PRPP or expanded CPP? Consider adding a pure longevity insurance payout option to the CPP

 The debate whether Canadians would be better of with the PRPP or an expanded CPP was recently reignited with the Ontario government (rightly) re-thinking the wisdom of the PRPP over an expanded CPP. This morning’s news that McKinsey has issued a report (which I have not read and I don’t know who commissioned it) suggests that “Canada’s retirement savings system needs multipronged boost” . “Multipronged” approach makes sense, but as usual the devil is in the details.

While I am not an avid fan of the expanded-CPP as the sole pension reform mechanism for Canada, it is no doubt a superior option to the PRPP (see my PRPP: An agreement to kick the can down the road and deliver more fees to Canada’s financial industry blog on what I consider the requirements of real pension reform; the PRPP gets an ‘F’ on all four requirements). So the surprise is not that the Ontario is having second thoughts on the PRPP, but that it hasn’t as yet been joined by other provinces.

 How about using a very simple extension to CPP payout options as one of the multiple prongs of “pension reform”? Canadians already have the flexibility to start CPP anytime between ages 60 and 70, with appropriate incentives for staring closer to 70 than to 60. Furthermore, the federal government has just announced similar inducement for delaying start of OAS. (By the way the same scheme would work for the U.S. Social Security system.) 

It is only a small stretch to allow the flexibility to (irreversibly) convert a portion of one’s CPP at age 65, to a life-contingent (i.e. if you die before 85, you get nothing) lifetime income starting at age 85. So how might this work? For a 65 year old starting CPP in 2012 maximum payout is almost $12,000 per year. The equivalent actuarial present value of such an indexed annuity stream is of the order of $300,000. If this individual would take at 65 a CPP payout of $9,000/year (instead of $12,000/yr) and she would have (25%) $75,000 value available to be converted to a pure longevity insurance option within the CPP framework. This would translate to an additional life contingent income stream starting at age 85 of about $47,000/year (on top of the inflation adjusted $9,000/year started when she was 65) based on recent New York Life quote of lifetime $0.64/year income starting at 85 for each single premium of $1 at age 65 (See Anne Tergesen’s article “How to create a pension with a few catches”  in the WSJ). The CPP payout might even be better than the New York Life payout given larger scale and additional flexibility. 

It’s not for everyone, but middle and above income private sector Canadians might find this a valuable mechanism to protect against longevity risk (i.e. running out of money) with the demise of private sector DB pensions.

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