The looming politics of pensions

Posted by ealboim under Media Commentary, Political Strategy

Elly Alboim

Fixing the Canadian pension system is now emerging as one of the urgent public policy priorities arising from the financial meltdown. It is also becoming a significant political priority because not fixing it will likely have significant electoral consequences.

When Canada’s governments came together a decade ago to ensure the sustainability of the Canada Pension Plan, the result was a triumph of political will and good public policy. The CPP has become a hybrid somewhere in between a fully funded plan and the pay-as-you-go pyramid scheme that many other countries cling to because they are unwilling to set premiums high enough to sustain future benefits.

The CPP is now sound although its maximum annual pay out still falls below $10,000.

That achievement masked an earlier failure to come to terms with the future costs of the other part of the public pension system, Old Age Security and its low income companion program, the Guaranteed Income Supplement. The OAS is clawed back progressively as income grows but the claw back doesn’t fully recover all payments until fairly high (and politically sustainable) thresholds of income. It is also indexed against inflation. Further, eligibility is based on individual income not family income the way the GIS is. That means that a low income partner in a high income family still qualifies for OAS, sometimes at the full benefit level.

Both the OAS and GIS are non-contributory and are funded exclusively from the Consolidated Revenue Fund of the federal government. They are, in effect, social income support programs designed to fill in the income gap in retirement for low income Canadians who, for a variety of reasons, do not have adequate income from the CPP and/or private pension plans, whether corporate or individual.

In overall design, Canada’s pension system rests on a number of legs. The public system encompasses the contributory CPP and the non-contributory OAS and GIS. It is designed to complement the tax-assisted private pension system which consists of group Registered Pension Plans (RPPs), typically company plans, either defined benefit or defined contribution, and individual Registered Retirements Savings Plans (RRSPs.) Notionally, the system is supposed to deliver 70% of pre-retirement income to individuals as the various programs are combined. That figure was deemed to be the equivalent of working income minus all of the expenses associated with working, in other words the same standard of living. For instance, the amount allowable for RRSP contribution is determined by the contribution one makes to an RPP, ensuring that everyone gets the same amount of tax assistance, based on the 70% replacement target. Potential CPP benefits are part of the calculation as well. The OAS is supposed to replace a similar 70% of an albeit lower pre-retirement income.

The reason for all this stemmed from a time when the incidence of poverty among Canada’s seniors was an international disgrace. Getting mean income up meant harnessing public dollars and incenting private dollars to build a strong pension system. We did that and achieved remarkable progress in reducing poverty among seniors although the take up on RRSPs never quite matched the hopes of policy makers, partly because of a lack of a strong savings culture and partly because to participate people need disposable income they can set aside.

It now turns out that the system may not have been strong enough to withstand the impact of the current financial tsunami — at least for seniors and near seniors who have run out of time to recover their losses in financial markets or whose company pensions are at risk.

Although the rules for tax assistance were quite clear and consistent, the regime governing what investments were made within RPPs and RRSPs was quite wide open. There were no provisions to limit risk. In some ways, this was a curious (and now potentially catastrophic) hole in the system. The Canada Deposit Insurance Corporation does not insure riskier investments on the reasonable proposition that public money should not be used to cushion against the losses incurred by individual investment decisions. There was no such provision on the pension side. The policy was that although everyone got the same tax savings (the public contribution), individuals or groups would benefit from good investments and suffer from bad ones – normal consequences in a private world of free choice.

Separately, the rules governing group pensions – primarily the treatment of surpluses and deficits within a context of actuarial soundness – mitigated against large hedges for bad times and did not protect pension plans well enough when their guarantors (mostly companies) risked insolvency themselves. Because of these rules and the onerous obligations imposed on defined benefit plan guarantors, there has been a massive movement towards defined contribution plans because of their much less ambitious guarantees (and less generous payouts.)

Unfortunately, the financial melt down has vaporized a lot of non-guaranteed investments (group and individual) and ended the possibility of many Canadians ever reaching the 70% replacement target. In other words, their standard of living is going to fall well below what they might have reasonably expected as a result of contributing faithfully to the variety of retirement instruments. And as their income drops, more and more will have to fall back on the publicly funded OAS and GIS. Some will have to rely on provincially funded welfare until they reach the age of eligibility for the federal programs. As well, governments may never get back the full value of the deferred taxes that they expected when people drew on their RRSPs. In other words, public dollars will have to support the losses in the private system, weakening the bottom lines of governments. And remember, this all involves the largest age cohort we have – the baby boomers.

It is not without reason that many are beginning to believe this will be the defining political issue of the coming decade – the need to summon the political will to develop public policy to fix the private pension system in the way a decade ago the public system was stabilized. The consequences of failure may turn the clock back to an era of poorer seniors and debt-ridden governments and the political instability that will entail.

Elly Alboim is an associate professor in the School of Journalism and Communications and a principal in the Earnscliffe Strategy Group, specializing in strategic communications and public opinion.