Why the CPP can weather the storm

Speaking at the National and International Perspectives on Pension Plans seminar on Sept. 15 in Ottawa, Jean-Claude Ménard explained that the partial funding approach for the Canada Pension Plan (CPP) is optimal in dealing with the current volatile economic landscape.

“Although the financing methodology could always be changed or reworked altogether, the objective of prefunding the Plan should remain paramount,” he explained. “By stabilizing the asset/expenditure and funding ratios over time, the steady-state methodology helps to ensure that the CPP is affordable and sustainable for current and future generations of Canadians. Moreover, steady-state funding of the CPP, which is a form of partial funding, complements the funding approaches of the other components of the Canadian retirement income system.”

The asset/expenditure ratio—the ratio of assets at the end of one year to the expenditures of the next year—is an important measure of the Plan’s funding status, said Ménard.

From 2000 to 2009, the net cash flows of the Plan have been positive, resulting in a rapid increase in the plan’s asset/expenditure ratio and funding status. Such net cash flows are invested in an effort to maximize the rate of return without undue risk and add to the level of pre-funding of the plan.

Protection from politics
The Canada Pension Plan features provisions which provide safeguards in the event the chief actuary calculates a minimum contribution rate that is above the legislated contribution rate of 9.9% and provincial and federal finance ministers cannot reach an agreement on the solution to restore the long-term sustainability of the plan. This design, said Ménard, provides the plan with a safety net without diminishing politicians’ responsibility for its future.

“The self-sustaining provision provides the way to increase automatically the contribution rate and, in addition, freezes the benefits,” he said. “The combination of these two measures allows for cost sharing between contributors and beneficiaries. The degree of this cost sharing depends on the magnitude of the increase in the steady-state rate; namely, the greater the increase, the greater the proportion of the costs that is borne by contributors.”

Today’s volatile economic landscape makes the partial funding method all the more relevant, according to Ménard, as the funded status of employer-sponsored pension plans, as well as fully or partially funded social security schemes globally, have deteriorated.

With the average OECD pension fund’s real return for 2008 calculated to be -23% (a weighed average skewed by U.S. results), social securities schemes are further affected as unemployment rises and, as a result, revenues from contributions to these schemes suffer.

“In this environment it is important to reconfirm that the partial funding approach is the optimal financing approach for the Canada Pension Plan,” said Ménard. “This approach provides successful hedging to both economic and investment risks. Moreover, the lower relative increase in contribution rate under partial funding method, as well as self-sustainable provisions of the CPP, also helps to mitigate the political risk and the risk of plan restructuring.”

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