Monday's announcement of potential changes to Alberta's public-sector pension plans puts that province in the front rank of Canadian governments trying to fix retirement arrangements that distort labour markets, expose taxpayers to huge risks and inspire pension envy among the majority of Canadians who cannot get other people to underwrite their retirement income.
Alberta's proposals are far from outrageous – stronger than the disappointingly modest measures for federal employees in the 2013 federal budget, but less ambitious than the far-reaching changes under way in New Brunswick. The actual measures in Alberta's spring budget will be a valuable test of whether Canadian governments can achieve evolutionary change to their employee pensions, or whether crises such as those unfolding in U.S. cities and states will force more abrupt and painful changes.
The challenges confronting public-sector plans aren't new to Canadians. The population is aging, which means there are fewer active employees to support the pensions of retired beneficiaries. People are living longer, which means pensions need to be paid out for longer periods. And rates of return on prudent investments are seriously depressed, which means pension plans can no longer put off tough funding decisions by counting on overly optimistic future investment income.
The formal costs of the four plans targeted by Alberta's reforms have already reached gigantic proportions. Every year, Alberta taxpayers and public-sector employees contribute a total of 25 to 35 per cent of wages and salaries to the plans' pension funds – about twice as much as their contributions at the start of the new millennium. The same is true for most other public-sector plans across the country. And that's not counting the fact that these costs are badly understated, since they assume investment returns far in excess of yields on other debts backed by taxpayers – those same taxpayers for whom retirement savings and pensions are not guaranteed by their counterparts.
Alberta's proposals will help curb the costs of funding pension promises, or at least stop them from climbing further. Their new governance model, designed along the lines of Ontario's jointly sponsored plans, and future inflation indexation conditional on the fund's performance will reduce taxpayers' exposure to risk. These reforms, however, do not go as far as New Brunswick's new shared-risk model, which protects future generations by permitting reductions of base benefits already accrued, in extreme situations.
The moratorium on benefit improvements and the ending of subsidized early retirement for those who retire before age 65 – five years above the newly legislated federal early retirement age – will greatly reduce funding pressures on future benefits. And the new constraint that funding be split 50-50 between employees and employers will lead to taxpayer savings. But the greatest potential for taxpayer cost savings resides in the proposed cap on total plan costs – a cap that has yet to be determined.
The most equitable way to mitigate costs and risks to taxpayers would be to cap Alberta's contributions as an employer at 50 per cent of the maximum tax-preferred limit available to Canadians saving in RRSPs or defined contribution plans. The rest of the amount needed to fund the plans at their actual service cost would come from employees. This would greatly limit taxpayers' exposure to pension shortfalls, while ensuring that they pay their fair share without subsidizing the accumulation of tax-sheltered pension funds at higher contribution rates than available to savers in RRSPs and DC plans.
Changing demographics and economic environments have exposed the governance and design failings of traditional defined-benefit public-sector plans. The Alberta reforms are a step in the right direction and deserve to be supported. If nothing is done, the climbing costs of public-sector plans will inevitably push for higher contributions on future generations and higher taxes to finance large unfunded liabilities – putting at risk the economy and the financial viability of these plans, as well as the retirement security of members.
William Robson is president and CEO and Alexandre Laurin is associate director of research at the C.D. Howe Institute.