Keith Ambachtsheer is director emeritus of the International Centre for Pension Management at the Rotman School of Management, University of Toronto. He is a member of the Ontario government's technical advisory group on retirement security, but the views expressed here are solely his.
According to the Melbourne Mercer Global Pension Index, Canada has the seventh-best pension system in the world. We could do even better if we solved a major shortcoming: Millions of our middle-income private-sector workers are not covered by a workplace pension plan.
This leads to two problems. Problem No. 1 is that some of these workers are saving for retirement on their own through high-fee mutual funds. Problem No. 2 is that others are not saving for retirement at all. Combined, these problems will lead to retirement income shortfalls for millions of workers in the decades ahead.
How to address these problems? A popular solution is to "ramp up the CPP." Proponents point to its actuarial and operational soundness, and its broad coverage and portability. If it works well with its current modest benefit levels, why wouldn't it work equally well with more generous benefit levels? This question deserves far more attention than it has received to date. To answer it requires a historical perspective.
The Canada Pension Plan was established in 1965 in response to an unacceptably high poverty rate among seniors. It was set up as a pay-as-you-go system, with payroll deductions quickly converted into modest benefit payments. In the beginning, with all workers contributing and only a few people eligible to collect benefits, it was a low-cost system. However, after 30 years of operation (i.e., by the mid-1990s), the system began to mature.
Rising future CPP benefit payment projections implied that future pay-go contribution rates would rise to unacceptably high levels. A federal-provincial consensus was reached to quickly double the CPP contribution rate to its current level of 9.9 per cent of pay. This would create a large enough reserve fund (to be managed by the CPP Investment Board) so that under reasonable economic, demographic, and investment return assumptions, the 9.9 per cent of pay contribution rate could be maintained into the indefinite future. That has been the case so far.
This brief recounting reminds us of the significant wealth-transfer embedded in the plan's 50-year history. In the beginning, younger generations of Canadians "gifted" CPP benefits to older generations. The mid-1990s measure to move the CPP from a fully pay-go system to a 25-per-cent prefunded system was intended to prevent any more wealth transfers of this kind in the future. To further ensure this, reformers amended the CPP Act to require that any future benefit enhancements would have to be fully prefunded. Any proposed benefit enhancement today has to be priced and paid for as the enhanced benefits accrue over time.
All this underlines the importance of understanding the path dependency element in the CPP story. To ensure that the prefunding requirement in the CPP Act really does protect future generations, a series of fundamental questions would have to be addressed. Here are three examples:
1. What investment return assumption should be used to price any future benefit enhancement?
2. Will these benefit enhancements be guaranteed? If so, by whom?
3. Will the answers to these questions ensure that future generations are not underwriting the risk that any CPP benefit enhancements we grant to ourselves (and price) today are too rich?
I have not seen the CPP expansion enthusiasts address any of these questions. My suspicion is that, consciously or unconsciously, they would like to do an end-run around the "no more wealth-transfers" safeguards put in place by the CPP reformers of the 1990s. This is not a place we should go.
Fortunately, there is a far simpler, more targeted route to providing Canada's middle-income private-sector workers with an opportunity to grow their retirement savings. Ontario is already leading the way with its Ontario Retirement Pension Plan initiative, which will sit on top of the current CPP/OAS/GIS structure. The government is still seeking input to its design. Ideally, in my view, it will have five key features:
1. A design that aims for (but does not guarantee) a postwork income replacement rate. For example, the current ORPP proposal suggests a 15-per-cent income replacement rate on top of OAS and CPP benefits.
2. Auto-enrolment into the ORPP of all Ontario workers without a qualifying employment-based pension plan. This would be a mandatory employer requirement. However, there would be an opt-out clause for workers who do not wish to participate (for example, low-income workers who are in danger of losing GIS benefits).
3. A "qualifying pension plan" definition. To qualify as an alternative to the ORPP, an employer-sponsored pension or retirement savings plan should have a contribution rate at least as high as that of the ORPP.
4. Open architecture. Workers should be able to move any retirement savings they have accumulated on their own into the ORPP if they so choose.
5. Setup as an arm's-length, expert institution with a stakeholder value-creating mindset.
Britain successfully rolled out its own version of this kind of supplementary pension plan three years ago. The time has come for Canada to follow.