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Six questions Ontario must answer before it starts a pension plan

Tammy Schirle is an associate professor of economics at Wilfrid Laurier University.

Like it or not, plans are moving forward with the Ontario Retirement Pension Plan. Mitzie Hunter has been appointed associate minister of Finance, tasked with designing the plan. Personally, I think we can justify some careful expansion of our public pensions. What's missing from the policy debate thus far, however, have been details. And with ORPP, the details are crucial. I humbly offer some thoughts and questions for Ms. Hunter to consider as she moves forward with this important portfolio.

1. Be clear about the market failures you are trying to address.

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Our markets fail to provide good insurance coverage for longevity risk. Certainly, annuities markets exist but the market for annuities suffers from adverse selection – a classic market failure. As such, annuities tend to be priced too high and large portions of seniors don't buy in. As a result, they find their savings running out as they live longer than expected. A public pension that offers a defined benefit fills this gap.

What is less clear is why some individuals fail to save for themselves when they appear able to do so. It's these folks that have prompted the calls to reform our public pensions, but are we merely being paternalistic? Perhaps not entirely – without serious training in finance it is easy to make mistakes in savings decisions, which are often irreversible.

2. Be precise about the policy target.

The ORPP will be mandatory for any paid employee that is not already covered by a pension plan with their employer. But what qualifies as a pension plan? Standard registered pension plans that offer defined benefits (DB) upon retirement are a clear example that should be exempt. The DB plans offer the same insurance as annuities. But what about defined contribution plans? Group RRSPs? Do we have a minimum replacement rate in mind?

As the research has shown, the general policy target here is quite small – a group of middle income individuals who don't have employer pensions and end up with relatively low income replacement in retirement.

Parameters will have to be defined to best capture this group, with the expectation that within a few years employers will respond in whatever way minimizes their labour costs and still attracts the employees they need.

3. Be clear about any redistribution that will occur.

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I think most people want clear legislation that requires the ORPP to be fully funded and directly links the contributions one makes to the benefits they receive. I would not want to see a rushed introduction of generous benefit payments for baby boomers that are funded by the contributions of youth. Rather, I want to see youth have an opportunity to save in a secure fund with good insurance for their own retirement. Clear legislation is required as there is often political pressure to lean toward redistribution, sending benefits to target voters.

Other forms of redistribution currently contained in the CPP model are also important to consider. For example, current CPP benefit calculations do not reduce benefits for individuals who are expecting to receive a survivor benefit in the future (whereas a reduction in benefits is common practice for employer-sponsored pensions). As such, the contributions of single individuals are used to subsidize the survivor benefits offered to married couples. The survivor benefits for married couples are also limited to surviving spouses that did not contribute enough to receive full CPP retirement pensions themselves, so that dual earner families are subsidizing single earner families. A clearer link between one's contributions, benefits, and the availability of a survivor benefit is desirable.

As another example, the CPP allows for exempting several years of low earnings and years spent in child-rearing when determining the average earnings that are the basis for benefit calculation. This boosts the benefits of individuals who spent time away from the labour force above what their contributions would have afforded them. Perhaps Ontario finds redistribution of this nature acceptable for the ORPP, but we should be explicit about that.

4. Notice that low-income families won't benefit from a simple expansion of benefits In work with UBC's Kevin Milligan, we considered the after-tax public pension replacement rates that would result from various CPP expansions. Because any increase in public pension benefits reduces GIS payments and is taxable, lower-income individuals have little to gain. Individuals with earnings around $25,000 or less already have income replacement rates at or above 100 per cent. They could actually be made worse off, having to make additional contributions during their working years with little to gain in retirement. A serious exemption – placed somewhere between $30,000 and $50,000 should be considered.

5. How are you going to deal with interprovincial migration and interprovincial employment arrangements?

This was the beauty of CPP and its co-ordination with QPP – Canadians are free to move between provinces and carry their pensions with them. Working within only Ontario is more difficult to administer (while still clearly linking benefits and contributions), and can reduce mobility in the labour market in a way that is undesirable.

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6. Enhancing the CPP remains the Ontario government's preferred solution.

There are other provinces interested in reforming CPP and this possibility is never completely off the table. While options for reform were rejected at the federal level last year, we need to consider the possibility that future governments might have a different view. We don't want to get locked into something that won't work for other provinces.

This is a policy that affects Ontario workers for many decades to come. The Ontario government wants the ORPP in place by 2017, a tall order at this point. Employers will need plenty of lead-time, with certainty in the ORPP's policy parameters that that they have time to adjust their plans. This is not a policy to be rushed.

Author's note: Many points I offer relate to work I've done with Kevin Milligan (University of British Columbia) examining the potential for CPP expansion, where readers can look for more details.

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