Patrik Marier- IRPP Study: Improving Canada’s retirement saving- Lessons from abroad, Ideas from home
Patrik Marier in the IRPP study “Improving Canada’s retirement saving- Lessons from abroad, Ideas from home”indicates that “Until now Canada’s retirement income system has done well in alleviating elders’ poverty and helping workers maintain their standard of living in retirement. But according to Patrik Marier, the latter achievement is threatened by problems in the coverage and governance of occupational pensions, and by the voluntary nature and high cost of savings alternatives. These issues, together with the limited generosity of public pension programs, mean that a significant proportion of today’s middle-income earners could face a decline in their living standards when they retire. Patrik Marier looks at pension reforms in Norway, Sweden, New Zealand, the United Kingdom and Saskatchewan to determine if there are lessons for Canada, and finds that all five systems have features that would complement Canada’s public pensions.”
Here is my attempt at summarizing Marier’s key messages in his 40 page report.
Overview of the Canadian pension landscape
-“The first section is an overview of the Canadian pension system. The second contains a discussion of some of the system’s key challenges, including issues related to the maturation of RRSPs/RPPs and the shift now under way with regard to occupational pensions. The third and fourth sections are analyses of experiences abroad and in Saskatchewan, and include an assessment of the political and policy obstacles to the introduction of similar programs in Canada.”
-“Slower economic growth, declining fertility rates and improved life expectancy are among the key factors pressing governments to alter their public pension schemes.” Countries with PAYGO and “general revenue” sourced systems (e.g. OAS/CPP/GIS and Social Security) will be particularly affected by these factors.
-solutions for most countries involved changes in “raising the retirement age, lengthening the contribution period, strengthening the link between contributions and benefits, and reducing the generosity of indexation mechanisms”
-“The adoption of individual pension accounts in some OECD countries, often within public pension programs similar to the CPP/QPP has led to debate in Canada on the merit of this policy tool”
-while an expansion of the CPP is considered here, the “the government could well raise the current CPP pensionable earnings ceiling; increase benefits by raising contribution rates; or even create a new occupational scheme, as part of the CPP, for workers who are not covered by a company plan”
-Table 1 on page 6 of the report summarizes the Canadian pension system, and then adds that “unlike the public earnings-related pension schemes of many European countries, which are designed to provide an earnings-replacement rate above 50 percent of the average wage, the CPP/QPP aims for a modest replacement rate of 25 percent of the average wage for 40 years of contributions (i.e., 47 years minus the worst 7 years). As a result, the role of private pensions is to ensure that most retirees receive adequate replacement income, as opposed to mere subsistence income.”
-in discussing Canada’s pension system he covers the various policy goals of such pension systems, such as: fighting poverty (and the risk accompanying the practice of indexing to inflation rather than standard of living), maintaining living standards (by “ensuring an adequate replacement rate for retirees”; “In Canada, public programs such as the OAS, GIS and CPP/QPP provide a high replacement rate for low- to middle income earners (see table 2). However, individuals with above-average earnings experience a sharp drop in income if they rely exclusively on public programs…see Table 2 page 8; Canada’s private pensions are the weakest link in the pension system), occupational pensions (DB, DC, group RRSP): A privilege? (In 2006 38% of Canadians had RPPs, but only 24% in the private sector. Pre-financial crisis the underfunding of the DB plans was considered manageable, unlikely to be so post-crisis; in addition to crisis: growing longevity, lower returns and lower discount rates all contributes to underfunded status in addition to contribution holidays during the 90s. DC plans are considered more “flexible” by most employers (risk transfer to workers) and by the more mobile and less risk averse employees. Group RRSP are not registered pension plans and are thus more flexible for employers as they require no contractual obligations.)
-regulatory oversight is a dog’s breakfast in Canada as due to multiple and overlapping regulatory schemes federal/provincial and provincial/provincial; there is no agreement among provinces about the need for harmonization
-“The ability of private pension plans to safeguard prior investments (or promises) has also been questioned. Beyond cases that have attracted media attention, such as pension losses due to bankruptcy or poor stock market performance, the overall governance and management of private pension plans have also been criticized”
-despite RRSPs, individuals without RPPs end up with lower retirement incomes due to: higher costs, no pooling of pension risk”, individuals underestimating costs and risks in retirement, and are unable to effectively deal with investment risk while accumulating assets
-Table 3 on page 15 summarizes pension reform in Sweden, UK, New Zealand, Norway and Saskatchewan. There are lessons to be learned but Marier warns that pension reform process takes a long time (…we don’t have time…besides, as somebody I used to work with always reminded colleagues that “it’s amazing how long it takes to do something that you are not working on!”) He then proceeds to discuss interesting/unique features of each country’s pension system and explores applicability and ease/difficulty of implementing in Canadian context.
Marier’s lessons for Canada pension system from:
-Sweden: similar components to OAS/GIS/CPP but CPP ceiling set at higher ($51,000) level and higher contributions (13%) with a higher replacement rate of 60%.. a mandatory 2.5% contribution (shared between employer and employee) is also collected for individual DC pension accounts, which could be invested in a default fund (with age-dependent risk level) or private funds registered with the pension authority. This latter mandatory DC account could be emulated by Canada, but it would have to be done much higher than 2.5% level due to the lower CPP replacement rate for average income Canadians. Advantages over RRSP are “higher level of participation and broad coverage” as well as low management fees (0.31%0 and low administration cost (0.19%)
-UK and New Zealand: as a compromise between mandatory schemes (“restricting individual choice”) and voluntary schemes (resulting in “wide gaps in both coverage and generosity”) introduced “automatic-enrolment individual accounts” where on starting employment the default is membership in the plan. “Individuals must then actively choose to leave the plan, as opposed to choosing to join it.” Both countries also “have tax incentives to entice individuals to remain enrolled” Also New Zealand has a non-contributory OAS-like pension scheme but set at a generous 60-65% of the average employee’s income. In addition to compensate for the rapid decline of DB type schemes. KiwiSaver was introduced, with auto-enrolment with a default of 4% of gross earnings optionally increased to 8%. Individual’s contributions are invested in one of six default funds, with option to select others. Employers’ contributions will increase gradually to 4% by 2011.There is strong employer participation in both the UK and New Zealand. Similar schemes could be introduced in Canada federally (if provinces agree) or provincially (so long as there are the necessary mechanisms so these plans “do not impede movement of labour across provinces and industries”. In the UK the automatic enrolment is either in an “occupational pension plan or a default individual pension account (NEST)”. Through NEST “workers will contribute a minimum of 4 percent of pay; additional contributions will consist of (at least) 3 percent of pay coming from employers and a 1 percent tax relief from the state. These contributions, which cannot exceed £3,600 per year, will be collected on earnings between £5,034 and £33,540.18 The NEST will be an arm’s-length trust governed by an independent board of directors”.
-Norway: the government developed a new mandatory occupational pension scheme and a new pension fund to pre-fund the CPP-like pensions. Marier suggest this approach of “expanding the occupational coverage by placing this responsibility in the hands of employers instead of the workers” might be a possible model for Canada, but feels that it might be a difficult thing to implement due to “differences in economic structure and ideological leanings.” The minimum requirement includes “a 2 percent contribution by employers (from roughly $12,000 to $150,000)…Employers receive tax credits for their contributions.” Special mechanisms were put in place to allow “small companies to benefit from economies of scale offered by larger pension schemes”. Box 6 in the paper has some interesting details on implementation pertaining to indexation of contributions and benefits, life expectancy indexation of eligibility to full pension,
-Saskatchewan: SPP was “created in 1986 to insure that homemakers and others not covered by RPP would have access to benefits beyond OAS and GIS” (Great idea!). Since 1992, the SPP “has been operating as a large DC voluntary pension scheme that can also be used by employers wishing to provide a modest occupational pension to their employees”. “At retirement, annuities are paid out monthly. With its low administrative fees and its flexibility (individuals are not penalized for irregular and fluctuating contributions), the SPP facilitates access to the equivalent of a private pension. Employers can make payroll deductions easily on behalf of workers, free of cumbersome administrative responsibilities. The SPP’s expense ratio for the Contribution Fund in 2009 was slightly less than 1 percent of assets (not bad considering the small size and the permitted irregular contributions, according to Marier), covering all administrative expenses related to this fund within the SPP.” Marier sees the SSP model as having the elements necessary for a Canadian plan if “contribution ceiling were to be raised substantially”.
Marier’s Bottom Line
“An increasing number of governments around the world are making adjustments to their pension systems to broaden coverage of occupational plans. It is time for this issue to be addressed in Canada, to ensure that future generations will be able to retire without a significant drop in their standards of living.”
Marier says that “four key questions must be answered before decision-makers can deliberate:
-enrolment: voluntary, mandatory or automatic (with optional opt-out)
-“role of employers and workers when additional coverage is sought”
-“role of provincial and federal authorities in enacting reform”
-“type of organization needed to manage or supervise newly created pension arrangements”