Social Policy in Ontario

The December Whitehorse meeting between Finance Minister Flaherty and his provincial counterparts led to a decision to consult Canadians on pension reform. These consultations are now under way, and could lead to some key decisions about the future of Canada’s pension system in late May, when the ministers meet again.

All this does not come out of the blue. Five years of research has thrown new light on a wide range of pension-related issues. Three dominant themes have emerged: pension coverage and adequacy; the structure and cost of managing Canadians’ retirement savings; and the sustainability of traditional defined-benefit pension plans.

It is a fact that three-quarters of our private-sector work force does not have an employment-based pension plan. A significant proportion of these workers are not saving enough to maintain their living standard post-retirement. A related question is: What does “saving enough” mean?

A modest-income, empty-nest couple with a mortgage-free home may only need a pension equal to 50 per cent of their employment earnings to maintain their standard of living. Their CPP and Old Age Security payments will provide a significant portion of that 50 per cent. Add employment-based pension plan membership, and they are likely set for life. At the other end of the spectrum, a middle- to higher-income couple without either a mortgage-free home or a pension plan will need to save a significant portion of their income – at least 15 per cent – for many years if they want to retire at age 65 and maintain their standard of living.

Three points of view have emerged as to what, from a public policy point of view, government might do about these realities.

1. Allow the market to work by updating current pension rules and regulations so that the financial services industry can offer large-scale, multiemployer, multiprovincial supplementary pension plans across Canada;

2. Create a national supplementary pension plan that would be low-cost, expert, and managed at arm’s-length from governments. It would be based on a series of default principles related to enrolment, contribution rate, and investment policies. Participants would own their pension accounts. The plan would be voluntary in the sense that workers and employers could override any of the defaults, including opting out of the plan altogether;

3. Expand the CPP/QPP, which could work in a number of ways. The benefit rate could be doubled to 50 per cent of earnings from 25 per cent, to yearly maximum pensionable earnings (YMPE is $47,200 today). Or the benefit rate could stay at 25 per cent, but the YMPE itself could be doubled to $94,400. Or the benefit rate and the YMPE could both be doubled. With any of these options, contribution rates would rise on an actuarially-fair basis.

Each of these options has pros and cons. The first sounds flexible and efficient, but has failed to deliver the promised increases in cost-efficiency in Australia. The second also sounds flexible and efficient, but faces significant implementation challenges. The third would be efficient and relatively easy to implement, but its mandatory one-size-fits-all approach concerns many people.

The structure and cost of managing retirement savings may be the elephant in Canada’s pension reform room. Too few people know that a single percentage point increase in annual fees can reduce the ultimate pension generated by 20 per cent. At the same time, too few people know that on the one hand, many participants in large-scale, collective, non-commercial pension plans pay 0.4 per cent to have their retirement savings managed, while on the other, many individual RRSP savers pay 2 per cent or more through actively managed retail mutual funds.

Simple arithmetic tells us that these RRSP savers may have to contribute 30 per cent more over their working lives to generate the same pension as participants in large-scale, collective, non-commercial pension plans. About $1.1-trillion of Canada’s retirement savings reside in this low-cost wholesale sector, while about $700-billion is in the retail sector. What, if anything, should be done about this highly asymmetric cost situation?

Some 4½ million Canadian workers continue to be members of traditional pension plans that promise a defined pension benefit, based on a crediting formula and years of service. While the pension management cost problem may be little-known, the Nortel and GM pension plan solvency problems have been making headlines.

Some observers believe that tinkering with the funding rules and creating a national pension insurance scheme can make these solvency problems go away. These are illusions. The Dutch solved their defined-benefit plan solvency problem by deciding to regulate these plans using the same prudential rules applied to insurance companies and banks. Is Canada prepared to do the same?

A global pension quality index currently ranks Canada’s combined public and private pension system fourth in the world. A number of thoughtful pension policy decisions by our finance ministers next month could lift us to the top of the pile. Owning the pension podium would be a good thing for all Canadians.

Keith Ambachtsheer is director of the Rotman International Centre for Pension Management at the University of Toronto. He was an adviser on the CPP/QPP reforms completed in the 1990s.

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