Impressions of the Whitehorse Pension Conference

In a Nutshell

There were no recommendations and no actions coming out of the meeting. Another conference planned for May 2010.

Despite the data presented and the optimistic assumptions used to generate it, the conclusion of the Mintz report is that (mostly) all is well with Canada’s pension system. (Oh yeah? Perhaps if one only looks at public service pension beneficiaries and Canadians earning average or less than average Canadian wage.) Poverty is almost eradicated among Canada’s elders; however mid-to-high income Canadians will see a drop in their standard of living (potentially a significant one). But the report suggests that a much lower income replacement (even 50-60%) is acceptable for above average earners. (Given the growing proportion of over 65 Canadians, this does not bode well for Canada’s economy in general.)

Data presented also indicates that retail mutual fund investors in RRSPs are facing head-winds (hurricanes?) up to 10 times greater that beneficiaries of large scale institutional pension plans (resulting in dramatically lower accumulated assets due to the less efficient investment vehicles available to them.)

There is only superficial mention of the systemic failure of Canada’s private sector (DB) pension system.

The Baldwin report is much more pessimistic about the current and future state of Canada’s retirement income system (RIS)

The Details

To fully appreciate the outcome (or lack thereof) of the Whitehorse Pension Conference, organized by the federal government, one really needs to read a number of reports and articles on the subject. Chronologically consider the following:

1. 1.    “Jack Mintz: Beware of super pension fund”  in the April 21, 2009 issue of the Financial Post and my commentary on the article at that time entitled “Jack Mintz: Beware of the super pension fund”-NOT

1. 2.    Jack Mintz: “Summary Report on Retirement Income Adequacy” commissioned by federal government and tabled at the December 17, 2009 Whitehorse conference (28 pages)

1. 3.    Bob Baldwin: “Research study on the Canadian income system” commissioned by Ontario government and tabled at the Whitehorse conference (97 pages)

1. 4.    Keith Ambachtsheer: “The Mintz and Baldwin reports on retirement savings adequacy: An assessment and policy implications” reviews and summarizes the Mintz and Baldwin reports (2 pages)

No doubt kick-started as a pension conference to generate potential solutions to and/or in response to a pension crisis, the Whitehorse conference has gradually morphed into a retirement income system data gathering conference (unless behind closed doors something more substantial has occurred). Pensions (historically DB) have to do with promises made to and about the deferred wages of retirees, as part of their lifetime employment. The Mintz report has almost completely glossed over the issues associated with defined benefit pensions, and refocused itself on the broader issue of retirement income system in Canada and how it meets Canadian’s needs ; the generally accepted range of required income replacement is 70-75%, though Mr. Mintz figures 60% is right number and is as little as 50% for those earning double the average ($45K) wage (when the reality is, in fact, of a very individual in nature).The Mintz report tabled was positioned as “policy neutral”, i.e. no recommendations (other than what should be considered adequate replacement income in retirement as a means of setting the reader’s expectation to a lower number being acceptable).

In Mr. Mintz’s April Financial Post article (1), he presents a vitriolic attack on the idea of super funds replacing or complementing existing Canadian retirement income system. The following sentence from that article best summarizes his views: “The idea of having super pension plans implies there are cost savings due to economies scale. However, group RRSPs can achieve similar results. There is also the underlying assumption that individuals make mistakes and pension plan managers are better at achieving results “and he concludes that article with following sentence: “Governments could beef up the Canada Pension Plan for low and middle-income individuals.” Clearly Mr. Mintz already knew in April that “super funds” are wrong, and RRSPs are the answer. If anything needed fixing, it was the CPP which needed to be beefed up for low and middle income Canadian.

Mr. Mintz’s concludes in the Whitehorse report (2) that Canadian retirement income system is performing quite well, but some Canadians do not have sufficient replacement income (in particular middle to higher income ones, not the low to middle income Canadians as implied in his April 2009 article).

Furthermore the Mintz report states that:

-Canada’s CPP/OAS/GIS insures that poverty among Canadians is at 4.4%, one of the lowest among OECD countries

-projecting 2006 data he concludes that expected replacement rate for those earning <$20K is 90%, $40-100K is 67-70%, $120K is 60% and $150K is 50%

-however this is based on following assumptions: (1)  35 working years and 20 retirement years (20 years is life expectancy for average 65 year old, but by definition 50% live longer than life expectancy, 10% live at least 10 years longer and there is a 25% probability that at least one of a 65 year old couple will live to 95), inflation will be 2% and real return on assets will be 3.5% (2% inflation sounds low by historical standards and certainly low when you factor in the effective “senior inflation”; also how do you get from a balanced portfolio 3.5% real return if you pay Canada’s usurious 2-3% mutual fund fees; one would do well to achieve 1.75% real return after fees from a balanced portfolio, 4.25% less an average of 2.5% MER), annual wage gains are assumed to be real 1%. The report then shifts away from income replacement rates to consumption replacement rates (more magic with numbers) and concludes that 70% and 78% achieve 100% and 90% consumption replacement rates, with low income groups doing much better than higher ones. Clearly, at 1.75% real return the income or consumption replacement rates would be a lot lower than suggested in the report.

-there is no clear indication whether these highly optimistic projections are for Canadian in general (I assume public and private; with 85% of the former having pension plans vs. only 25% of the latter having EPPs.) It is well known that Canada’s 3.5M public sector employees have much higher participation and income replacement rates than the 10.6M private sector ones; it is puzzling why would one lump these two together in the analysis?

-no clear indication whether owner occupied house value (principal residence) is included in assumed assets available for living off in retirement (I assume the report includes home in spendable assets, since it indicates that average Canadian net worth is $485K (though median is only $300K) divided almost equally in three parts: tax-sheltered, principal residence and other financial/etc assets. (If principal residence is included, then who will buy all the homes of the growing number of retiring Canadians who will have to sell to feed themselves?)

-to cover individual longevity risk for the non-pillar 1 and 2 (OAS/GIS/CPP) assets, annuities would usually be recommended but the report notes that “annuity benefits are reduced by distribution costs, profit margins and lower mortality built into insurance company annuities (so after spending a lifetime of saving in RRSPs using mutual funds with 2-3% fees resulting in 25-50% lower accumulated assets as a result, one should buy these annuities with an expected further 25-50% lower payout rate than would be achievable due the indicated annuity  head-winds)

-and by the way, the report also suggest that individuals tend to make timing mistakes which result in about 1.1% annual cost compared to an index approach (so the real return might not be 3.5% or even 1.75%, but only real 0.65%; why do I think that most middle and high income Canadians will do even worse than Mr. Mintz suggests? And I don’t remember reading in the report about the behavioral problems that tend to reduce people’s savings rates when it’s left to their initiative.)

-the report indicates that costs associated with asset management are 20bp for CPP, 25-35 for public pension plans, 30-45 for private pension plans, 40bp for (market index) ETFs to as high as 200bp for bond and 250-300bp for global retail mutual funds (does that suggest to an unbiased observer that perhaps scale (and institutional vs. retail channel) does have something to do with cost)

-only lip-service is paid to the DB pension fund issues (i.e. specifically what is mentioned is that plan shortfalls are exposed when sponsor is at risk of bankruptcy) which actually precipitated the entire pension crisis discussion. No mention that DB pensions are deferred wages yet that in bankruptcy the pensioners have to line up alongside with unsecured creditors for the remains of the sponsor’s carcass; also no mention of the systemic failure of the pension system, in that all DB pension plan checkpoints failed to raise the alarm preventing radical underfunding of the pension plans (like Nortel’s) in many cases. Sponsor Board of Directors, plan administrator, plan Trustee, plan custodian, asset managers, actuaries, government regulators and regulations- despite the fact that all these actors had fiduciary and/or professional duties or code of conduct responsibilities to act in the best interest of the pension plan beneficiaries, the red flags were not raised because of a combination of stupidity, ignorance, timidity, incompetence and/or conflict of interest.

The Baldwin report (3) commissioned by Ontario is actually the more meaty and balanced report and I suggest that you might want to read it. It starts off explaining that:

-“The adequacy of incomes arising from an RISis commonly judged by two criteria: how incomes compare to poverty measures, and how they allow retired persons to maintain their pre-retirement standard of living.” The benchmark replacement rate is typically considered to be 70-75%. Predictability is another virtue. “The life cycle consumption theory provides (that)… savings during the pre-retirement period should be at a level that permits continuity in consumption between the pre-retirement and post-retirement periods.”

-it also indicates the great strides that Canada has taken in reducing poverty in the over 65 age group,

-however, it quotes a Statistics Canada study which “estimates that roughly one-third of Canadians in the 45 to 64 age range are likely to end up with incomes that fall short of adequate minimum incomes and/or incomes that will allow them to maintain their standard of living.”

-It also points out that two important drivers to (unfavorably) different future outcomes of current RIS are: increasing retirement to pre-retirement ratio and “The gap between returns on financial assets and wage and salary growth is likely to shrink”. In addition there is s decrease in EPP (Employer Pension Plan) participation and a shift from DB to DC plans for remaining EPPs.

-ON, NS, BC/AB studies tabled recommendations….”The status quo is an option. However, it is an option that may leave a significant minority of people with moderate to high earnings facing a decline in their standard of living in retirement, and force many people to rely on sub-optimal pension and retirement savings institutions.”

-Canada ranks 26^thout 30 OECD countries having one of the lowest replacement rates provided by pillars 1 and 2, at under 30%, for those earning 1.5x average income.

-about 85% of public sector and 25% of private sector employees are members of Employment Pension Plans (EPPs)

– the complexity of defining replacement rate, what it really means and the implication of excluding participation in the economic gains that working Canadians will enjoy during the 20-30 year period of one’s retirement, and the low replacement rates among the 3^rd-5^thquintile earners.

-he reports that 33% of near elderly won’t meet 66% retirement income target and 44% won’t meet 80% target

-the loss of buying power in un-indexed DB plans and the risk of bankruptcy while underfunded

-without making specific recommendations, the Baldwin report at least lists some of the key considerations in design of future RIS including: should pillars1 and 2 offer higher replacement rates at higher than average incomes, participation should be voluntary or mandatory (auto-enrollment) for employees and self-employed, new initiatives to replace or complement current pillar 3, new plan coverage includes current or only future elderly, national vs. provincial roles, public vs. private roles, centralized vs. decentralized approach

-Baldwin concludes that “The option of leaving everything as is will have its adherents, but seems likely to result in a significant minority facing a decline in their standard of living in retirement and — looking beyond the numbers of people participating in EPPs — forcing many people to rely on pension plans and retirement savings institutions that are less effective than available alternatives.”

Finally, Keith Ambachtsheer summaries the Mintz and Baldwin reports (4) including his previous recommendations for an improved pension system for Canada, and he does that in two pages. If you read this far then you are interested enough in the subject to read those two pages. It is not the status quo.

Mr. Flaherty promises another conference for May 2010. Pretty disappointing to those of us who were looking for immediate action now. Hopefully there will be recommendations and actions, and hopefully it won’t be too late for many pensioners now already in crisis.