Pension reform options plentiful

But these are the lucky people, since they at least have access to a workplace pension. In a recent speech by David Denison, president and CEO of the CPPIB, he quoted a statistic from a 2007 study by the Canadian Institute of Actuaries that 11 million Canadians do not have access to a workplace pension of any type. Furthermore, the same study noted that only 1/3 of Canadian households are saving at levels that will generate sufficient income to cover their non-discretionary expenses in retirement. In Watson Wyatt’s own work, we estimated that prior to the 2008 meltdown, a DC plan member needed to save approximately 16% to 18% of salary to approximate a median DB plan benefit. Very few DC plans I know of are structured to facilitate 18% in contributions.

Clearly, the system is not working. So what are the options being proposed by the various industry participants?

One of the BC/Alberta Joint Expert Panel recommendations was the creation of a single fund whose investment strategy would be developed and overseen by an expert, independent group. The total cost of providing a savings vehicle would be limited to 0.50%. Presently, the industry convention is that DC plan fees are based on the assets of the members of the plan and their expected cashflows over the next few years. According to the DC vendors, the average member balance is approximately $25,000, which means that total plan assets are often under $10 million. The fees these members pay far exceeds the 0.50% recommended by the Panel. Just to put this into context, 0.50% is roughly the cost that largest, complex DB plans pay to administer their pension arrangements. Large DB plans that don’t use alternative asset classes are often able to deliver the pension benefit for 0.20% to 0.30% per year.

As I understand it, plans are underway to make the Panel’s recommendation a reality, and in fact, Manitoba and Saskatchewan have said they would also join this effort if the Federal government does not provide a similar type of option by year end. When plan sponsors from Alberta and B.C. were questioned about their potential use of such a plan earlier this year, they were undecided. However, a low cost plan that allows pooling of market and longevity risk for a reasonable cost could definitely assist some of those without access to workplace pensions.

The Ontario Expert Commission did not address the failings of the DC system, but it did suggest that a Canada Pension Plan (CPP)-like benefit could be offered to those uncovered workers. A few weeks ago, the CPPIB weighed into the debate with some detail as to how this might be delivered. David Denison suggested that a supplemental layer to the core CPP could be added, solely for pension benefits and like the CPP, this benefit would be “owned” by contributors and beneficiaries. This supplemental benefit would have the advantage of the existing administrative and investment capabilities already resident at the CPPIB, and would facilitate the pooling of risks that are inherent in a DB system (market, longevity etc). It would also enjoy the cost advantage that the largest DB plans enjoy, and which I noted earlier.

Another approach that could be taken is suggested by Mr. Denison. This would be a hybrid approach that would provide for a supplemental CPP pension-only benefit as an expanded, mandatory pension program, combined with voluntary regional and/or national DC plans. These would be accompanied by harmonization of federal and provincial pension regulation across all types of plans to ensure that individual retirement savings have access to the same tax sheltering currently only available to DB plans.

These are all good suggestions and offer an improvement over the current DC and individual savings systems. I would also add that the government should increase the amount that can be tax sheltered each year so that Canadian taxpayers can have the same advantage as their U.K. and U.S. brethren, who can save approximately twice what Canadians can on a tax advantaged basis.

The insurance industry&#8212which has become the main administrator and trustee of DC pension plans&#8212has been curiously silent about reform until recently. For many years, there have been those of us in the industry who have argued for change&#8212for a lower cost approach to delivering the DC benefit to members. One solution that has been discussed with the insurance companies is the creation of industry funds, similar to those found in Australia. The pooling of assets facilitates sharing of risk and cost reduction, such as is being proposed by the Panel. While there is the issue of who would sponsor such funds, insurance industry participants were not interested in exploring such an approach unless we could deliver real money. And why would they even want to explore change as this would potentially reduce their revenue?

As to which option I prefer, I prefer the one that improves the current DC pension system. We need to increase participation and reach, and to lower cost. I am agnostic as to how this is delivered as long as it is delivered. What many are starting to recognize is that insufficient savings becomes a public policy issue. Let’s fix it now while we still can.