Quebec Pulling a Detroit on Pensions?

Don Pittis of CBC reports, Workers not to blame for Quebec pension problem:

A deal's a deal, right? Well, not when it comes to the province of Quebec and the pensions of its municipal employees.

And if Quebec gets away with cutting municipal worker pensions, which have been eaten away through mismanagement by the very people doing the cutting, then watch this phenomenon spread.

Quebec is pulling a Detroit. About a year ago, I pointed out that the shattered dreams of Detroit pensioners should be a warning to the rest of us. But unlike Detroit, Quebec is trying to snatch back promised pension money by fiat through its proposed Bill 3 pension reform legislation, without the inconvenient legal process of bankruptcy.

To read many of the stories about these Quebec pension cuts you would think that it was the pensioners' fault. The same kind of thing happened in Detroit. Outraged taxpayers inveigh against government employees for sucking money out of the public purse for a cushy retirement. It's as if by choosing a job with a pension and keeping to their side of the contract, the workers are taking advantage.

"Right now, municipalities are taking all of the risk on the payouts and employees are taking relatively none of the risk," said economist and McGill Professor Brett House on CBC's Montreal's radio morning show.

Such comments anger Bernard Dussault, the architect of the Canada Pension Plan and former Chief Actuary for the Government of Canada. The CPP is well known around the world because, unlike many government plans, it is properly funded and can pay out forever (as I've mentioned before, the flaw with the CPP is the actual payout is too small, barely covering rent in many Canadian cities). In fact, this week the chief executive of Hong Kong's social services said he is studying CPP as a model for the reform of the territory's pension system.

As an actuary, Dussault is a sort of super statistician who studies lifespans, average investment yields and the cost of risk. He says that if you do your calculations right, update them frequently and set enough money aside, there is almost no risk involved with pensions.

He says "risk" is not the reason Canadian pension plans are facing problems, and he points out that Quebec is not an exceptional case.

"There are plans with problems all across Canada," says Dussault.

In every case, he says, the problem is a simple failure to set enough money aside.

Many blame the market crash of 2008 for shortfalls in pension plan investment returns. Dussault agrees that was a setback, but adds that it's a weak excuse, because as I write this the Toronto stock exchange has just hit another all-time record high. Yes, it's higher than the peak before the crash. And any pension contributions invested since the crash have seen extraordinary gains.

That assumes, of course, that the pension plans have collected enough money in contributions from both employer and employees, and have actually invested it. And therein lies the flaw.

In Quebec's case, the pension deficit can be traced back, in part, to a previous attempt to balance the province's books. Back in the nineties, Quebec downloaded hundreds of millions in costs to the municipalities. To help them deal with those expenses, since pension plan investment returns were strong at the time, municipalities were permitted to take a pension-contribution holiday.

Brett House agrees that pension holidays were a mistake, and regular contributions should have continued. "By any historical measure, those were exceptional surpluses that should have been saved rather than disbursed."

Actuaries know that even if things look really good one year, that only makes up for other years when things look really bad.

In the dark

And unless they did some serious homework, the workers wouldn't even know the pension pot wasn't full.

Their monthly contributions would come off their paycheques. They would get periodic pension statements showing their accrued benefits based on the promises in their contract, but the accounting in those documents was imaginary. By this year the province, which is ultimately responsible for municipal debts, was in the hole by almost $4 billion for municipal pension deficits.

Just like Detroit, just like the car companies, Quebec and its cities negotiated these pension contracts with their unions with their eyes wide open. Now they are planning to walk away from those deals. Years after you've signed a deal with the bank you can't go and say, "You charged me too much for my mortgage; I'm taking it back." Try it and see what happens. But that is what the province is saying to city workers.

And in their negotiations for improved pensions, the workers traded away other benefits, like better pay. "We’d rather have taken our salary raises," says the head of the Gatineau police union.

"It is terrible because it is stealing money that has already been accrued," says Dussault.

He adds that Canada has a good financial reputation because it regulates banks, insurance companies and pension funds.

"So now we allow pension plans to renege on their obligations," he says. "We will next allow banks and insurance companies to renege on their obligations?"

Dussault points out that Quebec is not the first to take away pensioners' accrued benefits. New Brunswick did the same thing and pensioners are still not happy about it. And he says if Quebec succeeds, it won't likely be the last.

Perhaps the most underfunded pension plan in the country belongs to the federal government. Federal employees have pension contributions deducted and they go into a "fund," but that fund is based on what Dussault calls "notional bonds." Essentially, the contributions are on the government's books, but they go into general revenue and no outside assets are purchased to cover them — ultimately the payment to the pensioner will come out of future general tax revenue.

"All this accounting is theoretical. It is not real money," says Dussault. "I don't see the federal government reneging on its obligations, but there are more and more pressures. And that frightens me."

Despite the theoretical accounting, Canada's federal government more or less has its financial house in order. But as we saw in Detroit, other governments — and many companies — have shown a willingness to hide disturbing amounts of financial trouble by sweeping it under the carpet of pension deficits.

It may be a painful process, but it appears that Quebec workers will be forced to negotiate a new pension deal. As they do so they should study other arrangements, such as the Ontario municipal pension fund OMERS and the Ontario Teachers Pension Plan. Those pension plans are fully funded and about as well managed as any pensions anywhere.

The difference? It's certainly not risk. They were exposed to the same market crash as everyone else.

What is different is where the money goes and who manages it. Contributions from both the employees and employer go straight into a fund. No notional bonds. No deficits. No promises to pay later.

And the fund is invested and controlled by the employees. The only way the government will get that money back is in the income tax those pensioners pay as they live out a comfortable retirement.

In her article, Ingrid Peretz of the Globe and Mail reports, Quebec pension status quo ‘no longer option’ says Montreal mayor Coderre:

Montreal Mayor Denis Coderre said he would “never give in to thugs” as the province’s political leaders appeared ready to take on restive public-employee unions over Quebec’s controversial pension-reform plans.

Hearings into the Liberal government’s pension legislation opened in Quebec City against a backdrop of heightened security and noisy street protests by municipal workers furious about the bill.

As employees protested outside, Mr. Coderre and the mayor of Quebec City, Régis Labeaume, both outspoken proponents of the pension changes, said taxpayers couldn’t keep sustaining the current pension regime.

“The status quo is no longer an option,” Mr. Coderre said. “We’re now confronted with a financial reality we can no longer ignore.”

Pension costs in Montreal have more than quadrupled since 2002 and now eat up 12 per cent of the municipal budget, the mayor said. Mr. Coderre said he was open to compromise with the unions but wouldn’t countenance the rowdy spectacle that unfurled at City Hall Monday night, when protesting firefighters and other municipal employees surged into the historic building and littered it with papers and other debris.

“The last few weeks have been hectic and even emotional for many people,” Mr. Coderre said. “But now, time has come to work together.”

The pension legislation, Bill 3, seeks to have municipal employees in Quebec assume a larger share of their pensions by requiring workers and cities to split the cost of covering their plans’ $4-billion deficit.

The proposal has morphed into the first major test for Premier Philippe Couillard, who has made belt-tightening a byword of his four-month-old government. He has vowed to stand firm on pension reform.

As expected, unions are up in arms over the proposals. Serge Cadieux, secretary-general of the Fédération des travailleurs du Québec, told the hearings Wednesday the bill was inequitable, set a bad precedent and was probably unconstitutional.

City unions in Montreal have never shied from a forceful fight with their bosses. Blue-collar workers have a track record of militancy: A former, high-profile union leader, Jean Lapierre, appeared at a demonstration in Montreal on Wednesday to announce that protest actions would get more “radical” and this was “only the beginning of hostilities.” Police officers in camouflage pants and fire trucks plastered with stickers have become routine in labor conflicts.

But it’s unclear whether the public will side with the unions this time. Several observers say Monday’s vandalism at City Hall may have cost the unions some public sympathy; police officers were seen on site standing by without reining in the rowdy demonstrators.

The head of Montreal’s police union, Yves Francoeur, defended his members on Wednesday, saying they never got the green light from senior officers to step in and carry out crowd control. Even after the boisterous mob had entered City Hall, police sought the go-ahead from their superiors to do their job, Mr. Francoeur said. But the rank-and-file officers were told no, because city hall had not requested police intervention. Mr. Francoeur referred to the incident as a “comedy of errors.”

Hearings into Bill 3 continue on Thursday.

There is a lot to cover in these articles. First, let me agree with Bernard Dussault, Canada's former Chief Actuary, Quebec's pension deficits were exacerbated by the 2008 crisis, but the real problem can be traced back to balancing the books by neglecting to top up pensions. These "contribution holidays" sounded good at the time because markets were roaring and interest rates were much higher, so many pension plans had surpluses instead of deficits.

However, contribution holidays ended up being a disaster for many Quebec, Canadian and U.S. plans. In fact, fast forward to 2014. While stocks and other risk assets pensions invest in (like corporate bonds) have soared to record highs in the last five years, interest rates keep declining to historic lows, and that spells trouble for pension plans.

Why? Because the decline in interest rates is a much more important factor in terms of impact on pension deficits than soaring asset prices. And if rates keep falling because global deflation takes hold, watch out, asset prices and interest rates will tumble, and pension deficits will explode throughout the world (like 2008 only much worse because it will last a lot longer).

Why is the decline in interest rates a bigger factor on pension shortfalls than soaring asset prices? Because future liabilities on pensions are typically discounted using market rates and if interest rates decline, pension deficits widen even if stocks and corporate bonds are doing well. In finance parlance, the duration of pension liabilities is a lot longer than the duration of pension assets, so a decline in interests rates will disproportionately impact liabilities a lot more than a rise in asset values. 

This is where I part ways (somewhat) with my good friend, Bernard Dussault. Given where we are now in 2014, and given the immense risks of global deflation that I see ahead, I'm not at all comfortable with the current risk-sharing aspects of Quebec's pension plans and have expressed my concerns here and here.

In my opinion, if Quebec doesn't slay its pension dragon once and for all, it will head the way of Greece where bond vigilantes rammed through savage cuts on public (and private) pensions and wages.

This is very important and I want people to fully comprehend the point I'm trying to convey here. Quebec is a lot richer than Greece but there are eery parallels in the way public finances have been mismanaged between the two and the insane power that public employee unions hold. In fact, one of my friends is dead serious when he warns me: "Mark my words, when the shit hits the fan, Quebec is the next Greece."

This might sound crazy but to those of us who know Greece and Quebec very well, there were a lot of promises made over the last three decades to buy votes from public employee unions, and everyone knew these promises cannot be kept in the future. But politicians being politicians were only thinking of gaining political power, not the powder keg they were creating in the future.

It's nice to retire at 55 or 60 after 30 years of working with a guaranteed pension till you die but is it affordable and realistic? These promises were made at a time when the demographics were favorable to pension plans, ie. when you had more active workers relative to pensioners and people weren't living as long as they do now. This is no longer the case. As the baby boomers retire, we will see a lot more pensioners relative to active workers and these pensioners are living longer. The ongoing jobs crisis plaguing the developed world will only exacerbate this trend.

Of course, it's not all driven by demographics because the reality is that investment gains in well governed defined-benefit plans account for 2/3 of most pension pots, and only 1/3 comes from employee and employer contributions. 

So what do we need to do now? We need to consolidate many municipal and city plans in Quebec to create a new municipal employee retirement system akin to OMERS in Ontario.Then we need to implement world class governance, adopting best practices from around the world, not just Canada.  Lastly and most importantly, we need to implement real risk-sharing so employees and employers share the risks of these plans equally so taxpayers don't foot the bill if pension deficits explode.

If you look at most fully-funded pension plans in Canada, whether it's HOOPP, Ontario Teachers or CAATT, the employees and employers share the risk of their plan. This means, if markets go sour, they implement measures to reduce the pension deficit by increasing contributions or decreasing pension benefits (like cost-of-living adjustments).

This is where a funding policy is critically important. I recently discussed PSP"s funding policy, going over some of the problems mentioned above with the federal government's pension plans. It's not yet clear what the federal government will do but my advice would be to have PSP manage the assets and liabilities accrued before 2000 of these federal plans and adopt risk-sharing measures. If that happens, the funding policy will be even more critical.

I know this is a long comment and pensions are an emotional subject for many people who have contributed to their pension plan over many years and expect the pension promise to be delivered. But the pension chicken has come home to roost, not only in Quebec but all around the world. 

I agree with Denis Coderre and Philippe Couillard, pension reforms cannot wait. If public employee unions don't sit and negotiate some form of risk-sharing in good faith, there will be a day of reckoning for pensions, and when it comes it will be too late. The bond vigilantes will impose savage cuts on public pensions and wages just like they did in Greece.

I'm not being a scaremonger here. I'm being brutally honest. While I agree with many of the comments of Bernard Dussault, the economic and political reality is that pension reforms cannot wait any longer. I'm all for defined-benefit plans but you have to get the governance and risk-sharing right or else they are doomed to fail spectacularly.

If you have any comments, feel free to email me at LKolivakis@gmail.com. Please remember to contribute to this blog via PayPal at the top right-hand side. I thank the institutions that have contributed and ask many more to do so.

Below, as Quebec workers vow to keep up the pressure over a proposed increase in their pension costs, I embedded an older clip where thousands of Greek pensioners have taken to the streets of the capital Athens to protest against government cuts to their income.

If you think this will never happen in Quebec or Canada, you're dreaming.  When the money runs out, Quebec and the rest of the world will head the way of  Detroit and worse still, Greece where savage austerity measures have been imposed by the bond vigilantes.

Of course, I agree with France's economy minister, German austerity is not the answer and it will only exacerbate the euro deflation crisis. It's time for Quebec, Canada and the U.S. to implement real pension reforms before we reach a critical point of no return, leaving the decision up to bondholders.