Is The CPP Proposal Doomed to Fail?

Don Pittis of the CBC reports, CPP plan won't help savers or stop the pension crisis:

If as many suggest, the government's latest plan to expand the Canada Pension Plan is pure politics, perhaps the details don't matter.

But based on the little we know so far, you should not expect the new scheme to solve what many worry is a coming Canadian pension crisis.

At first glance, the plan is enticing, especially after CPP's recently announced truly fabulous return on its (our) investments.

The plan, famous for being fully funded and managed by competent professionals without political interference, made a stunning 19 per cent return this year.

The Conservatives aren't saying it, but that huge return — better than almost anyone is earning from their private sector investment accounts — may be one reason the government abruptly changed direction and announced what appears to be an ill-thought-out way to let Canadians top up the CPP.

Magnificent returns

The magnificent CPP return suddenly made plans by the NDP and Liberals to expand CPP look enormously smart.

In fact, it may have made some voters think that those two parties had better financial judgement about what is best for Canadians than the Conservatives, who have repeatedly and stubbornly pooh-poohed the idea.

While the Conservatives can now boast of a "me, too," proposal to extend CPP, the one key detail of a plan almost free of details raises a number of complications.

And that key detail is that under the Conservative plan, investing in the CPP would be voluntary.

The first question is whether voluntarily investing additional funds in CPP is something you should do. That 19 per cent is certainly hypnotizing. But as with any startling one-time investment return, a detailed look reveals some very special circumstances.

Kudos to the professionals at the CPP Investment Board for investing the money offshore to diversify the risk instead of putting all our eggs in one Canadian basket.

But the earnings as a result of a plunging Canadian dollar, which added some 10 per cent to valuations when those foreign assets were recalculated in loonies, are not something that can be repeated annually.

The tax advantage

Not being in Canadian market funds dominated by plunging oil and commodities was also a great advantage, but once again not easily repeated. CPP's real long-run return, even averaging in this bumper year, is a far less stunning 6.2 per cent.

Good returns are important. But when it comes to deciding where to invest your precious savings, perhaps the biggest consideration is taxes, especially for those rich enough to decide to make additional voluntary contributions. And CPP benefits are taxable.

Although I am no financial adviser, paying taxes once on your money and then putting it in a Tax Free Savings Account and never paying taxes again on the profits seems an obviously better deal in the long run.

If that is the case, then those topping up the CPP under the Conservative plan would only be those who had already set aside the full $10,000 annual limit on TFSAs.

The second complication of a voluntary program is one that already concerns some critics of other CPP expansion plans. That is the mixing of new contributions with the decades-old nest egg set aside by Canadians who have paid into the plan over their working lives.

Those who add new voluntary contributions cannot expect to benefit to the same degree as those who contributed under the old rules. Anything else smacks of government interference in a system that has managed to avoid politics.

The grasshopper problem

But the worst part of the plan is that it does not solve the one single problem that could lead to a new crisis of poverty among the elderly. And that is that too many Canadians just don't save enough voluntarily.

The existing CPP's claim to fame in the world of pensions is that it is "actuarially sound." That means that unlike what we have seen in places as diverse as Greece, Detroit and most recently Chicago, the CPPIB has enough money saved and invested to keep on paying out for 75 years based on current expectations.

But there is a big however.

And that is that the amount we contribute off our cheque every month isn't really enough to keep us comfortable during our long retirement. In fact, in many places the entire month's CPP cheque would barely cover monthly rent.

That's super for people who have paid-off houses and other sources of income.

But of course people like that are among the ants of Aesop's Fable. The ants have been saving for the long winter ahead. They will not be part of the pension crisis, except insofar as they have to pay taxes to prevent the old and destitute grasshoppers from starving.

The problem lies around the fabled grasshoppers who live for the present and never get around to saving. They already have many voluntary ways to save. They just can't bring themselves to volunteer.

And even if the latest voluntary plan makes it past the consultation phase, it will do nothing to change that.

This article misses important points. I actually sent it over to Bernard Dussault, Canada's former Chief Actuary, who sent me his thoughts on it:

The only viewpoint expressed in this article makes much sense but it is unfortunately presented in such in a convoluted way that it is not easy to detect.

That valid viewpoint is simply that any plan financed on a voluntary basis is not expected “to solve what many worry is a coming Canadian pension crisis”. That should be obvious. Laymen have easily understood the point made by pension experts over the past few years that if workers are not compelled to save, they will not.

Most of the article refers to the recent high investment return on the CPP investment. This is irrelevant. CPPIB returns have on average since the 1998 reform been quite as planned and projected. Most big pension plans have also been successful in that regard. It is presumptive to speculate that the conservative government suddenly proposed the concerned CPP voluntary contributions scheme in light of the recent high CPPIB investment return.

I went over the record 18.3% return CPPIB delivered in fiscal 2015. No doubt, it was a spectacular year and currency gains played a big factor in those returns, but the point Bernard makes above is much more important, namely, the CPPIB has delivered solid long-term results, well above the actuarial target it is required to deliver.

Pittis is right to mention that the Tories' proposal to expand the CPP on a voluntary basis is full of holes. I explained why in my last comment discussing this proposal:

This latest proposal is going nowhere and even if it's implemented, the "voluntary" nature of it means it will only benefit the richest Canadians much like increasing the tax-free savings account limit to $10,000 a year (the few who  need it the least will wisely sign on but the majority who really need it will opt out).

Given a choice, very few people like to save, which is why I prefer mandatory CPP enhancement. Small business groups like the CFIB are vehemently opposed to the ORPP and enhanced CPP but that's because they are hopelessly myopic and don't see the long-term benefits of such a policy.

Importantly, enhancing the CPP will provide many Canadian workers with a very decent retirement income, something they can actually count on. Far from being a tax, it's a form of savings and the money is being managed by professional pension fund managers who can pool resources to lower costs, invest directly in public and private markets, and invest in world class funds where they can't invest directly.

Another big advantage of the CPP is it pools investment risk and longevity risk so people don't have to worry about putting off retirement because their investments took a big hit (like in 2008) or outliving their savings.

And what about Pittis' comments on TFSAs? I think they're ridiculous. As I highlighted in my last comment, most Canadians aren't contributing enough to their TFSAs, they won't take advantage of the new limits, and even if they do, most people will not out perform the CPPIB over a 10, 20 or 30 year investment horizon, especially on a risk adjustment basis.

"Yeah but Leo, you've been kicking ass in your TFSAs trading biotechs and I'm sure that others are outperforming the CPPIB or any of our large Canadian pension funds."

Wrong again! I take huge risks in my personal portfolio and stomach huge swings that would make 99.99% of retail and institutional investors vomit and have sleepless nights. Moreover, while I can be lucky on any given year, I know I can get whacked hard at any time.

As far as individual investors, I know of a couple of superstars who trade on their own and even a few great investors, but there are no guarantees that they will be able to outperform in these markets, none whatsoever. I've allocated to the very best hedge fund managers in the world and all of them have had serious losses at one point in their career.

Most Canadians are ill-informed, get clobbered on fees investing in mediocre mutual funds that underperform markets, and they know astonishingly little about constructing a well diversified portfolio and how to do this paying the least fees possible.

And even if they did, they're limited to investing in public markets. CPPIB invests in both public and private markets and it co-invests and invests with the very best hedge funds, private equity funds and real estate funds in the world.

What else? The federal government is also looking at relaxing the 30 percent rule to allow federal pensions to invest more in infrastructure in Canada, which will provide CPPIB and other large Canadian public pensions the ability to invest in big Canadian infrastructure projects.

Mutual funds can't invest directly in private markets, which is why over a very long investment horizon, they severely underperform our large, well-governed public pensions.

I'm tired of reading terrible articles criticizing mandatory enhanced CPP or attacking the ORPP and Wynne's pension boondoggle. If the Conservatives enhanced the CPP when Jim Flaherty was alive, we would be well on our way to a much better retirement system, much like the Netherlands.

But Canadians are being lied and misled on what enhancing the CPP is all about and why in the long-run, this will bolster our economy and lower our debt. I will keep repeating this till my face turns blue, good pension policy makes for good economic policy. And Canada desperately needs both at this critical juncture.

I will end this comment with some feedback from one of my blog readers, Jean-Pierre Morency, a retired civil servant who lives in Lévis, Quebec:

I am one of your followers, through your blog, for quite a while. I personally agree with about 90% of your writing and for the last 10% its involve more emotional than rationale arguments. That, being said, I also think that the last Tories move related to CPP is a fake or a political scam or whatever you want to call it. The Tories ideology and more particularly Stephen Harper’s one, as far as I am concerned, is private institutional and financial bias or extreme right as you like. They don’t give a damn to ‘working’ people but create of fancy and wealthy world for the ‘controlling or governing’ 1% as we say.

Now, don’t get me bad, I am a retired federal civil servant and I have the ‘luck’ of having quite a good, or some will say ‘gold-plated’ defined-benefit (DB) pension scheme. However, I also think that instead of fighting this approach, which of course need some improvement, all ought to be put in place to expand it to everyone whatever the CFIB, the Fraser Institute and some other related institutions promote against it. The fundamental rationale being that all other proposal is definitely not a pension as such. I don’t have to elaborate on the subject since you are a ‘pro’ of it and I am still trying to understand it.

One of the reasons I have finally decided to get in touch with you is the fact that you seem to have a high esteem for my friend Bernard Dussault which I think, as yourself, has paid the price for a frank and honest position on the matter when he was Chief Actuary. I hope he, as yourself, will continue this professional work.

Thanks for taking the time to read me and sorry about my English since, like Bernard,  I am a ‘francophone’.

Merci beaucoup Jean-Pierre, your written English is much better than my written French and I appreciate your honesty and comments. And you're absolutely right, we shouldn't be fighting against existing defined-benefit plans, we should be improving them, introducing more transparency, accountability and shared risk. More importantly, we should strive to enhance the CPP for all Canadians so more people can retire in dignity and security.

As far as the Harper Conservatives, I will refrain from getting political. I think they bungled CPP enhancement when Jim Flahery was still alive and they now realize it but their proposal is ridiculous.

The CPP plan the Conservatives are now peddling is doomed to fail (if it's implemented) because it's a total farce. Instead of making it mandatory, they're making it voluntary and lying through their teeth using asinine political jingoism like "we won't tax Canadians any further."

Enhancing the CPP isn't "a payroll tax" or "jobs killer". It's a sound pension policy, one the country desperately needs to get back on solid footing. By making their proposal voluntary, the Conservatives will end up putting forth a policy that fuels more inequality (much like raising the TFSA limit) and it will do nothing to stem the coming pension and economic crises Canada will experience.

Finally, I get emotional (more like irritated) at times when writing this blog but only because I don't like the way policymakers are dealing with the pension crisis. Also, I've put up with so much garbage in my life from such powerful yet weak and pathetic individuals who thought they can bully and intimidate me. Boy were they wrong! They completely underestimated my tenacity and resilience, not to mention the success of this blog which has had over 4 million visits since June 2008.

On that note, I thank all of you who have financially contributed to this blog and ask many others to donate or subscribe using the PayPal options on the top right-hand side. You'll notice I was a bit late with my comment today. I was tired and woke up late. I was also busy trading, analyzing markets and went to the gym this morning to work out. I've got to take better care of the man in the mirror.

Below, a Canadian Press clip where Justin Trudeau, Tom Mulcair question Harper's sincerity on CPP expansion. I too question the timing and sincerity of this proposal and think it's wishy-washy at best and going nowhere.

Also, Brian Milner, Senior Business Writer, The Globe and Mail joins BNN to discuss why making voluntary contributions to the Canada Pension Plan makes great sense for investors. It certainly does but make sure it's mandatory, not voluntary. Listen to Milner's comments, he rightly notes that bankers will try to kill this proposal.