Why The Fuss Over Pensions?
Brown, a professor of actuarial science at the University of Waterloo,
past president of the Canadian Institute of Actuaries and currently an
expert adviser with EvidenceNetwork.ca, wrote an op-ed piece for the Winnipeg free Press, Why the fuss over pensions:
of Canada's largest unions (Air Canada and Canada Post) recently went
on strike to save their defined-benefit pension plans against the
wishes of the employer to switch new employees to defined-contribution
What are these plans all about and why all the fuss?
the name implies, a defined-benefit pension plan promises to pay you a
defined benefit when you retire. This can be a flat benefit (you get a
pension that pays $1,000 a year in retirement for every year of
employment -- if you have 30 years of service you get $30,000 a year).
Or it can pay out a percentage of your salary just prior to retirement
(you get a pension that pays 1.5 per cent of final average pay for
every year of employment -- 30 years of service yields 45 per cent of
your final average pay).
in a defined-benefit plan, you know what annual benefit you will
receive in retirement and you have a good idea of how much more you
need to save on your own to be fully secure.
risks of a defined-benefit plan are carried by the employer (although,
in the long term, higher pension costs could force wages down).
The present environment packs a triple whammy of bad news for these employers. First,
interest rates are very low, so the value today of retirement income
to be paid many years in the future is not as significantly discounted
(e.g., at four per cent versus eight per cent). Second, because of the
financial crisis of 2008/09 and the mediocre recovery, pension plan
assets are worth less than they were expected to be and pension plans
are in the hole -- they owe more money to employees than they have in
the plan (Air Canada has a $2.1-billion deficit while Canada Post's is
$3.2 billion). Third, people are living longer and this means they
collect pensions longer and company costs go up.
to the concerns is the ratio of retirees to active workers that is now
about one-to-one at both Air Canada and Canada Post. This
matters, because the cash flow needed to pay benefits must come from
worker contributions and investment returns. With the growing ratio of
retirees to workers, the plan becomes more dependent on investment
returns that are low today.
defined-benefit plans, the worker has a defined benefit and increased
costs are the responsibility of the employer. This is bad news today
but if the economy improves, good times for the employer could return.
opposite is true for defined-contribution plans. Again, as the name
implies, in a defined-contribution pension plan, it is the contribution
that is defined with no commitment to how much will be paid out in
retirement. For example, the plan may provide that the employer will
contribute $1 to the pension plan per hour of work. Or it could state
that the employer will contribute five per cent of an individual's pay
into the plan.
Once the employer makes the
contribution, however, that is the end of the employer's
responsibility. If the stock market crashes or interest rates on
investments are low, the worker will have a lower asset pool at
retirement and, thus, lower retirement income. The worker, therefore,
has no idea until very close to retirement what income to expect and
how much more to save. Just imagine the difference between retiring in
2007 versus 2009.
It is also
true that, even if investments work out as hoped for, the new
defined-contribution pension plans being offered by Air Canada and
Canada Post should not be expected to result in benefits as large as
the defined-benefit plans they want to close.
the level of benefits now promised to Air Canada and Canada Post
workers, employer contributions in excess of 10 per cent of pay would
be expected in today's climate. One would not anticipate the new
defined-contribution plans being that rich.
benefits being negotiated are important and real. Management will
continue to attempt to pass the pension risks over to the workers by
using defined-contribution plans and workers will work equally hard to
retain their defined benefits.
That's the reason for all the fuss.
that's the reason for all the fuss about pensions. Workers want to
maintain their current defined benefit plans, but employers are telling
them "we can't afford it so get used to the idea of defined-contribution
In an op-ed to the Montreal Gazette, Bill Tufts, an employee benefits consultant and the founder of Fair Pensions for All, an organization devoted to public-sector pension reform, warns that the an unsustainable pension gap is growing:
Gazette's July 4 editorial, "City hall is right to get tough on
pension funds," applauded proposals from the city of Montreal to take
steps to control its growing pension obligations.
problems with public-sector pension affordability are being mirrored in
the rest of Quebec and indeed the entire country. Canada has become a
land of pension haves and have-nots. There is a growing gap between
public-sector-employee pension benefits and taxpayers who fund those
generous goldplated pensions but don't have one of their own.
Gazette reported that the average police officer in Montreal is
retiring at age 53 with a $59,000 annual pension. The average Canadian,
by comparison, has only $60,000 saved in his/her RRSP.
police officer will collect a pension every year for the rest of
his/her life, worth an estimated total of about $2.6 million until age
84. The way things are set up, many public-sector workers will collect
more income in retirement then they earned during their working
This pension gap has been
growing over the past 30 years and has now reached a level that is
unsustainable economically, politically and socially. Taxpayers are
being shortchanged and, without reform, things are only going to get
In an upcoming book that I am co-writing entitled Pension
Ponzi, will show how the Canadian government and hence taxpayers have
gone into serious debt to fund this significant transfer of wealth into
public-sector pension plans.
Those who favour the status quo
like to point out that public-sector employees deserve their plans
because workers pay into them. They are only reaping what they have
sowed, in other words. But this is a very weak argument.
Hydro-Québec as an example. In early 2009, the utility implemented a
questionable accounting concept called pension smoothing that "smoothed
out" or spread out over a number of years the $3.1-billion pension loss
that it incurred in 2008.
Pension smoothing allows Hydro-Québec
to present a picture of its pension situation that underestimates the
problems it is facing. Hydro's accounting manipulation only postpones
the necessary reforms that will ultimately be required to keep the plan
afloat over the long term.
pension smoothing was tried in San Francisco, the public defender said:
"It is like telling your spouse that you lost only $500 in Las Vegas
instead of the $5,000 you actually lost, because you are spreading your
losses over 10 years."
A fairer estimate of the cost to
taxpayers is to look at the actual cash pumped into the Hydro-Québec
pension plan. As the accompanying graph shows, the utility has had to
pump $869 million in special contributions into the plan from 2008 to
2010 to help boost the assets.
public pensions will not be easy. In the United Kingdom last week,
close to 750,000 public-sector employers protested on the streets
against raising the retirement age for public-sector workers to 66 from
65. In Canada, public-security workers can retire as early as age 50,
with the rest of the public sector eligible to retire at age 55.
municipal pensions are particularly expensive for taxpayers because
the concept of final average salary is used to calculate benefits. This
means that the average of the highest three, or five, years of salary
earnings is used to calculate the pension benefits (typically equal to
70 per cent of that average). Part of the U.K. pension reform would see
a move toward calculating benefits based on career average salary.
This needs to be done here in Canada as well.
should also be looking at moving toward hybrid pensions. In a hybrid
plan, the employer's pension contributions go into a traditional
defined-benefit plan, while the employee's contributions fund a
any future shortfalls in the plan after the employee retires do not
necessarily fall solely on the shoulders of taxpayers.
need to fight hard for public-sector pension reform. Too many taxpayers
without pensions of their own are being asked to pay too much money out
of their own pockets to finance the pensions of public-sector workers.
THE HEAVY BURDEN OF HYDRO-QUÉBEC PENSIONS
benefits paid out by Hydro-Québec grew by almost 50 per cent from 2006
to 2010 - from $420 million to $602 million. From 2008 to 2010, the
utility has had to pump $869 million in special contributions into the
pension plan to help boost its assets going forward.
Hydro-Québec pensions: contributions and benefits
2006 2007 2008 2009 2010 Total
Employee contributions $54 million $66 million $84 million $118 million $120 million $442 million
Hydro regular contributions $319 million $5 million $291 million $295 million $296 million $1.206 billion
Hydro special contributions $62 million 0 $149 million $370 million $350 million $931 million
Pension benefits paid out $420 million $460 million $510 million $551 million $602 million $2.543 billion
And finally, Jonathan Chevreau of the National Post writes on myths of defined benefit pensions:
Tuesday’s blog and Wednesday’s column
on Keith Horner’s proposal for a National Defined Benefit pension plan
grafted on to the CPP adds fuel to the eternal debate about the
relative benefits of DB pensions and the more market-driven DC (Defined
Contribution) plans that are displacing many employer DB plans.
Horner comes down in favor of a DB-like enhanced CPP, he also looks at
two alternative proposals built around the DC model, one of them
compulsory, the other voluntary. The government’s favored proposal of
Pooled Registered Pension Plans (RPPPs) falls somewhere in the middle
between the two DC schemes. We’ll look at this more in the coming
After the blog ran I heard from pension consultant Greg
Hurst, president of Vancouver-based Greg Hurst & Associates Ltd. In
a lengthy email followed with a telephone interview, Hurst confessed
to being “driven crazy” by the many DB myths that come up in any of
these debates about DB versus DC pensions.
As you can read in various Hurst-authored articles in Benefits Canada,
he has been a vocal opponent of CPP expansion and is in favor of some
kind of private-sector DC plan like the PRPP — however, he shares with
Big Labour a reluctance to simply turn PRPPs over to Bay Street’s fund
companies, banks and insurance companies.
Money In equals Money Out
began by saying he once learned from a wise actuary the valuable
lesson that “money in equals money out.” Seemingly simple, but DB
pensions get very complex when they start to factor in the dimensions
of time and pooling of risks and rewards.
But both DB and DC pensions are still subject to some simple arithmetic similar to what the wise actuary once stated:
Money In equals contributions plus investment gains.
Money Out equals benefit payments, expense payments and investment losses.
practice, both DB and DC pensions are usually invested almost
identically across diversified portfolios of stocks, bonds and other
asset classes. The fact that plan members in DC pensions often are
confronted with a myriad of investment choices tends to drive up their
costs and poor decisions by unsophisticated members tends to result in
lower investment returns than a pooled diversified portfolio might
Pure “no-choice” DC plans can be simpler than DB plans
says a “no-choice” plan would be a “pure DC” plan, one that is simpler
to administer than a DB plan. The result is lower expense payments,
which leaves more for benefits.
On the other hand, DB plans do
have the advantage of longevity risk pooling, which is normally absent
from DC plans unless they offer life annuities at retirement. The two
types of plans also have differences in timing of contributions
relative to delivery of benefits — what Horner’s study refers to as
“risk pooling between age cohorts.”
Generational conflicts and the 3-D Hurricane
Then there are the kind of intergenerational funding conflicts that were touched on in last weekend’s blog on the coming 3-D Hurricane
baby boomers are facing in many western nations. [If you've not yet
read it you may wish to do so now: that particular blog has generated a
large number of web "hits." 3D refers to demographics, debt and
As Hurst puts it, increasing
longevity, the demographic “bulge” of boomers moving to the benefits
phase and intermittent periods of economic recession all come into
The tendency is to raise benefits while holding funding
steady, which has resulted in pension crises around the world,
particularly in France, Greece and even the UK. The prudent thing
should be to build excess funding reserves in anticipation of adverse
demographic and economic conditions but few governments and almost no
private employer pension plans have done this, Hurst says.
Why reformers are tempted to build on the CPP
notable exception is the Canada Pension Plan, which was put on a firm
foundation in the 1990s. Perhaps that’s why so many current proposals
for reform, including Keith Horner’s, try to build on that firm base.
says Horner’s paper is an “excellent treatise” but says its principal
failing is in assessing the risks of the “critical differentiators”
We’ll close with this direct lift of Hurst’s email to me:
can the significance of such risks be ignored in the context of riots
in Europe and widespread media coverage of the state of public sector
pension plans in the U.S. and elsewhere? The current policy direction
being followed in Canada is to preserve the stability of our current
government programs, and enhance them with stronger, more universal DC
The former provides a strong basic level of
pension, while the latter can empower individuals to ensure their own
retirement income security with far less exposure to the demographic
and economic risks that have undermined the security of DB plans
not going to argue against the fact that the pension gap between
private and public sector workers is growing or that demographic and
economic risks have undermined the security of DB plans worldwide, but
the critics of enhanced CPP are distorting the facts to suit their
The most important fact lost in this debate is
that defined benefit plans can work if you get the funding right and
when administered properly using world class governance standards, these
DB plans outperform DC plans. I think people like Greg Hurst and even
Bill Tufts have a lot to lose if CPP expansion takes hold, which is why I
take everything they write with a grain of salt.
One huge point of contention I have with the "Greg Hursts" of this
world is that they claim a “no-choice pure DC” plan would be a lot
simpler to administer than a DB plan, resulting in lower expense
payments, which leaves more for benefits. This is pure and utter
nonsense. The last time I blasted Jonathan Chevreau on my blog, in
another entry on Canada's pension myths, I stated the following:
Last week it was Jonathan Chevreau of the National Post who criticized the Liberals' proposal, dragging "Big CPP" into Canadian politics.
I ripped into that analysis, and I'm going to rip into this one too.
The National Post should be ashamed of itself for publishing this
drivel. I'd love an opportunity to openly debate the likes of Jonathan
Chevreau, Neil Mohindra and anyone else who blindly supports the private
sector "solution" and openly questions the benefits of Canada's large
defined-benefit (DB) plans without basing their analysis on facts. Then
again, what else do you expect someone from the Simon Fraser Institute
to write? It would be nice if he disclosed how many banks and
insurance companies fund this institute.
I'm too tired and cranky to go through all the arguments I went over last week.
Do the large DB plans take too much equity risk? Yes, they do, both in
public and private equities. Do they invest in alternative assets like
hedge funds, real estate and infrastructure? Yes, most of them do
invest in all these asset classes (except hedge funds; a few funds
don't invest in external hedge funds) and they also have internal alpha
strategies to lower their costs. Are these alternative asset classes
"riskier" than bonds? Yes, but over a long period, they're typically a
lot less risky than stocks and they offer important diversification
As far as the "administrative costs" of the CPP, they
are shared by Human Resources Development Canada and the Canada Revenue
Agency, which is good. These agencies are delivering great service at a
very low cost. The private sector wouldn't do a better job at
administering the CPP.
Finally, as I mentioned in my comment on the "Big CPP," most Canadians are clueless about CPPIB's investment partners,
but I assure you that no defined-contribution (DC) plan can invest in
Brevan Howard, Bridgewater, Apax, Lone Star, Texas Pacific Group or any
of the other top private funds listed on their site. This is an
important source of alpha, on top of the internally generated alpha,
adding basis points on their policy (benchmark/ beta) portfolio. Over
the long-term, all that alpha adds up, which is why CPPIB pays these
managers big fees for delivering meaningful alpha.
Mohindra and Mr. Chevreau can find me a low cost ETF that delivers a
performance remotely resembling that of these top fund managers, then I
will listen to their arguments. Till then, I suggest the National Post
stops publishing these spurious comments from biased "experts" who
spread disinformation and perpetuate myths claiming Canada's large DB
plans can't do a better job than the private sector in managing our
retirement savings. They are doing a better job and they should be given
increasingly more responsibility to continue delivering low cost
pension fund management to as many Canadians as possible who are willing
to pay premiums for a secure retirement.
So, while people worry about the "Pension Ponzi," I'm far more worried
about "Pension Poverty," which I see growing by leaps and bounds over the
next decades. It's high time Canadian policymakers get their collective
heads out of their asses, stop reading the right-wing drivel Mr.
Chevreau and the National Post publish and start listening to real
pension experts like Bernard Dussault, Canada's former Chief Actuary and
others who actually know what they're talking about.
If we're going to solve the pension crisis once and for all, we need
concessions from all stakeholders, but we also need to leverage off our
smartest resources and avoid so-called "experts" who pander dangerous
ideas that will only ensure more pension poverty down the road. They
are hazardous to the pension health of our great country and I will call
them out every single time.
Bernard Dussault, Canada's former Chief Actuary, sent me these comments:
Regarding Rob Browns’ analysis of the “Why The Fuss Over Pensions” (more
specifically with respect to DB plans), my view remains that there would
essentially be no fuss if DB plan sponsors were not allowed to take contribution
holidays and were compelled to amortize any emerging pension surplus or deficit
over a pre-determined number of years (5, 10, 15?). Moreover, the high ratio of
pensioners to active members is not a financing pension issue per se. The issue
is the lack of assets/liabilities matching, a matter that can easily be
addressed by plan administrators but often overlooked.