Canadian Bank Chief Sounds the Alarm?
The head of one of Canada’s largest banks is proposing a dramatic overhaul of the country’s pension regime, arguing that average Canadians need more certainty and simplicity from their savings than existing investment tools provide.This is a stunning endorsement for expanding the Canada Pension Plan (CPP). I commend Mr. McCaughey for coming out and sounding the alarm on our failing retirement system. He raises excellent points which tells me he absolutely understands the gravity of the looming retirement crisis we face in Canada.
Canadian Imperial Bank of Commerce chief executive officer Gerry McCaughey said Canada should reform the Canada Pension Plan to allow people to make voluntary contributions that are beyond what they already pay through their salaries.
The move could give many Canadians something they do not have with RRSPs and other investment vehicles tied to the markets: a predictable payout when they retire.
Much as Canadians understand exactly how long it will take to pay off their mortgage when they buy a house, average earners should have a pension system that helps them forecast how much money they will have at retirement, and allows them to accelerate their contributions, Mr. McCaughey said in a speech to the National Summit on Pension Reform in Fredericton on Tuesday night.
“It would give Canadians the choice to put aside more – a little at a time – with the confidence of clearly knowing what benefits it will bring,” he said. “It would improve the future of Canadians who choose to opt in – through forced savings and no withdrawals – over the arc of 40 years.”
The country faces a looming pension crisis. Persistently low market returns and the erosion of defined-benefit pensions in corporations are leaving many people, particularly those in low to medium income brackets, with less certainty about their future financial security. One analysis suggests that Canadians now in their late 20s and early 30s could see a 30-per-cent drop in their standard of living when they retire.
A stronger, easier-to-understand pension system is better for the economy, Mr. McCaughey said, which is ultimately better for banks. While he still advocates the benefits of RRSPs and tax-free savings accounts, he said CPP is more reliable and clear on how much it will provide, which encourages saving. “This is not a solution that addresses every problem and meets every need,” he said. “But it’s a … starting point that gets to the heart of what a large number of Canadians need most – and that’s certainty of outcome.”
Pushing for a greater focus on the federally run CPP is remarkable coming from one of Canada’s top bankers, since the sector derives considerable revenues from investment products such as mutual funds in RRSPs.
But the suggestion comes at a time when Ottawa is concerned about falling savings rates. As Canadian companies scaled back their pension offerings over the past five years, the federal government has laid the groundwork for the creation of Pooled Registered Pension Plans, or PRPPs, which are essentially private funds operated by financial institutions. Banks and insurance companies and other financial institutions are expected to offer them once they gain provincial regulatory approval. In December, federal Finance Minister Jim Flaherty said he would work with the provinces in 2013 on ways to expand CPP for all Canadians.
Mr. McCaughey believes CPP is the best vehicle for boosting retirement savings, since it promises a certain payout on a specified date (age 65, or 60 if taken early at a reduced amount) and the contributions are committed over a long period – meaning they can’t be withdrawn on a whim. This allows the funds to compound. However, banks cannot operate funds that deny customers access to their money, leaving CPP as the best option, he said.
Savings rates are falling in Canada, but home ownership is among the highest in the world. Mr. McCaughey believes this shows Canadians understand the value of putting money into a home.
“Canadians go into a mortgage knowing that if they keep up their end of the bargain – if they make their payments – they are, on a specific date in the future, going to own that home free and clear. So, over the long term, housing has proven to be an effective vehicle for future savings,” Mr. McCaughey said. “Why does the home ownership system work so well? Because Canadians understand it. It’s date-certain and amount-certain. It’s predictable and transparent. There’s good governance. And the outcomes are clear.”
CIBC economists predict that Canadians now in their late 20s and early 30s can expect, on average, a 30 per cent drop in standard of living when they retire, based on current savings rates.
“We’re not talking about the normal reduction in income that individuals typically see in retirement,” he said. “We’re talking about a real and significant decline in living standards as measured by consumption power,” Mr. McCaughey said.
“Today, for many Canadians, there’s a bigger emphasis placed on investing – on rates of return – than on the critical need to actually set aside money. Individuals are more focused on how they’re investing their money rather than on how much they’re putting away, and for how long.”
I hope his peers follow his lead and also come out in favor of expanding CPP. Once they do, the federal government can drop this silly PRPP solution they've been banking on and get back to the table with provincial finance ministers to reform the CPP.
Of course, some experts think forced, not voluntary contributions, are the way to move forward. Bernard Dussault, Canada's former Chief Actuary notes the following:
Voluntary contributions to the CPP would not produce an additional layer of CPP defined defined benefits but rather just additional savings subject for each voluntary participant to investment risks (eg low or negative returns and/or capital losses) for the rest of their life.
Still, we desperately need to reform the CPP. Those of you who read my blog regularly know I'm worried about Canada's perfect storm. Through prudent bank lending standards and exports to China, we've been lucky to escape the worst of the US financial crisis. But that doesn't mean we have conquered cyclical downturns and I'm worried we're due for a whopper in the coming years led by the downturn in housing.
Imagine there is a severe contraction in housing and prices start plummeting. Hopefully I'm wrong but this would create a significant negative wealth effect on Canadian households. The problem now is most young Canadians can't save enough because they're putting a huge portion of their disposable income to paying off their (overvalued) houses. They simply aren't diversifying their savings properly.
I raise this issue because this is exactly what happened in the United States and according to Brendan Greeley of Bloomberg Businessweek, U.S. Homeowners Are Repeating Their Mistakes:
If there’s one thing Americans should have learned from the recession, it’s the importance of diversifying risk. Middle-class households had too much of their net worth tied up in their homes and were too exposed to stocks through 401(k)s and other investments.Indeed, people do not know how to properly manage their risk, which is another reason why we need to introduce forced savings into the equation and have that money managed by professional pension fund managers.
Despite the hit many Americans took, there’s little sign they’ve changed their dependence on homes as the mainstay of their wealth. Last year, Christian Weller, a professor at the University of Massachusetts, looked at Federal Reserve data for households run by those over 50. The number of families with what Weller calls “very high risk exposure”—a low wealth-to-income ratio, more than three-quarters of their assets in housing or stocks, and debt greater than a quarter of their assets—had almost doubled between 1989 and 2010, to 18 percent. That number didn’t decline during the deleveraging years from 2007 to 2010; its growth just slowed to a crawl.
The Fed will conduct a new wealth survey in 2013, but don’t look for a rational rebalancing. The same pressures that drove families to save less before the recession are still in place: low income growth, low interest rates, and high costs for health care, energy, and education. Families have been borrowing less since 2007, but the rate of the decline has slowed. As soon as banks start lending again, Weller says, people will put their money back into housing. “The trends look like they’re on autopilot,” he says. “They don’t suggest that people properly manage their risk.”
In my last comment on America's new pension poverty, I raised the key reasons why we need to expand large, well governed defined-benefit (DB) plans to provide secure retirement and combat old age poverty. In particular, cited the following reasons:
- Unlike defined-contribution (DC) plans, DB plans guarantee a payment to retirees based on years of service and contributions. This means someone about to retire is not vulnerable to the whims of the market at the end of their career, jeopardizing their retirement dreams.
- Large, well governed DB plans are able to pool resources and significantly lower costs and fees. Moreover, they are able to invest directly and indirectly in public and private markets using their own investment managers or through the best public, private equity and hedge funds in the world.
- The long investment horizon of large pension plans is what gives them a significant advantage over mutual funds and other funds that face pressures to deliver returns on a much shorter investment horizon.
Economists talk about productivity as the key determinant of the wealth of a nation but few talk about how having a good job with great benefits actually enhances productivity. I don't care if it's Microsoft, Google, Costco or Ford, companies that take care of their employees are the ones that thrive in an ultra competitive environment.I realize that some of you may disagree or dismiss my views as "Marxist, communist propaganda which tries to nationalize pensions." Nothing can be further from the truth. I'm more conservative and pro-business than Prime Minister Harper's staunchest allies but when it comes to setting out good economic policy for the long-run, I know what makes sense and what is pure rubbish.
But because most companies cannot offer defined-benefit plans -- and indeed those that do offer them are cutting them to new employees -- I argue that the government should step in and create large, well-governed defined-benefit plans that covers all citizens. Let businesses worry about business, not pensions. This way workers can have portable pensions and are not at risk if a company goes under. It's logical and makes good economic sense for the long-term fiscal health of any nation.
Once again, I applaud Mr. McCaughey for demonstrating true leadership and sounding the alarm on our failing retirement system. Hope all leaders from the six major Canadian banks come out to support expanding the CPP.
By the way, just so you know, CPPIB, the fund that invests on behalf of more than 18 million contributors and beneficiaries of the Canada Pension Plan reported gross investment returns of three per cent in its fiscal 2013 third quarter. CPPIB is also planning for the future:
The CPP Investment Board, with headquarters in Toronto and offices in London and Hong Kong, is a professional investment management organization that invests the funds not needed by the Canada Pension Plan to pay current benefits.I've said it before and I'll say it again, Canadians are lucky to have some of the world's best public pension funds, true global trendsetters. We have everything it takes to significantly improve our retirement system. All it takes is political will and the backing of influential lobbies, like the banking and insurance lobbies.
In the latest triennial review released in November 2010, the chief actuary of Canada reaffirmed that the CPP remains sustainable at the current contribution rate of 9.9 per cent throughout the 75-year period of his report. That includes the assumption that the fund will attain an annualized four per cent real rate of return.
The 10-year annualized nominal rate of return of the fund currently is 6.7 per cent, although the five-year rate is 3.1 per cent.
The latest chief actuary report also indicates that CPP contributions are expected to exceed annual benefits paid until 2021, providing an eight-year period before a portion of the investment income from the CPPIB will be needed to help pay pensions.
Below, Global's Mike LeCouteur reports on the last meeting where provincial finance ministers gathered to plan a way to force Canadians to put away more for retirement. Let's see if the grinches who stole CPP's Christmas finally do what's right for Canada's retirement system.