Making Alberta's Pensions Great Again?
One of Canada’s leading pension experts is warning Albertans to consider the “double jeopardy” of falling contributions and investment asset values they might be subjecting future generations to if they replace the Canada Pension Plan with a provincial alternative.Keith Ambachtsheer's report is available online here. Take the time to read it, it's not long and very well-written. The gist of it is available below:
In a report published on Wednesday, Keith Ambachtsheer, president of KPA Advisory Services and director emeritus at the International Center for Pension Management, said that a potential switch to a provincially run pension plan could cost hundreds of millions of dollars to establish and would also put its contributors in danger of facing serious underwriting and investment risks.
Primarily, Ambachtsheer is concerned an Alberta Pension Plan could be used to double down on the oil and gas industry.
“It’s a simple diversification argument: If your underlying economy is to a significant degree dependent on the health of a particular industry that if you also put your retirement savings into that industry, it’s double jeopardy,” said Ambachtsheer. He added that Norway avoided making the same error with its fossil fuel industry by ensuring its pension plan’s investments are all international and beginning the process to divest from oil and gas.
In November, Alberta Premier Jason Kenney floated the idea of pulling the $40 billion Alberta has in the CPP and putting it under the management of the Alberta Investment Management Corporation amid frustrations that the province’s economic interests were being neglected by Ottawa. A “fair deal” panel made up of former politicians and business leaders has since been created and has been consulting with Albertans through town halls about withdrawing from the pension, among other issues. The panel will present its report to the government by March 31.
An Alberta Treasury Board and Finance spokesperson said it welcomes all submissions about the potential creation of an Alberta Pension Plan to the panel, including Ambachtsheer’s.
“It is worth noting that there have been a variety of views expressed by experts on this topic, including those from the Fraser Institute, the CD Howe Institute and the Alberta Investment Management Corporation, all of which highlighted potential benefits of an Alberta Pension Plan,” the spokesperson said.
Some of the appeal surrounding a withdrawal is centered around the potential for Albertans to make lower contributions than the current 9.9 per cent of pay. Studies from the Fraser Institute and C.D. Howe suggested that an Alberta Pension Plan could cut contributions to the six-to-eight-per-cent range while providing the same benefits. This is mostly due to the fact that the majority of Alberta’s contributors are much younger and higher-paid than the rest of Canada’s.
That younger population — the median age, according to Statistics Canada, is 37.1 years old and the youngest in the country — has led to Albertans contributing more than they otherwise would to the plan, Kenney argued in November.
Ambachtsheer questioned the legitimacy of a lower contribution rate due to the potential of Alberta’s younger citizens leaving the province for greener pastures should the oil and gas industry continue to decline.
Should the industry continue to struggle, Ambachtsheer said he worries there could be fewer jobs available in the province, especially those that pay well. That could impact the total contributions made to the APP and the only way to make up for the lost capital would be to raise the rate.
Building out and administering the plan could also lead to a exorbitant bill for taxpayers to front. Ambachtsheer points to the $70 million Ontario spent developing a potential pension plan of its own between 2014 and 2016, before joining the CPP expansion instead.
As for the costs to operate it, Ambachtsheer uses the example of the Alberta Pension Services Corporation, which provides pension administration services to 375,000 public sector employees in the province. It pays $175 per person, per year to do so. Using that math, it would cost $525 million to administer the plan to the three million Albertans currently making CPP contributions.
The process has yet to be tested, but no province has ever withdrawn from the CPP.
[...] the paper addresses three questions:
- What underwriting risks would current and future APP members be undertaking by shifting from the CPP to an APP?
- What costs would Alberta taxpayers be incurring in setting up and managing an APP?
- What investment risks would current and future APP members be undertaking by shifting from the CPP to an APP?
- By shifting to an APP, Albertans would be taking on material underwriting risks. To mitigate these risks it would be imprudent to lower the base APP contribution rate below the CPP’s current 9.9% of pay up to the maximum earnings.
- Establishing an APP would incur set-up and operating costs in the $100s of million dollars.
- Establishing an APP would also expose plan members to political involvement in deciding APP’s investment policy. Would its assets be managed ‘at arm’s length’, or would they be used to shore up a potentially declining oil and gas industry? The latter outcome would expose APP members to a double jeopardy possibility of falling APP contributions and asset values at the same.
In terms of investment risks, Ambachtsheer notes the following:
Presumably, the Alberta Investment Management Corporation (AIMCO) would manage the assets of an APP. As AIMCO’s structure is based on the globally-admired Canada Model, it likely would make a competent job of it. It already manages over $100 billion of assets related to such provincial asset pools as those of the provincial public sector workplace pension plans and of the Alberta Heritage Fund. Instead, a possible investment risk lies in the AIMCO legislation clause that reads: “…..the Government may issue directives that must be followed by the Corporation”. Where could this lead somewhere down the road?Here, I think Keith Ambachtsheer raises excellent points but is a bit confusing. Let me explain. He's right, Norway made a decision a long time ago to invest outside the oil & gas sector and outside of Norway.
Consider recent comments on the APP idea made by former Wild Rose Party Leader Danielle Smith: “I think that’s part of the reason why Albertans are looking to have their own investment fund. They know there is a divestment mood in all of the pension funds across Canada and internationally. If the CPP starts bailing out of energy resources, we don’t want to be in a position where our money is being used to support solar or wind or other experiments that the CPP might want to invest in….”. From a different perspective, the former Chair of the Alberta Teachers Pension Board, Greg Meeker agrees. Commenting on legislation which requires AIMCO to manage the assets of the teachers’ pension plan: “We’re really worried that [the government is] going to treat these huge pools of assets as monopoly money that they can play with to support some agenda that they haven’t articulated to the public but that might include making risky investments in what most people see as a sunset industry.”
Premier Kenney and his Finance Minister Travis Toews respond that such fears are unfounded. The assets will be prudently managed at ‘arm’s length’. Indeed, the AIMCO legislation requires it. Yet, it is worth recalling how Norway has handled the financial windfall from its fossil fuel industry over the last four decades. It diverted most of this windfall in a national endowment fund called the Government Pension Fund – Global. Today, the GPFG has an asset value of some C$1.3 trillion, belonging to a population of 5.3 million (i.e., about C$250,000 per Norwegian). In contrast the Alberta Heritage Fund value is about C$18 billion, belonging to a population of 4.4 million (i.e., about C$4,000 per Albertan). As further gestures to long term investment care and prudence, the GPFG does not invest inside Norway and more recently, has begun a process leading to the exclusion of fossil fuel investments world-wide. Why? Because it wants to avoid the double jeopardy of having its financial assets invested in the same country and industry that is also a major source of employment and government revenues in that country.
Why compare the financial behavior of a sovereign country to that of a province of a federation? Clearly, Alberta did not have the same decision options as Norway did over the course of the last 40 years. The reason is to point to the reality that creating an APP will require political decisions to be made regarding its investment policy. The previously cited quite different views of Danielle Smith and Greg Meeker recognize this reality. What would other political views be on how the assets of an APP should be managed? Creating an APP would require this question to be addressed and decisions made.
Also, unlike Alberta, Norway made the wise decision to invest its oil and gas proceeds a very long time ago (Alberta dropped the ball on that decision which is why its Heritage Fund isn't as big as it should be).
Moreover, unlike Norway's GPFC, AIMCo invests across public and private markets all over the world, including in its own backyard. There's nothing wrong about this as long as it is in line with the organization's mission and objectives.
But in terms of independence, and AIMCO's CEO Kevin Uebelein has been explicit about this, the government of Alberta has no say in how AIMCo invests its funds. None, zero, zilch. That will never change, nor should it.
It's also worth noting that AIMCo invests in traditional and renewable energy already, proving my point that it doesn't invest according to what Albertans or their politicians want. It invests according to what is in the best long-term interests of its beneficiaries. Period.
AIMCo can in theory manage the assets of an APP, just like the Caisse manages the assets of the QPP but it's not in the best long-term interests of Albertans just like QPP-Caisse isn't better than CPP-CPPIB over the long run. Quebecers got screwed but nobody really talks about it because the Caisse did a great job managing these assets but if we are to be ruthlessly objective, QPP wasn't the wisest decision back then, it was done purely for political reasons.
All this to say, I have no doubt AIMCo can manage these assets and do a very decent job but I question whether it wants to (it's an administrative nightmare) and more importantly, whether it's in the best long-term interests of Albertans (just like Quebecers would have been better off in CPP instead of QPP, Albertans would be wise not to exit CPP).
What else? Over the holidays, Bob Baldwin, another eminent pension expert, sent me an intelligence memo he wrote, The Alberta Pension Is No Slam Dunk:
Alberta leaving the Canada Pension Plan (CPP) and creating its own Alberta Pension Plan (APP) has been discussed for many years, and has resurfaced as the newly elected Premier of Alberta has said there is a compelling case for creating an APP, and launched a formal study.Bob Baldwin's memo is superb, he hits on all the points Keith Ambachtsheer and I covered above but in a much more eloquent way. And he's right, APP is far from being a slam dunk.
The case for creating an APP is straightforward – at least on the surface – but far from a slam dunk.
Base benefits – benefits that were in place before the creation of additional benefits that are now being phased-in – are the major component of the CPP. They are financed primarily by a direct transfer of income from working age contributors to retired beneficiaries. The higher the ratio of contributors to beneficiaries, the lower the contribution rate. A relatively youthful population will have a relatively low contribution rate and an older population will have a high contribution rate.
Because Alberta is relatively young, it is argued that Alberta could create an APP that would be similar to the CPP in its benefit provisions and financing with a lower contribution rate. The contribution rate for base benefits in an APP could be roughly two percentage points or more below the CPP rate of 9.9 percent. So convinced are some prominent Albertans of this line of argument that the advantage of a separate APP has been called a slam dunk.
If Alberta could be sure of staying forever young, this argument would have merit. As always however, there is uncertainty about the future and in Alberta’s case there is real uncertainty about its ability to remain forever young.
Globally, age structures are determined by basic demographic factors: the number of children born per adult female (the fertility rate) and the length of time that people live beyond birth or other specific ages like retirement age. But Alberta’s youthfulness is not based on these demographic factors. Fertility rates and life expectancies in Alberta are very similar to those for Canada as a whole. What distinguishes Alberta is its receipt of a very large inflow of young interprovincial migrants whose move to Alberta has been driven by a strong oil and gas industry.
This source of youthfulness faces a serious challenge as we look to the future. The downward global pressure on the use of carbon-based energy is inexorable and its adverse effects will be felt most acutely by high-cost producers. Stagnation or even contraction of oil and gas production in Alberta are likely to bring with them a significant decline in inbound migration and undermine Alberta’s relatively youthful status and its lower-cost APP benefits.
Quebec provides a cautionary tale on this kind of demographic gamble. At the time it decided to create a separate QPP, it was a relatively youthful province. That is no longer the case and the QPP contribution rate for base benefits is higher than the CPP rate.
It is also worth noting two things that produce an overstatement of the potential advantage of an APP.
Some analyses that promote the advantage of an APP focus exclusively on the base benefits and ignore the newly created additional CPP benefits.
Alberta’s demographic advantage is basically irrelevant to the additional benefits because they are to be fully funded with invested contributions and returns. Cost advantages for the additional benefits will be determined by the rates of return garnered by the CPP Investment Board and the Alberta fund manager, AIMCO. AIMCO has a very good track record as an investment manager. But it will still be relatively small compared to CPPIB even after an equitable asset transfer from the CPPIB. So it isn’t clear AIMCO would have any advantage over the CPPIB in generating the returns necessary to sustain the additional benefits.
Some analyses also tend to assume that administrative costs for the APP will be at the same level as for the CPP. This is very unlikely given the economies of scale that exist in pension administration. Startup costs will be substantial. Alberta will have to create a capacity to collect contributions, calculate and pay benefits, maintain earnings records and adjudicate disputes. The government will have to add APP-related analytical capacity.
All things considered, the creation of a separate APP looks less like a slam dunk than a three-point shot from midcourt.
If the Government of Alberta had any brains (I'm not sure), it would drop this silly proposal once and for all. AIMCo is a great organization but it isn't CPPIB nor will it ever reach CPPIB's status (for a lot of reasons).
APP sounds great, might garner cheap political points from the Wexiters out there, but to the long-term detriment of Alberta which quite frankly now more than ever, needs the rest of Canada.
Don't get me wrong, I'm pro-Alberta and pro-pipelines but I see a long-term secular decline in the oil & gas industry, one which is already impacting the demographics of that province for a very long time. Albertans need to get real and think carefully about what is in their best long-term interests (and the rest of Canada also needs to get real and help Alberta during its moment of need!).
One final note on the hijacking of the Alberta Teachers' Retirement Fund, I've provided updates here and got into a Twitter spat with Greg Meeker who seems to have an axe to grind with my views.
There's a tremendous amount of nonsense on AIMCo and ATRF on Twitter and I've given up trying to convince people who post nonsense like this:
I just learned AIMCo has offices in Toronto, London and Luxembourg, as opposed to ATRF which has one office in Edmonton, attracting world class investment professionals to live and work in Alberta. Which approach is better for our economy? #abed #ableg https://t.co/ymiuDKjcOO— Jonathan Teghtmeyer (@atypicalalbertn) January 8, 2020
Between you, me and the lamppost, all of Canada's mega pensions including CPPIB, the Caisse, Ontario Teachers', OMERS, PSP Investments have international offices because they need boots on the ground to partner up with the very best partners to invest across public and private markets all over the world .
The fact that AIMCo has more offices than ATRF all over the world, including one in Toronto, the pension capital of Canada, is an unambiguously good thing.
And one last time, the reason AIMCo pays out less performance fees is because it manages a lot more assets internally than ATRF, does a lot more co-investments where it pays no fees.
AIMCo should know that the performance “fees” are not really fees at all, they are profit sharing arrangements paid to partners upon success of the investment. AIMCo has lower performance fees because their assets, get this, do not perform as well.— Greg Meeker (@yomeeks) November 15, 2019
Anyway, I'm done tweeting about these things with people who think they know best, they clearly have an agenda but let me assure all of Alberta's teachers, over the long run, you're much better off having your assets managed at AIMCo than ATRF and hopefully, your CPP contributions will remain there and that money will be managed by CPPIB.
Below, the former CEO of AIMCo, Leo de Bever, explains why a separate Alberta pension plan doesn't make much sense from an efficiency point of view. As you can read above, it doesn't make much sense from a lot of views, including a long-term investment view. Leo also focuses on why Alberta is frustrated and adds some common sense into the discussion, going past the debate on CPP.