trying,” he says.

There are “major challenges” either way, says Towers Watson senior consulting actuary Ian Markham. Both build on existing efficient frameworks. Ideally, PRPPs will be established through a single federal legislative framework. Markham worries about the higher CPP premiums employers or employees (or both) might face under an expanded CPP. He says there’s only so many extra deductions employers can load onto payrolls before they look to cut back on employee pay — including existing DB or DC pension arrangements.

One benefit cited by Finance is portability of benefits. Another is the “fiduciary” duty for pension administrators. In theory, that should provide peace of mind to employees that their interests are being put ahead of the firms managing the money.

Employers still have a major role. If they choose to offer PRPPs, they can make “direct employer contributions to the plan,” the draft document states, “along with remitting contributions from the employee.”

That doesn’t sound more onerous than the payroll function firms of all sizes must in any case provide. Doug Carroll, vice president of tax at Invesco Trimark Ltd. says this may help investors save who otherwise might not: “Automatic payroll deductions keep cash out of sight and out of mind,” while pre-tax payroll deductions let the gross amount of contributions be invested every pay period. By contrast, lump-sum RRSP deposits are often made with after-tax dollars after tax returns are filed.

The biggest drawback is PRPPs are voluntary for both employers and employees. Pension consultant Keith Ambachtsheer says “both empirical evidence and common sense tell us the purely ‘voluntary’ uptake of these PRPs will be minimal.” He views the initiative as less than serious reform and more a “PR exercise/financial services sector business opportunity.”

Susan Eng, vice president of advocacy at CARP says it’s is better than nothing because it does “a few good things.” Large pooled funds provide better returns than individuals can achieve on their own and the massive marketing likely to accompany it may encourage more Canadians to save. But she’s skeptical banks and insurance companies will keep fees as low as they suggest, or that they’ll truly do what’s best for clients (as required by a fiduciary standard).

Ottawa previously resisted such plans, Eng says, because RPPs cost the treasury tax revenue. But the more Canadians save inside such plans, the less they can contribute to RRSPs so to some extent it’s a wash.

Add the PRPP to either an existing or expanded CPP as well as the new Tax Free Savings Accounts launched in 2009 and Canadians who fail to save for retirement will have only one party to blame: Themselves.

I also have my doubts on the ''fiduciary standards'' of PRPPs and I agree with Keith Ambachtsheer, this was a less than serious reform to our pension system and just another giveaway to the banks and insurance companies.

Don't get me wrong, I got nothing against banks and insurance companies, but let's get serious on pensions. Like healthcare and education, I consider pensions a public good. I truly believe that policymakers should implement changes that try to cover as many Canadians as possible so they can retire with a secure pension. You simply can't compare RRSPs, defined-contribution (DC) plans or PRPPs to a well run defined-benefit (DB) plan.

What would have been a better solution? I had a discussion with a colleague and he mentioned that they could have used the insurance companies' and banks' distribution to offer products from large DB plans. ''After all, that's all that banks and insurance companies really have: distribution.''

Bill Curry and Karen Howlett of the Globe and Mail report, New pension plan would require employers to offer it but allow opt-out:

Canada and the provinces endorsed a new Pooled Retirement Pension Plan Monday, promising to address concerns about yet another voluntary savings option by forcing employers to offer it to their workers.

Finance Minister Jim Flaherty also agreed to keep talks alive on enhancing the Canada Pension Plan – which involves mandatory contributions – and promised an update in June.

Quebec and Saskatchewan agreed to the extended talks on CPP reform, leaving Alberta as the only province that is solidly opposed to the idea.

Advocates of enhancing CPP benefits through a phased-in increase in premiums have recently argued that it is the only way to ensure those who aren’t saving enough for retirement will start putting money away.

The criticism of the pooled system was that it was voluntary, and therefore unlikely to make much more of a difference to retirement savings than existing savings programs such as RRSPs.

But Mr. Flaherty argued that by forcing employers to offer the new PRPP – without forcing them to contribute – and by forcing employers to automatically enroll workers into the system with an opt-out provision, millions more Canadians will start putting away extra cash for retirement.

But employees, who under CPP must match employer contributions to the plan, would be under no obligation to contribute to PRPP.

“The real benefit of it will be seen many years down the road,” said Mr. Flaherty. “We think the PRPP will, to a significant extent, address the savings issue.”

Quebec’s Finance Minister Raymond Bachand noted his province has offered multi-employer savings plans for years, but the mandatory aspects of the PRPP will make a big difference.

“This will increase participation by an enormous amount,” Mr. Bachand said.

While Mr. Flaherty and Mr. Bachand stressed the mandatory parts of the plan, not all provinces have agreed to those details. That will be worked on over the coming months, with the expectation that a final plan will be ready in the “short term.”

The PRPP is aimed at workers who – either because they are self-employed or because they work for a small company that does not offer a pension – do not currently participate in a payroll-based pension plan.

Proponents expect that through regulations and new federal and provincial laws, governments can ensure that the private sector firms offering the pooled pensions will offer lower management fees than those currently available. The hope is that these workers will then be able to take advantage of the investment benefits that came with participating in a large pension fund. Ministers also said the pension will be portable when workers change jobs.

Ontario Finance Minister Dwight Duncan said he supports the PRPP but was pleased to see talks will continue on CPP enhancements.

“We don’t think that’s the whole enchilada,” he said of the PRPP. “We need more.”

Susan Eng, VP Advocacy at CARP, brought to my attention that there is no auto-enrollment requirement in the federal proposal forcing mandatory contributions. It's odd that Minister Flaherty emphasized this requirement. (Read CARP's statement, Pension Opportunity Missed).

Moreover, I strongly doubt PRPPs will make a significant difference in the savings rate down the road. And I repeat, PRPPs cannot compete with the large defined-benefit plans that already exist. The latter exhibit better performance, their fees are lower and their governance standards are way better.

The point on fees was made in Paul Vieira's article in the National Post, Pension rule changes may be key to success:

The debate among country’s key policymakers over what measures would best secure Canadians’ retirement income may be missing one key point.

Ottawa and the provinces discussed the merits of an expanded Canada Pension Plan over a pooled registered pension plan (PRPP), recently pitched by Finance Minister Jim Flaherty as the way forward. At the end of a full day of meetings on Monday in Kananaskis, Alta., there was a tentative agreement to study the benefits a pooled scheme can deliver.

There was little talk, though, about possible changes to pension rules that would make it easier for Canadians to contribute for retirement.

Experts suggest unless such changes are on the table — they would, in essence, remove limits to annual contributions, place less restrictions on what type of income can go into a retirement savings vehicle and help level the playing field between RRSPs and gold-plated defined-benefit plans — then all the pension-reform talk might be for naught.

“Structurally, there is nothing wrong with the pooled pension arrangement. And there could be an expansion of CPP along with that. But this is absolutely not a solution to the pension saving problem in Canada,” said James Pierlot, a Toronto-based lawyer and pension consultant who proposed in a 2008 paper the private pooled scheme Mr. Flaherty is now championing. “This is a rearranging of the deck chairs on the Titanic.”

Mr. Pierlot recommended pooled pensions, to be managed by banks and life insurers, as part of a larger package that included amendments to pension tax laws. For instance, tax rules don’t allow individuals to choose how much of their total annual compensation they will allocate to retirement saving (capped at 18%) and when - in essence penalizing workers when they make big income gains in a particular year.

But such changes are not under consideration, at least not yet. Mr. Pierlot said that’s because governments would sustain a short-term hit to cash flow as the incentive to save improves.

“If you have a budgetary deficit do you really want to solve the pension problem, which would necessarily see a lot more deductible contributions going into these plans? This is the elephant in the corner of the room,” he said.

Even though there was a tentative agreement to look at the pooled pension scheme, no final decision on how to proceed with pension reform is expected for years. And the debate still rages on after years of blue-chip panels, and myriad recommendations via academics and think-tanks.

Still, pension watchers, such as William Robson, president of the C.D. Howe Institute, and Jack Mintz, head of the public policy school at the University of Calgary, said an eventual combination of private pooled management and “some” improvement to the CPP — by, for instance, making defined-benefit arrangements more available — could help address future retirement-income needs.

“There’s no reason why you can’t do both,” Mr. Mintz said.

Six provinces, led by Ontario, have pushed for an enhanced CPP, and Mr. Robson noted that’s to their benefit because it would remove political responsibility to do something.

Still, any plan to boost CPP comes with consequences. Certainly it will lead to higher contributions from employers and employees, or an increase in payroll taxes -- a risky move in a decade most economists argue will be dominated by slow growth.

“One way or another the mechanics have to work through into wages, or else there is going to be job losses,” Mr. Robson said. “And the money has to come from somewhere.”

In addition, increased contributions would disproportionately penalize lower-income earners, as they would be left with less disposable income and the income they could draw at retirement could conceivably be clawed back.

As for the pooled scheme, the biggest criticism is relatively high management fees charged by banks and insurers will eat into returns. And Mr. Pierlot said data from recent years indicate the returns from defined-contribution plans and RRSPs have lagged those of large defined-benefit plans, whose fees tend to be “much lower” than those charged by financial institutions.

Finally, just to underscore the challenges we face with pensions in Canada, CTV reports, Pension plans treading water:

Canada’s pension plans are “running in place” and struggling to return to financial strength despite two years of strong market returns that have bolstered the value of their holdings.

The culprit is falling interest rates, which are offsetting – even outpacing – the improvement in investment returns on pension plans’ assets.

The result, pension experts say, is that many major plans are still grappling with significant financing deficiencies at the end of 2010, and companies are still facing new obligations to put more cash into their plans, more than two years after stock markets fell sharply in 2008.

“Pension plans are running in place,” said Paul Forestell, senior partner at pension consulting firm Mercer. “As interest rates go down at the same time assets go up, the funded position doesn’t move.”

Federal and provincial finance ministers wrestled with similar issues affecting government pension plans in a meeting in Kananaskis, Alta., and have agreed on a framework for a pooled private-sector pension plan for small firms and the self-employed.

Many of Canada’s biggest companies are coping by plowing cash into their pension funds to make up shortfalls. Some payments are being made ahead of the required schedule for eliminating shortfalls because companies have available cash.

BCE Inc., for example, announced this month that it will make a voluntary $750-million payment to its employee pension plan, on top of a regular required payment this year of $500-million. The company, parent of Bell Canada, said its estimated pension solvency deficit of $2.4-billion at the end of 2010 will be reduced to $1.6-billion as a result of the special payment.

BCE’s chief financial officer Siim Vanaselja told analysts that the company decided it makes sense to speed up funding of the pension plan, given the sustained low interest-rate environment in Canada.

“We believe it’s prudent to address permanently our pension deficit,” he said. “By making what should be a final special contribution, we’ve set a clear path to eliminating altogether any deficit funding obligations for Bell by the end of 2014.”

Canadian National Railway Co. has similarly said it will put $430-million into its pension plans this year – including a $300-million additional voluntary contribution above required levels. The company said it wanted to strengthen the financial condition of its primary employee plan.

The ongoing funding problems are linked directly to falling bond yields.

Pension plans have two sides to their funding equation. One is the value of the plan’s assets, which are investments made to finance pensions for retirees. On that front, plans have posted strong returns for the past two years. In 2009, for example, a typical plan earned returns of 16 per cent. In the first 11 months of 2010, plans earned about 7 per cent on average.

The problem lies on the other side of the equation with the pension liability, or the estimated cost of financing the plan’s future benefits. Those liabilities are calculated using bond yields, and are highly sensitive to even small changes in interest rates. As rates fall, more money needs to be in the pension plan to cover future costs, because it is assumed long-term returns will be lower.

Pension specialist Ian Markham at consulting firm Towers Watson says a one-percentage-point drop in interest rates typically causes a plan’s liabilities to rise by about 15 per cent – creating a huge hole in a plan’s funded status.

He estimates that a typical plan earned a return on its investment portfolio of about 7 per cent in the first 11 months of 2010, while plan liabilities have climbed about 15 per cent on an accounting basis for financial statement reporting.

That means many companies are going to be reporting a bigger pension deficit at the end of 2010, and will face increased funding costs from a financial statement perspective.

Companies also measure pension liabilities on a so-called solvency basis, which measures how much money is needed to be in the pension plan under the assumption that the company would go out of business immediately and freeze pension contributions.

On a solvency basis, Mr. Markham said liabilities have climbed about 7 per cent so far this year, which means the funded ratio of a typical plan is not worse, but has also not improved in 2010, despite better market returns.

Either way, the decline in interest rates is whipsawing companies who are trying to budget for future pension-plan costs.

“These are very dramatic changes that are taking place,” Mr. Markham said. “Unfortunately, the trend has been toward lower and lower long-bond yields, as the markets believe that inflation is going to remain relatively low.”

While statistics for 2010 are not available yet, numbers for 2009 compiled by Mercer show that the 111 companies with defined-benefit plans in the benchmark S&P/TSX composite index contributed a total of $8.5-billion to their pension funds last year. They still had pension shortfalls totalling $13.6-billion at year’s end.

Mr. Forestell said that while companies are looking at longer-term solutions such as changing their investment strategies or closing their plans to new members, in the short term, most must put even more cash into their plans to address immediate funding problems.

“The only thing that will fix the problem quickly is an increase in interest rates,” Mr. Forestell said. “But I always tell my clients that will fix your pension problems – but what does it do to the rest of your business?”

What worries me is that funding problems will only get worse and many companies will be forced to cut defined-benefit plans altogether. And then what? PRPPs to the rescue? I guess we're going to have to learn the hard way that when it comes to pensions, the private sector solution is really not a long-term solution at all. It's a shame that our policymakers squandered yet another opportunity for meaningful pension reform. Canadians deserve much better than these half-baked measures.