Yves Trudel is a professor of finance at Sherbrooke University, and co-author of The Benefits Of Hindsight: Lessons From The QPP For Other Pension Plans, published recently by the C.D. Howe Institute.
The experience of the Quebec Pension Plan – Canada Pension Plan's equivalent for the province – holds cautionary lessons for the country's new pension options, such as the pending Ontario Retirement Pension Plan (ORPP) or proposed CPP enhancements. Without proper independent governance and rate-setting mechanisms, risks are great that the ORPP or an enhanced CPP will end up improperly funded, leading once again to more intergenerational transfers of wealth.
A recent C.D. Howe Institute report shows that the QPP's contribution rate was set too low from the beginning, despite the advice of experts and actuaries. As the plan matured, multiple reports pointed to imminent needs for contribution or benefit adjustments, yet succeeding governments took way too long to increase contribution rates for fear of public backlash.
The result has been a massive intergenerational transfer of wealth between cohorts of retirees.
Early cohorts were able to draw more in benefits than they paid in contributions, shifting the funding problem to the next generation. Had the contribution rate been set high enough, or increased as little as five years before actual adjustments were made, QPP assets would be worth substantially more today. For example, had policy-makers listened to actuaries at the time by setting the initial contribution rate only 0.4 percentage points higher, QPP assets would be worth almost 80 per cent more today. Comparable conclusions could have been reached for the CPP, since both plans evolved under similar parameters.
So what lessons can we learn for the ORPP, if it goes ahead? Full capitalization should be introduced, with benefits increasing gradually and only paid in full once the plan has reached full maturity – about 40 years out. To prevent the buildup of intergenerational transfers, automatic adjustment mechanisms should be triggered at certain levels of funding and shielded from political influence.
In addition, regular performance evaluations should be mandated. Fund managers are frequently subject to performance measurements based on investment benchmarks, yet no such evaluation seems to be formally implemented for public pension plan managers. For instance, plan managers could be evaluated on their ability to produce equitable returns between cohorts of retirees.
Such criteria cannot be reasonably implemented if plan managers have little or no decision-making authority in setting the plan's parameters. This lack of independence comes at a high social cost, both in terms of underfunding and inequity. Independent and expert contribution-rate settings should be the standard for all public pension plans. Monetary policy is conducted independent of political meddling. Why not pension fund oversight?
With respect to the ORPP or CPP enhancement, a rigorous evaluation of the relevancy of creating or enhancing public pensions has been lacking. What are the retirement problems, and are public pension plans the best solutions? For example, specific needs might not be addressed efficiently when imposing compulsory contributions on all workers and employers – after all, the impact of a payroll tax on the economy is not neutral.
And have we discounted countereffects? When individuals come to rely on public institutions for retirement benefits, they are provided little incentive to become financially literate. It could very well be that the beneficial effects of new compulsory public pension enhancements will be offset by disincentives to save that these plans create.
On the whole, if the ORPP or CPP enhancements are to go ahead, the QPP experience suggests that they must be designed in a way that ensures proper funding and regular performance measurements. Public pension mistakes come at a high cost to future generations.