There must be something in the Vancouver air. Reacting to the recent Federal-Provincial agreement to expand the Canada Pension Plan (CPP), our friends at the Fraser Institute have launched another CPP-bashing barrage.i It appeared in a June 20 Vancouver Province article under the title “Case For Expanding The CPP Based On Myths – Not Facts”. The article explains that there are five CPP myths masquerading as facts. If people only understood that these five things were myths rather than facts……the plan to expand the CPP would surely be quickly be aborted.
Here are the five purported CPP myths:
- Canadians are not saving enough for retirement
- Higher CPP contributions will increase overall retirement savings
- The CPP is a low-cost pension plan
- The CPP produces excellent returns for individual contributors
- Expanding the CPP will help financially vulnerable seniors
However, when the five myths are placed in their proper factual context, it is the Fraser Institute’s arguments that turn out to be flawed. I explain below why this is the case, and close with some thoughts on the real challenges that will need to be addressed for the proposed CPP expansion to attain its intended goals.
The Two ‘Savings’ Myths
The Fraser Institute correctly points out that the majority of Canadians retiring today appear able to maintain their living standards. While this is good news, it is also beside the point. The CPP expansion is not about today’s retirees. It is about today’s young people. They are entering the workplace later, and with more student debt. Also, they will not have the generous workplace pension plans and the decades of strong financial and real estate markets their parents enjoyed. In short, today’s young people need all the retirement savings help we can give them to have a reasonable shot at retirement security 20, 30, 40 years down the road.
As for higher CPP contributions displacing private savings to some degree, that is a plausible outcome. But once again, it is beside the point. The point is the quality of CPP retirement savings versus those in other retirement savings channels. The CPP Investment Board has been outperforming the market by successfully transforming retirement savings into future wealth. In contrast, investment ‘advisors’ steer the bulk of private retirement savings into high-fee retail mutual funds, predictably producing average results materially below market returns, and thus destroying rather than creating client wealth. More on this below.
These two ‘savings’ realities make one wonder where Myth #5 came from. I have no recollection of hearing or reading anywhere that the proposed CPP enhancements are going to help financially vulnerable seniors today. What I have heard and read is that there are still isolated pockets of poverty among Canada’s elderly, and that the problem should be addressed through some combination of tax credits and restructuring the Guaranteed Income Supplement (GIS). Tying this issue to CPP enhancement is quite beside the point.
The ‘Low Cost’ Myth
To achieve its goals, the CPP performs two functions through two separate organizations: HRSD Canada performs the CPP’s administrative functions, and the CPP Investment Board manages the CPP’s financial reserves. HRSD reports 2014 administration costs of CAD$400M, or CAD$21 per member. By comparison, CEM Benchmarking Inc. reports a range of pension administration costs of CAD$13-535 per member, with an average cost of CAD$155 for its 52 global participants.ii Clearly, the statement that Canadians benefit from low CPP administration costs is not a myth…it is a fact.
On the investment side, CPPIB reported all-in FY 2015/16 investment costs of CAD$2.6B, or 0.93% (93bps) of the March 31, 2016 asset value (internal costs CAD$0.9B, external fees CAD$1.3B, and transaction costs CAD$0.4B). In comparison, CEM Benchmarking Inc. reports an investment cost range of 4-259bps with an average of 64bps for its 410 global participants. However, because of the inability of many CEM database participants to capture transaction costs, its investment costs do not include this cost component. Restating CPPIB’s investment cost to exclude the CAD$0.4B transaction costs component, a 78bps cost results.
Clearly, at 78bps, CPPIB is closer to being an ‘average cost’ rather than a ‘low cost’ investment manager. For example, the lowest-cost fund in the CEM database spent only 4bps compared to CPPIB’s 78bps. But of course, focusing on investment costs only is, once again, beside the point. The economic question is: are CPP members getting ‘value-for-money’? Or stated differently, is there a big-enough payoff to justify the additional expenditures over some minimum base cost like 4bps? CPPIB answers this question by reporting that, over the course of the last five years, the additional expenditures produced an additional annual net 1.5% return on assets cumulating to an additional net ‘value-for-money’ $16B in CPP assets over the last five years.
This positive ‘value-for-money’ CPPIB result contrasts sharply with the dismal investment results reported in a recent academic study involving 500,000 Canadian mutual fund investors and their 5,000 financial ‘advisors’. The academics found that over the course of the last 15 years these investors underperformed the market by an average 3% per annum. They were also able to measure the performance of the investment portfolios of the ‘advisors’ themselves…..who underperformed the market by 4% per annum. Somewhat kindly, the academics wondered if the ‘advisors’ had the requisite education, skills, and experience to be in the investment advice business.iii
The ‘Excellent Returns’ Myth
The Fraser Institute article correctly points out that early CPP beneficiaries received a high real return on their contributions (i.e., based on the relationship between the benefits they received vs. the money they paid in), and that this real return has now dropped to 2% per annum for current contributors. What it failed to explain is the reason for the drop. Its origin was the 1965 decision by the creators of the CPP/QPP to treat the generation of Canadians who went through the economic depression of the 1930s and the world war of the 1940s generously.iv They did this with full knowledge that subsequent generations would not only have to pay for their own pension, but also for a part of the pensions going to this ‘greatest generation’ of Canadians. The key CPP/QPP reform of the 1990s was to spread this ‘greatest generation’ cost as fairly as possible across current and future generations of contributors.
This important piece of history leads to yet another ‘it’s beside the point’ observation. The CPP/QPP creation decisions of the 1960s and the reform decisions of the 1990s will always be with us. The recent CPP enhancement decisions cannot change the past. What will be different in this new agreement is that the new pension enhancements will be fully pre-funded. As a result, future contributions will receive the full long term return compounding benefit from CPPIB’s investment programs before they are paid out as pensions. Likely, that future long-term return will exceed the 2% embedded in the ‘old’ CPP/QPP.
The Real Challenges Facing CPP Enhancement
Having shown the ‘beside-the-pointedness’ of the five myths conjured up by the Fraser Institute, I close with three questions on the real challenges facing CPP enhancement. I set them out in the Globe & Mail op-ed piece on March 23 last year titled “How not to ramp up the CPP”:
“To ensure that the prefunding requirement in the CPP Act really does protect future generations, a series of fundamental questions would have to be addressed as part of any future enhancement plans. Here are three examples:
- What investment return assumption should be used to price any future benefit enhancement?
- Will these benefit enhancements be guaranteed? If so, by whom?
- Will the answers to these questions ensure that future generations are not underwriting the risk that any CPP benefit enhancements we grant to (and price) ourselves today are too rich
I have not seen the CPP expansion enthusiasts address any of these questions. My suspicion is that, consciously or unconsciously, they would like to do an end-run around the ‘no more wealth-transfers’ safeguards put in place by the CPP reformers of the 1990s. This is not a place we should go.
Keith Ambachtsheer is Director Emeritus of the International Centre for Pension Management at the Rotman School of Management, University of Toronto. He is also President of KPA Advisory Services, and a part-owner of CEM Benchmarking Inc. His new book “The Future of Pension Management: Integrating Design, Governance, and Investing” (Wiley) was released in March.
Endnotes
- For an earlier episode, see the March 2016 critique “Comparing Pension Plan Operating Costs: Correcting the Fraser Institute’s Faulty Analysis and Conclusions” by Ambachtsheer, Dupont, and Scheibelhut on the website of KPA Advisory Services Ltd.
- CEM Benchmarking Inc, is the globe’s premier organization benchmarking ‘value-for-money’ results in the pension administration and investment management functions. Keith is co-founder and part owner of the organization.
- See Linnainmaa, Melzer, and Previtera (2015), “Costly Investment Advice: Conflicts of Interest or Misguided Investment Beliefs?” Working Paper. The study’s general findings are also consistent with a personal experience from some time ago. A 65-year-old just-retired friend wondered if I could have a look at her $300K retirement savings portfolio. It was made up of five high-fee equity mutual funds with no obvious connection to her age, risk tolerance, or her approaching need for supplemental retirement income. Her ‘advisor’ was shocked when she informed him that she was closing the account and moving to a lower-cost solution more suitable to her circumstances.
- Tom Brokaw called them ‘the greatest generation’ in his 2001 book with that title.