What Were They Thinking?


Pension plans are in crisis, and it’s only going to get worse. An aging population, historically low interest rates and a stagnant economy have combined to create a perfect storm that threatens the retirement income of millions of people in Canada.

The assault on pensions has several dimensions but they all come back to one thing: money or, more precisely, the lack of it. There simply isn’t enough to cover the promises that were made to employees who contributed to plans for many years.

The Ontario Teachers’ Pension Plan is a classic example. Once considered one of the strongest in the country, it now faces a $9.6 billion deficit. CEO Jim Leech insists it’s not really a crisis, pointing out that the plan is 94 per cent funded. But Ontario Finance Minister Dwight Duncan says he will not ask taxpayers to make up the shortfall, suggesting the solution is for teachers to cut their benefits.

The teachers are not alone. Air Canada’s pension plan showed a $4.4 billion deficit at the end of 2011, in part due to low interest rates. Pension plan managers normally hold a significant percentage of their assets in fixed-income securities such as government bonds.

When interest rates are low, returns fall short of the actuarial projections on which the viability of the plans are based. A prolonged period of low rates, such as the one we are experiencing, can be devastating. Air Canada, with the support of its unions, has asked Ottawa to give it until 2024 to get the plan back into balance.

The worst-case scenario is a pension plan that folds, leaving its members to cope with the fallout. Fortunately, we have not seen many instances of that in Canada yet – the winding up of the collapsed Nortel plan, which is still being fought in the courts was the biggest to date.

But in the United States, pension plans are collapsing with alarming frequency. The Pension Benefit Guaranty Corporation (PBGC), a U.S. government agency that bails out members of failed plans, reports that 152 underfunded single-employer pension plans were terminated during 2011 – almost one every second day. The result was PBGC’s obligations increasing to US$107 billion, leaving it with a nearly US$26 billion deficit. (Canada has no national equivalent of the PBGC.)

The pressure on existing plans is just part of the problem. The other is coverage – only a minority of Canadian workers belong to a pension plan and coverage has been gradually declining in recent years. According to Statistics Canada, in May 2012, 38.8 per cent of employees had pension coverage in 2010. That was down from almost 42 per cent in 1997. More than half work in the public sector.

Another disquieting trend revealed by Statistics Canada is that the percentage of plan members who have defined benefit (DB) pension plans has fallen to 74 per cent from more than 84 per cent a decade earlier. DB plans guarantee a person’s income at retirement, usually based on a combination of salary and years of plan membership. Defined contribution (DC) plans, which are increasingly used by employers because of lower costs, provide no guarantees.

So what is Ottawa doing about the situation? Not much. For a while, there was talk of expanding the Canada Pension Plan, which is a DB plan in that it guarantees a level of payment. The idea was supported by trade unions and other groups. But it was shot down by opposition from employers, who have to pay half the contribution cost, and resistance from key provinces such as Alberta.

Instead, the federal government decided to launch Pooled Registered Pension Plans (PRPPs). These will be defined contribution plans administered by the private sector, with banks and insurance companies playing a lead role. They can be used by small- and mid-sized companies and by self-employed workers, keeping costs low by pooling the assets of several plans, thereby creating economies of scale.

Legislation setting up the regulatory framework for PRPPs received royal assent last June. However, when this issue went to press, there had been no announcement as to when the new program would actually be launched. Provincial governments have to pass their own enabling legislation for PRPPs to work and, to date, none have done so. The Ontario Liberals have been calling instead for a “modest” extension of the CPP instead of PRPPs.

This provincial foot-dragging has not deterred the federal Conservatives who are ploughing ahead with the program and singing its praises at every opportunity.

“PRPPs are the right solution at the right time to help many Canadians better save for their retirement,” Ted Menzies, minister of state for finance, told the Economic Club of Canada in Toronto in August. Really? The C.D. Howe Institute begs to differ. In a commentary published in August, C.D. Howe associate director of research Alexandre Laurin, along with Toronto lawyer James Pierlot, contend that PRPPs in their proposed form will fall far short of the government’s lofty expectations and represent only a “mild improvement” over Registered Retirement Savings Plans (RRSPs).

“This is because tax rules for PRPPs – essentially identical to those that apply to RRSPs and similar to those for DC plans – will prevent many private-sector workers from saving enough for retirement and from receiving retirement income in the form of a life pension,” the authors say.

Worse yet, PRPPs could end up penalizing low- to middle-income wage earners. By contributing to such plans, these people will “pay taxes and government benefit clawbacks on withdrawals in retirement at rates that are significantly higher than the refundable rates that apply to contributions,” says the report.

The authors contend that over a lifetime, these people would be much farther ahead by putting their money into a Tax-Free Savings Account (TFSA). They call on the government to amend the legislation to allow TFSA-like plans to be set up within the broader PRPP framework. (Contributors do not receive a tax deduction for money put into a TFSA, but the withdrawals are tax-free and are not counted as income for purposes of calculating government benefits or clawbacks.)

“High effective tax rates that result in part from the clawback of income-tested benefits for the elderly mean that governments are effectively getting more taxes back from many Canadians when they retire than the amount of taxes forgone when those Canadians contributed to pension plans and RRSPs,” the authors write.

The study’s damning conclusion: “PRPPs … are for the most part a re-release of an existing retirement savings vehicle – RRSPs – with a new coat of paint. For middle- to upper-middle income workers, PRPPs will be of little help because they do not address the gap between DB pension plans and RRSPs in terms of accumulation room. Finally – and irrespective of working-life income – PRPPs will not pay ‘real’ pensions to their members.”

Clearly, PRPPs are not the answer to the escalating pension predicament. We need a better model that will address the basic problems. What Ottawa has delivered is a pitifully weak response to one of the most important social issues of our generation.

(December 2012)