Updating the Canadian Pension System

Jody White of Benefits Canada reports, Leech calls for pension system update:

The failure of pension plan legislation and design to keep up with the times is hurting the ability of Canadians to prepare for retirement, according to the president and CEO of the Ontario Teachers’ Pension Plan.

Jim Leech told a Toronto audience on Wednesday that the current state of Canada’s retirement system is markedly different than it was in 1966 when the Canada Pension Plan was made available at age 65. Life expectancy then was 72, so the gap to be bridged between the end of a career and death was narrow.

That was then

It is now a different world. Life expectancy for those born in 2007 is 80.7 years, according to Statistics Canada, with an additional 20 years for those who make it to age 65. In the face of increased longevity risk and elusive investment returns, many plan sponsors have joined the migration to defined contribution (DC) plans in order to shift the pension burden to the shoulders of plan members.

As a result, private sector workers are increasingly chafing at the prospect of losing their DB plans while their public sector counterparts enjoy a guaranteed benefit for life. Leech cautioned that such optics are contributing to “pension envy” which threatens to spoil the debate on pension reform.

The perception that DB plans are unaffordable to most plan sponsors is due to two main culprits, he said. Short-sighted tax rules and court decisions have discouraged plan sponsors from saving enough in good times to offset losses in bad times, and “weak-kneed managements who, out of expediency, promised unrealistic levels of future benefits in order to dampen salary demands.”

Leech outlined the social costs of the DB to DC migration, including the prospect of retirees outliving their savings and ultimately costing taxpayers more in social services.

Instead of a choice between the two plan types, Leech offers a hybrid plan as a possible solution. He illustrated recent steps taken by British, Dutch and Australian governments, such as raising the universal plan to a livable pension, extending pay-as-you-go plans to all workers, and amalgamating pension plans in order to spread out the investment risk and lower costs.

“The Dutch also bought ongoing sustainability by setting guaranteed pension to a career-average compensation level, rather than a top-five-year average level, and without indexation,” he said. “Employees can then purchase additional credits through a DC overlay should they wish. In other words, a DB/DC hybrid.”

Leech acknowledged the inclination of the federal and several provincial governments to allow a greater role for the private sector in pension reform, but stressed that the current fees collected by advisors and managers continue to be an issue.

“I think the solution is going to come in many different ways,” he said. “But the private sector has to address the cost issue—which is a big issue.”

His ideal outcome of the pension reform effort would feature individual hybrid retirement accounts featuring a guaranteed portion with a DC overlay on top of it.

“Some sort of a plan that has a 2% guarantee, so that I know if I’m saving money every year I’m going to get 2% (returns) or better