Enormous, unfunded public pension liabilities are a ticking financial time bomb for Canadian governments and taxpayers. But even where the pensions of public- and private-sector workers are backed up by invested assets, how solid is that funding base compared with retiree obligations?
A video co-produced last year by Cormana Group and the Ontario Teachers’ Pension Plan, Pension Plan Evolution (available online at otpp.com/pension-plan-evolution), delves into this question.
The $117-billion Teachers plan is considered one of Canada’s best-run, with an average annual return of 10 per cent since 1990. Yet its actuarial liability is growing more quickly than its assets, resulting in an unfunded liability of some $10-billion.
In a letter sent with the video to business leaders across Canada, then Teachers chief executive Jim Leech said: “Pension plans across the globe are facing the same set of challenges … changing demographics, low interest rates and slow-growth economies all serve to complicate the already ponderous issues of pension fund financial sustainability and intergenerational
The video highlights some of those “ponderous issues.” Fund growth has been seriously hampered as returns on low-risk investments, such as government bonds, have fallen to less than 1 per cent. The addition of progressively more generous benefits, such as early retirement options and inflation indexing, has coincided with longer lifespans for retirees.
While the video doesn’t claim to have the solution, one commentator states that we need to “lengthen the work dimension and shorten the post-work dimension.”
The issues raised in the video are reinforced by a Dominion Bond Rating Service report last year that looked at 461 defined-benefit pension plans in Canada, the United States, Japan and Europe. The conclusion: “For the first time since DBRS began evaluating the health of pensions, the aggregate pension deficit is now in the danger zone” with only 41 per cent of the funds in “good shape.”
The evidence is clear. Traditional defined-benefit plans that guarantee pensioners a fixed retirement payout based on a combination of years worked and earnings during the final (and usually highest-paid) working years are almost completely unfinanced in the public sector and financially unsustainable in the private sector.
So are defined-benefit plans doomed? In the private sector, that question is already being answered in the affirmative. Many of Canada’s biggest companies have shifted to defined-contribution plans, wherein the employer and the employee contribute a percentage of earnings; the employee’s pension payout depends upon the accumulated value of invested funds at retirement.
One benefit for workers is that invested assets are completely portable should they change jobs. The big advantage for employers is that because there is no guaranteed payout, no funding deficits can occur. This is driving a strong trend to defined-contribution plans across the corporate world, from Europe to the United States to Canada.
So far, few governments have followed the business world’s lead. But mushrooming unfunded public pension liabilities, together with increasing pressure on taxpayers, makes it impossible to let things stand as they are.
The Netherlands is leading the way with a “shared risk” public pension structure wherein factors such as economic growth (or lack of it) help determine pension payouts.
New Brunswick, facing a $1-billion pension funding shortfall for public-sector workers, has introduced a shared-risk plan based on the Dutch model.
The new model, which aims to combine the most important features of defined-benefit and defined-contribution programs, has been embraced by public-sector unions worried that existing plans are doomed to failure.
Changes include pegging the pension to a percentage of career-average earnings, rather than to final salary, and raising the minimum age for retiring, without a reduction in pension payments, to 65 from 60.
The provincial government said the changes address “demographic challenges that make the current system unsustainable, including fewer people working and a larger number of retirees who are living longer.”
That description sums up the challenge facing both private and public pensions around the world.