Great Canadian Pension Reform Debate and PRPPs

In a recent edition of the Daily Reckoning the author Bill Bonner had this to say about fairness.

And here's another important point. Since more wealth is only interesting from a RELATIVE point of view...that is, it is only useful when it gives you higher status...a normal, healthy human being cares more about "fairness" than he does about absolute wealth. Of course, fairness can mean practically anything you want it to mean. It can mean fairness of opportunity - as in, we all play by the same rules. Or it can mean fairness of outcome - as in, we all end up in the same place.

In an up and coming economy, with limited government and low taxes - like the US in the early part of the last century - people care more about fairness of opportunity. People are making money. They're creating status for themselves. Things change fast. You are responsible for creating your own wealth, power and status.

Later, as the economy matures, fairness of outcome becomes more important. New wealth is harder to get. It's harder to move "up" in society. People get a hold of the government and turn it into a zombie- protector. They use it to make sure the rich get richer and the poor stay poor.

The banking and investment community is currently in the process of positioning themselves for the PPRP. Terence Corcoran commented on pensions in his article entitled The Great Pension Myth.

If you missed the news and don't have a clue about what these new PRPPs might be, don't worry. I'm not sure the ministers even know what they are. There's certainly no possibility of PRPPs coming into existence any time soon. The politicians issued a brief description of what pooled pensions might look like, then they "tasked federal, provincial and territorial officials to work collaboratively to examine, among other things, changes that would be required to permit defined contribution Pooled Registered Pension Plans across Canada."

While experts have been on the pension-reform case since the stock-market crashes of the last decade undid their pension models, the issues -- technical, ideological, economic, tax, political, jurisdictional and regulatory -- are numerous and complicated. They don't lend themselves to easy solutions, unless you're a union leader and can parade mythologies as reasonable options. All we need, they say, is a massive expansion of the Canada Pension Plan to give all Canadians generous pensions.

The core mythology of pensions is the all-too widely accepted idea that it is possible and even easy for individuals to get more out of their savings and investments beyond a reasonable but modest rate of return. That's the great pension fantasy, an extravagant promise that somehow there is free money to be had.

There are, essentially, only three sources for this free money. 1) New funds can be voluntarily contributed by corporations and employers offering pensions as an employment perk, adding to the total savings returned to the individual. 2) New money can be taxed from others and transferred between generations or income groups to provide higher returns to one set of individuals at the expense of others -- a form of wealth redistribution. 3) Expert investment advisors and managers can achieve dramatically superior investment returns that will reward each individual with larger retirement savings and payments than they could achieve on their own.

There are no other possible sources of bonus pension benefits beyond what the individual contributes. One of those sources, moreover, has proven to be mythical. The stock markets have turned out to be unreliable over the long term, and expert managers rarely emerge as superior performers. It is also logically impossible for all pension managers to beat the market.

The Great Canadian Pension Reform Debate is essentially an attempt to come up with a new way to keep the fantasy alive. However complicated the issues, Canadians should know this basic fact: There is no free pension payoff and any extra returns and bonus payouts will have to come from somewhere.

In an excellent piece the Alberta Venture magazine produced a thoughtful analysis of the current pension situation in Canada.Second Life

Things aren’t much better when it comes to employer pension plans, given the fact that Albertans have the dubious distinction of having the lowest corporate participation rates in Canada. Nationally, approximately 40 per cent of employees belong to a registered pension plan (RPP) offered through the workplace. In Alberta, though, that figure drops to 33 per cent, and if you take out the RPPs in the public sector the total shrinks further to just 18.3 per cent. Mintz thinks that’s a reflection of Alberta’s low union rates relative to other provinces, and the Alberta Federation of Labour agrees. As its 2009 policy paper, The Looming Crisis in Retirement Incomes, states: “It’s simply a fact that workplace pensions are rapidly becoming a thing of the past in non-union companies, and unless the rate of unionization rises, we can expect further declines in pension coverage.”

As a result, the next generation of Albertan retirees are even less prepared than other Canadians for their so-called golden years. Pension analysts caution that Canadians on average are currently on track to replace only half of their pre-retirement income, when 60 to 70 per cent is the generally recommended guideline for comfort. But Alberta’s “replacement ratio” is only 45 per cent, which again is the country’s lowest. In fact, according to a University of Waterloo retirement study funded by the Canadian Institute of Actuaries, two-thirds of private-sector workers currently earning between $30,000 and $100,000 won’t have enough retirement income to cover basic living expenses. Canada still has the lowest poverty rate among seniors in the world, but how much longer will that last?

Governments around the world are particularly worried about the state of the first pillar, government-funded pensions and programs, which will be under even greater pressure in the years to come as the massive baby boomer demographic becomes a senior citizen explosion. Under such a scenario, the sheer volume of new retirees drawing on entitlement programs would threaten to deplete reserves that a comparatively smaller workforce won’t be able to replace in time for their own retirement. Germany and Australia have already reacted to this potential crisis by raising the eligible retirement age from 65 to 67, while the United States and Great Britain are quietly shifting theirs to 67 and 68 respectively. Here in Canada, calls for an increase to CPP premiums have come from labour leaders and the political left, but in December of 2010 Finance Minister Jim Flaherty announced that the Canadian government would go in a different direction. Rather than making significant changes to the CPP, the government instead decided that it will create a new pension instrument called the Pooled Registered Pension Plan, a voluntary program that will be administered by the financial industry.

While the shakiness of the first pillar is grabbing headlines worldwide, the second and third pillars aren’t in much better shape. When Nortel declared bankruptcy and refused to honour its pension obligations, retirees discovered that the once ironclad reward of a corporate pension for years of dedicated service may be no more than a hollow and unenforceable promise. Others watched their retirement funds evaporate as RRSP savings lost up to 30 per cent of their value during the recent economic downturn and related stock market collapse. And as more soon-to-be retirees approach their golden years without having paid off their mortgages, even the idea of cashing in by downsizing one’s home is becoming a dubious option.

Beginning in the late 1990s, businesses began to shift the burden of providing for retirement from their shoulders and back onto those of their workers. The gold-plated defined benefit pension plans of the past are fast becoming an endangered species in corporate Alberta, rarely seen outside the safe confines of unionized and public-sector workplaces.

The defined benefit plan guarantees a worker a set income for life after retirement, one that’s usually indexed for inflation. The precise amount is determined by an employee’s cumulative contributions from years of service and the total wages that they earned during that time. If that sounds a bit like CPP, it’s no coincidence. The CPP is a classic example of a defined benefit plan, although one that’s maintained by the government rather than a corporation.

For businesses, the defined benefit system system worked well in an era when employees tended to stay with one company for the bulk of their career. It also reflected the spirit of the time, one in which corporations took on a paternalistic role in their relationship with employees in exchange for their loyalty. Not surprisingly, corporations were more adept at reading the writing on the wall about the looming pension crisis than governments were, and they acted accordingly. Several decades ago they realized that saddling themselves with predetermined payments to an ever-increasing pool of former employees, who also happened to be living longer, was no longer financially sustainable.

If the plus-45 set is mourning the passing of the defined benefit pension plans that their parents enjoyed, there’s a younger generation of workers who may not even know what they’re missing. Kristin Smith, a pension lawyer with Spectrum HR Law LLP in Calgary, feels the up-and-coming generation of employees have moved past the direct benefit versus direct contribution debate. “Most have never had a direct benefit plan so it’s not an issue. For them it’s something from the past that their parents had.”

Something else their parents didn’t have is responsibility for managing their own portfolios. “Employees must become more engaged in their retirement future,” Smith says. “But are they prepared to do so? Some do better than others, but employees who invest conservatively in low-risk default options like money markets or GICs may find they aren’t earning enough to pay for their retirement.” The issue of financial literacy comes up over and over again at conferences, she says, but it’s yet to be adequately addressed. Making matters more complicated is the fact that companies are legally prohibited from providing direct advice for group RSP or direct contribution plans. But, Smith says, they can help with financial education by bringing in outside advisors and providing the best information available in order to encourage employees to make good choices.

This leads us to the current plan on the table the Pooled Pension Retirement Plan. A good overview of what is currently know about the PPRP was released on a blog by http://calgary-accounting.com - What is the framework for Pooled Registered Pension Plans?

So far the plan is well thought out and building on previous work done on retirement savings plans. On of the key foundations that can be seen in the PPRP design is the work of CAPSA. This work was initiated to deal with the decline of defined benefits pension plan. It set out the guidelines that employers needed to adhere to to properly manage defined contribution savings plans in the workforce.


Bill Tufts 
Fair Pensions For All