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Avenues for Reforming the Canadian Retirement Income System

| June 4, 2010

The recent financial crisis and recession have brought the viability and security of employer-sponsored pension plans, the sustainability of public pension programs and the adequacy of individual retirement saving into the spotlight since late 2008. In this context, and at a time when governments in Canada are actively consulting about the issue, the Institute for Research on Public Policy held a symposium to explore the retirement income prospects of today’s middle-income workers and possible reform options. This is in contrast with earlier pension debates, when then-current retirees were the focus. The event consisted of expert panels and presentations based on research commissioned by the IRPP and other groups; it brought together 60 invited experts and practitioners from government, business, labour and academia. The following highlights some of the issues raised and conclusions reached during the event.

  • Two complementary pieces of research pointed to a potential problem for future retirees. Grant Schellenberg and Yuri Ostrovsky’s research found differences of 7 to 9 percentage points between the earnings replacement rate of current 70-years-old male retirees who were covered by a registered pension plan (RPP) at age 55 and those who were not covered. The age of retirement was highlighted as a way workers adjust their replacement rate.
  • Michael Wolfson produced a sophisticated forecast of the incomes of future retirees under the current retirement income system using LifePaths, a unique Statistics Canada micro-simulation model. He found that “about half of individuals born between 1945 and 1970 who are in the middle 50% of the earnings distribution in their prime working years can expect a decline in their standard of living after retirement of at least 25%.” Further research is warranted to better incorporate items like housing and saving that are not explicitly tagged for retirement.
  • Insolvency law could be improved to better protect workers’ and pensioners’ claims in pension funds sponsored by private employers. However, more promising avenues involve reforming the funding and governance requirements of defined-benefit (DB) plans, and possibly setting up a national pension guarantee fund. The latter would require federal-provincial coordination to address “moral hazard” and “adverse selection” issues. Pension fund surplus ownership remains a core issue that needs to be resolved.
  • Workers without access to collective saving vehicles must face large financial and longevity risks on their own, which is costly for reasons such as a lack of expertise and the absence of economies of scale. The most efficient way to share and manage risks likely does not involve traditional DB structures, which fared well during the past three decades because of favourable demographic and market conditions that no longer hold, or traditional defined-contribution (DC) structures, which do not allow individuals to share risk efficiently under current regulations. In the spirit of reforms in the Netherlands, discussions should include alternatives like plans where the payment of a target level of benefits is conditional on financial outcomes. Today’s pension arrangements are often hedged by such conditions, and, according to rapporteur Bruce Little, absolute pension commitments – many of which promised more than they could deliver – might be a thing of the past.
  • What role can financial literacy play in improving the outcomes of individuals who must make complex decisions about retirement? US research indicates that employer-based financial education improves employees’ decision-making, and that this is the most efficient means of teaching retirement planning. However, well-crafted default options (in which workers are automatically enrolled, for example) are also important, and there is need to explore further the relative value of all available instruments in improving retirement outcomes.
  • Many programs targeted at smalland medium-sized enterprises (SMEs) in Quebec and the US, which were discussed by a panel, have resulted in a limited take-up, even though they address SME owners’ concerns regarding simplicity and cost. Some participants argued that a large percentage of SME workers do not want or need further pension coverage, and that it might be more efficient to simply improve on the options already available – including expanding access to individualized financial advice. Several participants noted that a lot of employers “want out of the pension business.”
  • Bob Baldwin compared reform proposals that alter the boundaries between voluntary and compulsory or private and public activity, and noted that preserving the parts of the current system that work well makes choices difficult; it might be easier to deal with a total failure that demands a greenfield approach. Two major issues are declining pension coverage and the ineffectiveness and inefficiency of existing retirement savings options, and he noted that the reform proposals differed on how to address these in their degree of compulsion, the treatment of the self-employed and the relationship to existing RPPs.
  • Baldwin also noted that with changing demographics, “stabilizing the relationship between contributions and benefits will require some mix of higher contributions, lower benefit amounts, and later retirement,” and that it is impossible for different cohorts to insure each other so that each cohort receives a fair benefit. This has a bearing on intergenerational fairness, which is a criterion by which to assess reform proposals. In contrast with past reforms, all current proposals assume that any new benefits would be fully funded; this is consistent with the current focus on avoiding imposing undue costs on future workers.
  • Based on his simulations, Keith Horner favoured an expansion of the Canada Pension Plan (CPP) over the creation of a new large DC plan. This is mainly because of the greater new savings it might generate; this would offset the future cost to government of the Guaranteed Income Supplement (GIS), which would be very large because tax-free savings accounts benefits are excluded from GIS eligibility calculations and because of the CPP’s efficiency on the labour and financial markets. His proposal would increase CPP benefits from 25% to 40% of earnings up to the year’s maximum pensionable earnings (YMPE) and from 0% to 25% of earnings between one and two times the YMPE, leaving room for additional discretionary saving, and it would encourage supplemental voluntary DC plans similar to the Alberta-BC proposal or Quebec’s SiPPs.
  • Jonathan Kesselman argued for further expanding the CPP and possibly phasing out old-age security in the future. In his view, we should displace inefficient employer-based plans, and expanding the CPP would address concerns about the current system and some of the reform proposals, such as costs, labour mobility problems and the need for risk pooling. Wolfson, based on his simulations, also favoured a doubling of the CPP, which would partially solve the problem identified in the status quo simulations he presented earlier.
  • Although there was some agreement on the advantages of auto-enrolment compared with purely voluntary plans, there was less agreement on the role of the financial industry and the degree of compulsion needed in any reform. Andrew Jackson defended the Canadian Labour Congress’s CPP-based proposal, highlighting its low cost and the fact that private sector employers and the financial sector had not been able to deliver sufficient coverage since the 1960s. Many participants expressed strong support for expanding the CPP in some fashion.
  • Some panellists argued that instead of expanding the CPP the focus should be on improving the current system. Bill Robson presented his assessment grid, and he emphasized the importance of avoiding forced savings or unrealistic promises, and increasing flexibility in terms of the options available to workers/savers and employers/sponsors. He favoured increasing tax-deferred saving room and expanding privately delivered and better regulated DC plans.
  • Flexibility was at the core of the Canadian Life and Health Insurance Association (CLHIA)’s proposal to further develop multi-employer pension plans, perhaps with mandatory pension coverage in firms with 20+ employees. Some participants opposed mandatory coverage, while Horner noted that the scale and targeting of mandatory plans involves a trade-off between increased retirement income security and higher welfare costs of forced saving.
  • The CLHIA’s proposal would address the concern many participants expressed with the prospect of putting large sums into the hands of a single organization; the Caisse de dépôt et placement du Québec was cited as an example to avoid.
  • Several participants argued that the outlook for retirees will keep worsening, as many Canadians want to retire earlier than previous generations did. Others pointed out that current generations are staying in school longer and taking on more debt, resulting in a longer retirement supported by a shorter working life. Some see this trend as unsustainable in the long run and thus likely to reverse itself (it has already begun to).
  • With increasing life expectancy and the changing nature of work, the age at which people retire is likely to rise naturally over the coming decades. Some believe it may be unnecessary to raise entitlement ages, as others suggested; but it will be crucial to take into account changing life cycle dynamics and the health of future retirees in analyses and policies.

Pension politics are difficult, and participants raised concerns that some proposals had little political appeal. But in his address Ontario Finance Minister Dwight Duncan said that “doing nothing is not an option,” pointing out that all reform options might not be mutually exclusive and that the optimal policy outcome – the one meeting agreed upon principles – may require a mix of different elements. He said political decisions will determine the balance among the criteria.

The rapporteur noted there is a danger that for all the consultation by government, the debate will now move behind closed doors, leaving little room for nongovernment voices to weigh in on the various proposals. At any rate, there is no quick fix and the recent political momentum could wane, so progress might be slower than expected. For all the recent urgency in public discourse, he noticed an implicit acceptance at the symposium that this round of talks could take years to come to fruition. Politicians – possibly excepting British Columbia – seem concerned that quick solutions will be suboptimal, and appear inclined toward caution. This was certainly true for Federal Finance Minister James Flaherty, who said that all options were still on the table, but he did not want to unduly increase the future burden on his triplet sons. The federal government, he said, would not avoid making difficult decisions, but it would not make them hastily.