A New Pension Debate?
Back in the 1960s and 1970s there was a big Canadian pensions debate, centred mainly on the issue of how to address the then pressing problem of poverty and income security in old age. It resulted in the launching of the contributory CPP/QPP and the improvement of the demogrant Old Age Security/ Guaranteed Income Supplement. Public pensions in tandem now provide between $15,000 and $19 ,000 per year to persons aged 65 and over, and have given Canada one of the lowest rates of poverty among seniors in the OECD. Today’s retirees also enjoy, on average, a high ratio of income replacement compared to their previous earnings, essentially the effect of public pensions combined with the maturing of employer sponsored defined benefit pension plans in the 1980s. The architects of today’s income security system in old age – such as Tom Kent – authored a notable Canadian public policy success story.
The second big pensions debate came in the 1980s and first half of the 1990s when the neo liberal right, urged on by the World Bank and the OECD as well as the CD Howe Institute here at home, urged a shift from public to private pensions in the form of individual retirement accounts to reduce the costs of an aging society and to delay the age of retirement. In Canada, they largely failed. The CPP/QPP was trimmed a little, but it remains solidly in place and the investment reserve means that it will continue to support modest public pensions into the foreseeable future. Finance Minister Paul Martin’s plan to family income test OAS benefits was also beaten back, with the modest exception of a high income clawback fro individuals. Canadians have recognized that they need public pensions to support a decent retirement.
The problem on the pensions front today is that public pensions replace only about 40% of the previous earnings of an average worker, and much less for those higher up the income ladder. Meanwhile, and this is a big problem, fewer and fewer workers are covered by workplace pensions, especially defined benefit plans which provide a secure and adequate replacement income in retirement. Only about one in five workers in the private sector are now covered by a defined benefit pension plan, meaning that they have to save as individuals – mainly through RRSPs – to have any prospect of a secure retirement. Defined benefit plan coverage remains high among unionized workers in both the public and private sectors as well as among managers and professionals in large private sector companies. Such plans generally work quite well from both a worker and employer perspective where there is an expectation of secure, stable, long term employment – but this is decreasingly the norm, to say the least, and very, very few new plans are being established.
The evidence shows that RRSP savings have not risen to offset the decline of workplace pensions. Median RRSP assets of persons aged 55 to 65 are just $60,000, and it is essentially only the prudent affluent who utilize their theoretical RRSP room to the full. Some workers are still covered by defined contribution benefit plans, which often amount to little more than a group RRSP to which an employer makes some contribution. But the fundamental fact remains that many workers in their 40s and 50s today and, especially, younger Canadians can expect a much less comfortable and secure retirement than those who are now in their 70s and 80s.
The financial industry has long supported private savings as the solution to income security in retirement, because they extract high profits from managing RRSPs, from creating and managing mutual funds for RRSP investments, and from managing private pension assets. But current pension arrangments have begun to come under critical attack from more neutral pension experts, including actuaries and pension managers. They note that individual savings compare very badly to traditional workplace defined benefit plans in that people save far too little, the final pension they get from those savings is highly variable and uncertain depending upon the asset mix chosen and the time of retirement, and in that very few individuals can match the returns of large pension plans. Big pension plans can achieve annual rates of return of 3-4% per year more than individual RRSPs due to economies of scale, a broader mix of investments, and better controlled costs. That is an enormous difference when it accumulates over twenty or thirty years. In short, individuals on their own do very badly, at least on average.
The decline of workplace pensions and weak RRSP saving may be one reason why the age of retirement stopped falling in 2000, and why the labour force participation rates of seniors have been rising quite dramatically over the past seven years. The collapse of the dot com boom and low interest rates in recent years have not been good for many investors. Of course, other factors are also at play – falling unemployment means more people may choose to work later. Combining pension income with income from part-time work or self employment has become much more common.
One obvious solution to the problem of growing income insecurity in old age would be to significantly expand the CPP/QPP, which provides very modest benefits compared to public pensions in other OECD countries. The labour movement has long called for a replacement rate of half of average earnings, which would increase income security in retirement and reduce the need for private savings.
What is interesting is that at least some of the pension experts have begun to break ranks with the financial sector in order to advocate new, collective savings vehicles. Most notably Keith Ambachtsheer (KA) has just published a proposal for a Canada Supplementary Pension Plan through the CD Howe Institute (once a strong advocate of individual retirement accounts.)
KA proposes a new public or quasi public pension plan on top of CPP/QPP which would target an overall, combined 60% earnings replacement rate. Individuals would be automatically enrolled, but allowed to drop out, and their savings would be deducted from earnings. Employers might contribute, but would also be allowed to opt out. The new Fund would essentially manage an aggregated group of individual retirement accounts, achieving economies of scale, and would convert individual savings into annuities (equivalent to defined benefits) at a low cost, with various options available. The plan would offer full portability between employers, low costs and potentially much higher investment returns compared to RRSPs, and could create a significant source of new savings for investment.
The plan is already being attacked by parts of the financial sector and will probably not go far in Harper’s Ottawa. However, it is not out of line with the thinking of some pension experts, including managers of large pension funds, actuaries and government policy makers.
KA’s analysis is good and his proposal strikes me as eminently worthy of discussion. However, he offers no rationale for rejecting an expansion and improvement of the CPP/QPP which would be less individualistic and would entail mandatory employer as well as individual contributions. No doubt he is sensitive to neo liberal rejection of large public savings pools and the “temptations” they supposedly offer to governments to guide private investment, and is also sensitive to financial industry concerns that a significant space be retained for them in the pension system. He might argue that it would be better to have two big public pension funds than one huge fund.
Still, it is refreshing to see a paper from the Howe which so cogently defines a pressing problem, and puts forward such a radical solution.