No Surgery Needed?

Timothy Inklebarger of Pension & Investments reports, Proposals target Canadian corporate plan funding:

Canadian corporate pension plans will be able to negotiate funding arrangements with participants and retirees when restructuring their plans as part of the proposals announced Tuesday by Canadian Finance Minister Jim Flaherty.

The proposals would amend the 1985 Pension Benefits Standards Regulations, according to a news release from the Canada Department of Finance.

Among the proposals were the following:

• allow plan sponsors to secure letters of credit in lieu of making funding payments to the pension fund, up to a limit of 15% of plan assets;

• require corporate plans to be fully funded before being terminated; and

• void any amendments to a pension plan that would reduce the plan’s solvency to below 85%.

The proposed changes are a federal initiative and would not apply to provincially regulated pension plans.

“These changes will help pension plan sponsors to better manage their funding obligations while providing additional protection to plan members and retirees,” Mr. Flaherty said in the release.

Annette Robertson, spokeswoman for the Finance Ministry, could not be reached for further details.

Following a 30-day public comment period, the proposals will go to the government for further consideration.

I discussed these proposals with some contacts and here is what they shared with me:

This is just a reprise of the announcements made earlier in the year – now with regulations in place. None of the govt’s pronouncements in any form give solace to the Nortel pensioners nor to anyone like them. The only impact is in preventing pension fund deficiencies in the future by strengthening the rules – yet they still don’t prohibit contribution holidays and risky investments – which as you have said are the main causes of fund deficiencies – even in good economic times and a major disaster in bad economic times.

...

That is correct...it only applies to federally regulated pension plans (banks, Air Canada, Bell Canada...<10%)....and I am not sure it buys them much either... clearly our current government still plans no pension reform of any substance, see today's article by the government's mouth-piece on the subject, Jack Mintz entitled "No Surgery Needed".

I read Jack Mintz's editorial below (bold comments are mine):

Facts keep getting in the way of those who push for big changes to our retirement income system. Most Canadians have sufficient replacement income in retirement years and have generally paid down most of their debt by 65 years of age. (Really? Then why is pension poverty growing and the Bank of Canada sounding the alarm on our growing debt?)

Canadian household net wealth per dollar of income has already surpassed the earlier 2000 peak and is approaching 2007 levels. Unlike the U.S., Canadians have experienced no decline in housing equity, which is now close to $1.9-trillion. (Ah yes, the great Canadian housing boom. We're due for a major correction, especially in some of the frothier markets)

Housing wealth is as large as all the combined assets held in pension plans, RRSPs and CPP/QPP, although, as most Canadians know, downsizing or reverse mortgages have no tax consequences, unlike pension and RRSP withdrawals, which are fully taxed. On top of this, Canadians have more than $2-trillion in net financial and business assets that are not sheltered from tax. Modest and middle-income Canadians hold many of these assets, not just the rich. (Along with reverse home mortgage growth come increased opportunities for fraud and scams)

As recent research confirms, almost 90% of Canadians have managed their affairs quite well, taking all the assets into account. On average, most middle-income Canadians have at least 60% replacement income at retirement. While some modest-income Canadians may not be saving enough, others save more than they need in their retirement years. (Which recent research are you referring to Jack? Last I checked, the number of Canadian seniors living in poverty soared by 25%)

And, Canada has done a good job in protecting the elderly from poverty. Even with the recent uptick in poverty, with a loss in financial income — which is a concern — Canada’s poverty rate is one of the world’s lowest. With Old Age Security, the Guaranteed Income Supplement, CPP, medicare, provincial support programs and tax breaks for the elderly, most low-income Canadians maintain their consumption after retirement. Focus instead should be directed where poverty rates are highest, such as single-parent working families.

Some proponents of pension reform argue that Canadians will earn poorer returns in the future than in the past. Actually, returns on investment, once adjusted for inflation, were quite poor in the 1970s and in the past decade. Those with defined contribution plans or RRSPs would find a large variation in retirement incomes depending on their years of investment, which is why plans with at least minimum guarantees are less risky.

The average annual return on assets has been 5.5%, which is just as likely to be the case in the coming decades as in the past. The system is performing well — we certainly don’t need major surgery. (How do you conclude 5.5% is "just as likely" when US 10-year bond yields are 3.5% -- and this after a huge recent spike in yields?!? We'll be lucky to see anything close to 5.5% in the coming decades, even with emerging markets leading the way).

Some nips and tucks could help, though, to remove regulatory and tax barriers that undermine the efficiency of retirement income markets. For example, smaller and medium-size businesses have difficulty pooling resources in multi-employer pension funds, since only the employer or a union sponsor such plans. Broadening sponsorship to include financial institutions could make it easier to develop cost-efficient multi-employer plans. (MEPPs are full of governance issues -- just look at the problems that Canada's largest MEPP is going through. But instead of broadening sponsorship, let's just give the assets to public pension funds).

Then there’s discrimination against the use of group RRSPs. At present, employer contributions to registered pension funds reduce the payroll tax base for calculating CPP, QPP, Employment Insurance and workers’ compensation payments. But this is not the case for group RRSPs, which can be a cost-efficient mechanism to provide retirement income to workers (and a flexible plan for employees who change jobs frequently). (RRSPs stink! Most Canadians are better off having their retirement money managed by public pension plans!)

The decline in defined-benefit arrangements in the private sector is also a concern since these options enable individuals to pool risks optimally with employers or financial institutions. Unlike defined-contribution plans and RRSPs, defined-benefit plans and annuities allow Canadians to share longevity risk by pooling across the population. Defined-benefit arrangements also enable many workers to know better their income at time of retirement, since employers or financial institutions absorb a significant share of the risk.

In the past, both regulatory and legal obstacles have made it more difficult for employers to offer defined-benefit arrangements. Some employers prefer to keep defined-benefit plans for workers as a competitive edge in labour markets. Recently, federal and provincial governments have improved the treatment of defined-benefit plans, such as enabling greater surpluses to be generated in the good years to offset declines in bad years. However, more still needs to be done, such as dealing with an inappropriate sharing of risks and surpluses in face of partial windups.

And those on disability insurance need to be assured that employers facing bankruptcy cannot have access to trust funds that are meant to cover their benefit payments. (Yes, the disabled always get screwed. Just listen to this interview with Jackie Bodie, a disabled Nortel employee who lost her LTD benefits)

This leaves whether CPP should be expanded. The Canadian Labour Congress proposes the doubling of the current earnings limit of $47,200 in seven years’ time, resulting in an estimated sharp hike in payroll taxes from 4.95% to 7.95% each for employees and employers (almost a 60% increase).

The virtue of the CPP is that contributions are pooled to reduce both investment and longevity risks, which for some workers is the only defined-benefit arrangement available to them. CPP pools risks best since it is a mandatory savings plan, forcing all Canadian workers to save more or reduce holdings of other assets.

Nonetheless, a CPP expansion has consequences. Some young Canadians prefer to put their money in a home, business or other financial assets rather than the CPP. Small businesses will find it more costly to hire workers. As an anti-poverty measure, CPP is less effective than the Guaranteed Income Supplement, since the latter is available to all seniors, whether they have worked sufficient years in the past or not.

More important, a CPP expansion could result in a large transfer of wealth from workers to retirees. For this reason, governments are considering a fully funded CPP expansion to avoid inter-generational transfers — a hard sale since payroll taxes would rise before benefits would be received.

Some modest increase in CPP to provide more defined-benefit arrangements makes some sense. However, bringing in higher payroll taxes at a time when the Canadian economy is on the rocks is rather bad timing. (Businesses will ultimately be better off if we expand CPP! In fact, all businesses should worry about business, not pensions. Let public and private pension fund managers worry about pensions)

When federal, provincial and territorial ministers of finance meet just before the holidays, they should first focus on low-hanging fruit, such as regulatory changes, and put off CPP expansion until the economy is in better shape.

Bernard Dussault, former Chief Actuary of Canada had these comments to share:

There is no new issue with the CPP. It had big ones that were addressed through the 1998 reform. Its partly funded status is due to the insufficient contributions made from 1966 to 1996 and to granting full accrued benefits after only 10 years of contributions to the original (1866) cohorts of contributors, which gave rise to a huge deficit, too huge to ever be amortized. Therefore , our children, grand children, grand-grand children and so on will have to pay 9.9% (half paid by employer) rather than 5.5%. Pure case on intergenerational inequity.



The CPP is not a target benefit plan and not meant to be one. The decreased in future benefits in 1998 (the then current pensioners were not affected) was one good mean to correct errors (re: insufficient contributions) of the past. Real target plans do not allow known insufficient contributions. In 1966, it was clearly reported that the CPP 3.6% contribution rate was insufficient. It was a political decision to go ahead with the 3.6% and leave the problems to future generations.

Finally, Canadian policymakers should look at Australia who just announced reforms to their pension system, attacking fund fees:

Australia unveiled reforms to its A$1.3 trillion ($1.28 trillion) pension funds industry on Thursday, aiming to tackle high management fees in a move that could trigger consolidation in the sector.

The government, responding to a recent review of the huge but often inefficient pensions industry, said it would introduce a simple, low-fee investment product and also force funds to modernise back-office systems to further reduce costs.

The long-anticipated reforms are expected to force smaller funds to merge and trigger industry consolidation: the government estimates the measures will rip A$2.7 billion in fees out of the industry every year over the long term.

"The government is acting to reduce the unnecessary fees and charges on working Australians retirement savings, and to remove barriers to a low cost and efficient superannuation system, Assistant Treasurer Bill Shorten said in a statement.

Canadians are getting raped by fees. We have some of the highest management expense ratios (MERs) in the developed world. It's a farce, especially since most of these mutual funds underperform market indexes. All the more reason to expand CPP!