Fending Off Canada’s Pension Crisis?
The numbers are far from reassuring. In 2001, one Canadian in eight was over age 65. By 2026, one in five will have entered their golden years. Yet in spite of the aging Canadian population, more than 60 per cent of working Canadians currently don’t have a workplace pension. And even those who do are not guaranteed retirement security.
Further, as employers increasingly opt for defined-contribution rather than defined-benefit pension plans, the burden of managing the risks associated with a pension — such as longevity and the market performance of assets — has shifted to the worker. Access to a stable, secure and adequate standard of living after retirement is becoming increasingly rare for middle-income Canadians.
While the traditional defined-benefit pension plan remains the primary model for occupational pensions — where they exist — defined-benefit plans have been in a slow and persistent decline for more than two decades. And while this shift may have curtailed pension costs for businesses, it has also left workers more vulnerable financially, since many are not equipped with the resources to plan effectively for retirement.
With respect to the policy reform proposals currently on the table, there are ways to improve pension coverage and better manage risk for pension members, while also providing cost predictability for employers. Expanding the CPP/QPP would indeed be worthwhile but, it appears unlikely to be undertaken in the current economic and political environment. Meanwhile, the recently proposed pooled registered pension plan (PRPP), lacks mandatory employer contributions and will do little to reduce risks for individuals.
However, in a recently published study by the Institute for Research on Public Policy, we propose a voluntary pooled target-benefit pension plan (PTBPP). It involves commingling assets across all participating workplaces to maximize scale efficiencies in investment and to manage actuarial risk. Employers’ matching contributions would be mandatory but fixed, as in a defined-contribution plan. As with the PRPP, it would be available to individuals and the self-employed.
Most importantly, upon retirement, members could expect a benefit within a target range, depending on market performance. We propose a benchmark of 50 per cent income replacement, requiring a slightly higher contribution rate than in many defined-contribution plans today.
While the target-benefit design would not eliminate the risk that benefits could decrease due to market underperformance, the model proposed includes mechanisms to mitigate this risk. The plan would be managed by actuaries and investment managers, instead of by workers. To curtail administrative costs, the PTBPPs would be required to maintain a minimum pool of $10 billion, and management fees would be capped at 40 basis points, considerably more cost-efficient than most defined-contribution plans and RRSPs today, which typically pay 250 to 300 basis points.
The extent to which higher management expense ratios can severely limit capital accumulation over an individual’s working life and, thus, pension outcomes is dramatic. Consider two middle-class workers who work 40 years, have the same earnings history and contribute regularly to their pensions. One has a pension fund which pays management fees of 40 basis points, while the other pays fees of 150 basis points. The worker in the more efficient fund will receive a benefit upon retirement 18 percentage points higher relative to annual salary than his/her peer.
The PTBPP could be implemented within the legislative framework recently created for PRPPs, but this would require concerted action by the provinces.
On balance, the proposed PTBPP would provide better pension coverage, cost efficiency and retirement income security for plan members than would PRPPs or most current private group or individual plans. While the PTBPP would not solve all the challenges facing Canadians in securing their retirement incomes, it should yield less volatile costs than traditional defined-benefit plans and be more cost efficient than defined-contribution plans.
For employers, the advantages are undeniable. The PTBPP model is more sustainable than a defined-benefit plan, and it limits risk much like a defined-contribution plan. For a typical defined-contribution or group RRSP plan, total contributions may be slightly higher under this model, but employers would gain immensely improved benefits for their employees. Employees would still face some pension risks under this plan although, with the impact of pooling, the risks would be minimized in a more efficient and effective way than in a defined-contribution plan. For members of a defined-benefit plan facing the prospect of conversion to defined-contribution, the PTBPP would provide a better alternative to preserve future benefits.
Perhaps most important for policy-makers, the PTBPP is a timely proposal with the potential to address many of the limitations of the PRPP within the framework of Bill C-25.
Given the uncertainty surrounding the future of pension reform in Canada, it should be viewed as a key step forward.
I find the idea of PTBPP interesting as it addresses important deficiencies of defined-contribution plans, namely, higher fees and the fact that individuals are the ones taking investment decisions, but my biggest concern is governance. Who will govern these plans and under what rules?
This is why I keep harping on the case for boosting defined-benefit plans. Everything else will fall well short of the optimal desired outcome, much like in US health care where they're tinkering at the margins but at the end of the day, the single payer system will lower costs and provide coverage for all.
Canada needs a pension revolution. We need to roll all private defined-benefit plans into large public defined-benefit plans. Companies need to focus on business, not pensions. Just like health care, pensions must be available to everyone and administered by well governed large public pension funds. This is the only permanent solution to fending off Canada's pension crisis.
The same argument can be made in the US where Social Security is in trouble and even in Japan where the weight of pension obligations threatens to sink small companies. The entire world needs to rethink its pension system, implement common sense reforms, and bring back defined-benefit plans with a vengeance (debt crisis will get worse if governments don't!).
Below, a senior official in the Cuomo administration says a deal with the Legislature will save state and local governments about $80 billion in pension costs over 30 years. The WSJ laments that Cuomo is hyping a modest pension deal. You can read my comments on this deal here.