CPP's Unfair Regulatory Advantages?

Michelle Morton of Global News reports, New study compares your Canada Pension Plan to private or public options:

A researcher with the Fraser Institute says comparing the Canada Pension Plan to private and public sector pension plans is like comparing apples to oranges.

Moin Yahya said it released today’s study comparing the pension systems, after the federal and provincial governments decided to expand CPP coverage and increase premiums.

He says their study found that private pension plans have regulatory and legal burdens the CPP does not, because the private pensions have characteristics that the CPP doesn’t.

“You should be aware of this is why your plan might be a little costlier than the CPP, but it’s because you’re getting a better product or maybe a more diverse product or a more… nuanced product than just the plain vanilla CP,” he said.

“If you still wanted to have CPP expand, then at least you’ve done so with full disclosure, but you should be aware of what the trade-offs are. This is going to affect the quality and quantity of offerings that their own pension plans will be able to deliver.”

Yahya says it’s important for people to understand what drives the cost differences between the CPP and private and public alternatives.

The Fraser Institute released this press release, Private pension plans face greater, more costly regulatory burden compared to the CPP:

Compared to the Canada Pension Plan (CPP), private pensions are subject to far more regulations, are more complex in their make-up and face higher costs as a result, finds a new study released today by the Fraser Institute, an independent, non-partisan Canadian public policy think-tank.

“The regulations governing private pension plans—which can lead to increased transparency and accountability—inevitably also increase costs, but often those same regulations and costs don’t apply to the Canada Pension Plan,” said Moin Yahya, Fraser Institute senior fellow, law professor at the University of Alberta and co-author of Understanding the Regulatory Framework Governing Private and Public Pensions.

The study comprehensively reviews the different rules and regulations governing the CPP compared to other pension plans, including private and public-sector pensions, as well as private registered accounts such as tax free savings accounts (TFSAs) and RRSPs.

The CPP is, for example, exempt from many customer-related and disclosure regulations such as regular financial statements, as well as provincial rules and industry-organization standards. Private plans, on the other hand, face all of these government-imposed regulations, which lead to additional costs.

“Too often people jump to the conclusion that the CPP’s comparatively lower costs are a function of efficiency, but the reality is that substantial regulations are imposed on private plans that the CPP avoids,” explained Yahya.

In addition, private plans have a number of characteristics that the CPP does not, which also affect costs. Notably, private pensions have to account for transferability from one plan to another whereas CPP contributions are not transferable.

And whereas RRSPs, TFSAs and some defined contribu­tion pension plans allow contributors to choose where their funds are invested, the CPP offers no such choice.

Further, there are almost no laws allowing for the CPP to be sued for bad governance, so where the CPP enjoys substantial cost savings from not having to anticipate or defend against any liabilities, private pension plans are under near constant threat of litigation and must account for that.

“Understanding what actually drives the cost differences between the CPP and private alternatives is critical,” Yahya said.

“The reality is that some of the cost of private pensions is a result of government-imposed rules and regulations from which the CPP is exempt.”

The full report is available here. Below, I provide you with the executive summary:

A common argument made to expand the Canada Pension Plan (CPP) is that it is cheap to administer. While many studies have cast doubt on this claim, why would a public pension plan be cheaper to administer than a private one? Many factors affect the cost of running a pension plan, but a crucial yet overlooked factor is the regulatory landscape that private pension plan.

This paper examines the regulatory requirements among various types of public and private pension plans to determine whether private pension plans are at a cost disadvantage with respect to public ones, with a specific focus on the CPP. In short, the paper finds that the CPP—due to its characteristics and legal obligations—enjoys a marked cost advantage over other pension plans.

First, consider the legal responsibilities of the various plan administrators. Broadly speaking, private pension plans are subject to a variety of statutory and common law regulations. These require the pension plan administrators to act as fiduciaries. While the administrators of the CPP are also under these requirements, as a practical matter, the CPP is seldom entangled in any lawsuits regarding the administration and management of its assets. On the other hand, private and some public pension plans (mostly provincial) are always under threat of litigation, whether by an individual pensioner or through a class action. Although public pension plans do face litigation rarely, and usually prevail in court, the CPP is almost never sued at all. There are almost no laws allowing for private enforcement of governance laws against the administrators of the CPP, so the CPP enjoys substantial cost savings from not having to anticipate or defend against any liabilities that may arise from bad governance, something private pension plans must account for.

Private pension plans are also subject to far more disclosure and customer-related regulations; the CPP faces no such requirements. For example, anti-money laundering laws—sometimes known as “Know Your Customer” laws— affect individual pension plans, such as RRSPs and TFSAs, and any other private pension plans that engage the use of a bank or brokerage services. While a public pension plan could be engaged by such laws, there does not seem to be any focus on such plans by enforcers of these laws. A search of the CPP Investment Board’s website showed no noticeable compliance with anti-money laundering laws.

Moreover, because the CPP is a federally constituted entity (legally speaking), it is not subject to any provincial regulations. Nor is it subject to the jurisdiction of any regulations by industry organizations. As a practical matter, the CPP and its administrators carry on their business without any real consciousness of legal or regulatory sanction. Private pension plans, as well as RRSPs and TFSAs, all have to pay filing and administrative fees. The CPP pays no such fees. Private plans, depending on the province, have to constantly file reports with their provincial pension superintendent. Again, the CPP does not.

Now consider differences concerning pension plan characteristics. Private and public pension plans have multiple characteristics and options for their members. For example, there are different rules governing contribution rates for each plan, and early withdrawal triggers various consequences depending on the specific pension plan. Payouts also vary depending on whether the member retires early or waits till 65. If a member leaves their employment early, they have several choices regarding whether to take the accumulated funds or not, known as the lock-in rules. Generally speaking, even if they cannot access the pension funds accumulated, they can still transfer the funds to another plan. These possibilities create more uncertainty for the pension plan administrator. It requires more planning and safeguards, and thus costs.

In contrast, the CPP has very simple rules. Every income earner between the age of 18 and 65 contributes to the CPP at one rate per income up to an annual maximum. There is a maximum payout at retirement with some limited flexibility on which age the pensioner chooses to receive their CPP. Other than these two basic variables, the CPP rules are quite rigid, thereby simplifying the administrative costs of running the plan. There is no ability to take the accumulated funds and transfer them to another pension plan. In contrast, RRSPs and TFSAs allow for individuals to withdraw their contributions at any time (although there may be consequences for doing so). All contributions are invested by the CPP administrator in whatever funds they choose, and, unlike an RRSP, TFSA, or even some defined contribution pension plans, individual CPP contributors have no flexibility to dictate where their funds are invested. Any actuarial surplus in the CPP fund, i.e., any excesses not needed to fund current payouts, remain with the CPP and must be invested by the CPP Investment Board.

Additionally, the number of CPP contributors is large and diverse, giving the CPP a diversified set of contributors and payees. A private pension plan may have a skewed demographic in terms of its employee age profiles, which can pose its own unique challenges which the CPP does not face.

Finally, contribution rates that employees and their employers pay are set by CPP administrators and enforced by the federal government without much choice or input from employees. Private and public pension payouts are usually set by a bargaining between employers and employees, whether it is done formally in a unionized setting or whether it is done informally in a competitive marketplace. This means there is no accountability to the employees or even employers for the management of the CPP funds.

Interestingly, the Fraser Insitute is known to be a right-wing think tank funded by Canada's powerful financial services industry, so it doesn't surprise me to see a report complaining about CPP's regulatory advantages.

But without even knowing it, the authors of this report make the case to switch everyone over to the CPP and do away with crappy private pensions once and for all.

Importantly, go back to read my comment on why CPP is a great deal for Canadians where I wrote the following:

I cannot overemphasize how lucky Canadians are to have an organization like the Canada Pension Plan Investment Board managing their CPP contributions.

Let's quickly examine what advantages this offers:

• The CPP pools assets and pools longevity and investment risk. This means individuals won’t outlive their savings like they risk doing with their RRSP or be unable to retire if a financial crisis like 2008 strikes and it clobbers their portfolio.
• Also, CPPIB operates at arm's length from the government and is looking to maximize returns without taking undue risks. It can use its huge size to lower costs and hire smart people to manage assets internally across public and private markets all over the world as well as build solid relationships with world-class asset managers in public and private markets.
• What this means, in effect, is that CPPIB’s long-term strategy to invest in a globally diversified portfolio across public and private markets ensures higher risk-adjusted returns over a traditional 60/40 stock bond portfolio. The value-added is significant over a long period and so is the lower volatility.
• Importantly, the brutal truth on RRSPs and defined-contribution plans is they're not real pensions, they do not guarantee a secure pension payment for life because they are too beholden to the whims and fancies of public equity markets which are very volatile and will remain very volatile in a low-rate, low-return world. 
• Lastly, the authors fail to acknowledge the benefits of Canada's large defined-benefit plans. They are directly and indirectly responsible for creating well-paid jobs and they ensure more people can retire securely, lowering social welfare costs and increasing revenues for governments. None of this is mentioned above.

This is why I can't take these authors from the Fraser Institute seriously (not that I ever took anything from the Fraser Institute seriously).

Once or twice a year, you'll see some flimsy reports from the Fraser Institute poo-pooing the CPP. My best advice is to ignore them but the media love this stuff and laps it up without scrutinizing them by talking to different pension experts.

It's not their fault. Who would you rather quote in the article, some professor who wrote a long report for the "venerable" (more like laughable) Fraser Institute or some obscure blogger on pensions who actually worked at Canada's largest pensions and knows what he's talking about?

Sure, CPP has regulatory advantages over private pensions. So what? It still has to follow the law and the assets are being managed by CPPIB which is arguably more transparent than many private pensions which have hidden fees as they try to milk Canadian suckers clients dry.

You ever seen that Questrade commercial, "it's not a game, it's my retirement." Most Canadians are woefully unprepared for retirement because they're financially illiterate, making them easy prey for big banks and big mutual fund companies raking them on fees.

Last week, I hooked up for lunch with two former long-only portfolio managers from PSP, Frederic Lecoq and Jérôme Bichut. We had a great time and discussed many things.

One of the things we talked about is how financially illiterate many people are. For example, Jérôme shocked me by saying most people do not know how to open up an online discount brokerage account and they don't know the commissions they're paying for every transaction.

He also said that even sophisticated investors aren't as diversified as they think. For example, most people have a large chunk of their wealth tied up in their home and then they go and heavily overweight financials in their portfolio without realizing that those assets are interest-rate sensitive.

So, if we get a housing market collapse and rates go down, guess what, your portfolio made up mostly of financial shares isn't diversifying your total wealth and protecting you from a severe downturn in housing. Only government nominal bonds will protect your portfolio from getting clobbered, a point I keep repeating on this blog.

These are basic things to professional money managers. You don't need a wealth manager to think about how to best diversify your wealth, you need common sense and to think about making a portfolio which can withstand a deflationary or inflationary shock.

Admittedly, it can get complicated, especially if you have substantial assets and need tax advice. That's where wealth advisors earn their fees, they provide you with "wrappers" where they wrap all this advice (investment, tax, etc.) into one service (and charge you hefty fees for it).

Anyway, getting back to the study above. Something really irks me about it. The number one cost advantage CPP has over private plans is it's universal and non-voluntary, has captive clients and it's able to pool those resources to lower overall fees in two ways:

1. First, just like other large Canadian public pensions, CPPIB is able to bring a substantial portion of the assets internally to lower the administrative and operational costs of managing that money.
2. Second, CPPIB is able to partner with the very best external managers around the world across public and private markets and it uses its clout to lower fees directly or indirectly via large co-investments. Other large Canadian pensions do the exact same thing. 

Another thing that irks me about this report, Canada's large pensions do enjoy many advantages but they are all highly regulated and very transparent, especially CPPIB which is arguably the most transparent of all Canadian pension funds and for good reason, it's managing the pensions of over 20 million Canadians.

CPPIB has world class governance, one of the reasons why it's been able to deliver strong long-term gains which literally trounce most private pensions over the long run (go read my coverage of CPPIB's fiscal 2018 results here).

Again, there are advantages that Canada's large public pensions do enjoy, like having captive clients, which private pensions don't enjoy and this leads to legitimate questions on compensation but given the outstanding long-term results, one can argue compensation is fair and merited.

As far as these Fraser Institute studies, take them with a grain or shaker of salt. When I read this one, I just thought to myself: "Yeah, so what's the big deal? All you're doing is reinforcing my point that we should close down all private pensions and have CPP manage all pensions."

I'd better stop before I get accused of being a left-wing socialist (I'm as fiscally conservative as you can find and generally don't believe in government interference except when it makes perfect logical sense like enhancing the CPP!).

Below, some commercials to remind Canadians and Americans what a great job the private sector has done managing their retirement money (love that fireman in the second one).

I'm not advocating for or against Questrade, Schwab or anyone else but will tell you flat out, even if you pay little to no fees and think you are the best stock picker in the world, over the very long run, you're better off having your retirement money managed by CPPIB. Period.