Tuesday 14 December 2010

CPP Adequacy "Myth" in Greg Hurst's Financial Post Pension Article

In Pension Myths published Dec.2, 2010 on the Financial Post website private pension consultant Greg Hurst rails against what he says are myths about CPP.

Myth 1 according to Mr. Hurst is "Canada's pension system is insufficient for the delivery of adequate pension income." He then cites the Mercer Melbourne 2010 Global Pension Index as a source to assert that Canada is well positioned compared to the rest of the world with a number two rank on the pension adequacy sub-index. Fortunately, the Mercer study is available on the web here, so your faithful blogger, ever the nit-picking detail guy, happily dove into the Mercer documents to do a reality check.

The reality:
  • Mercer doesn't say that Canada's system is sufficient, it merely says that Canada's system is better than most of the other insufficient systems around the world. No country attains an A grade from Mercer as a "first-class and robust" pension system on an overall level and though Mercer does not actually assign grades on its three sub-indices, Canada's 75 score on the Adequacy sub-index would put into the B grade of "a sound structure with many good features ... but has some areas for improvement"
  • Canada's score fell from 2009 to 2010 in Total and across every sub-index (p.19). Is that cause for complacency and doing nothing?
  • Mercer's Adequacy entails a miserly low level of income. The Adequacy sub-index doesn't just use the CPP, it uses ten questions to arrive at a rating. Canada does comparatively well because of its score on the two heaviest weight questions (attachment 1, p.64). Question 1 assesses the ability to provide a pension to the aged poor. Thus, in Canada OAS/GIS enables people to receive 32% of the average single person's wage (0.32 x $40,600 = $13,000), which is, according to the OECD, where Mercer got its data on this question, enough to keep someone above the poverty line set at 30%. Whooppee, happy days, huh? It is ironic that Hurst should cite Mercer whose conclusion on Adequacy relies on OAS and GIS when his myth 3 says that those two programs are at risk because they are funded from general tax revenue. Would an increase in tangible funding to CPP through higher rates not then make sense? Q2 deals with a target income replacement rate. Mercer says the net (considering taxes and deductions) replacement rate of lifetime average earnings for a median income single earner should be in the range 70-100% and Canada is reasonably close at 63.6%. Lest these numbers seem to be a high target, Mercer reminds us that the lifetimes earnings model from OECD (found in Pensions at a Glance 2009 - gotta love the sly humour in that name for a 283 page document) on which the scores are based assume no real (though it does keep abreast of inflation) pay increase throughout a working career and should thus be targeted much higher than a replacement rate based on final salary. A median Canadian worker thus would get 0.636 x 40,600 = $25,820 to live on. Would that support an active fulfilling retirement or one that entails working to supplement income? Mercer themselves comment that "A net replacement rate below 70% of lifetime earnings suggests a significant reliance on voluntary savings" (p.24).
This last point is the nub of the current problem and debate, one which Hurst himself acknowledges, and Mercer confirms (see its recommendations for Canada on page 57). The reliance on voluntary savings in defined contribution plans and RRSPs isn't working too well, it needs improvement. People are not saving enough and the trend towards types of plans where they have to manage their own investments with all the exposure to their own mistakes and high fees makes the future quite problematic.

As I have blogged before here and here, the CPP seems to offer a better solution to meet retirees' needs. Probably, changing the CPP by both raising the contribution rate and increasing the earnings limit on which CPP is deducted will both help. So what if "Expanding CPP benefits is a very complex undertaking that would likely have widespread repercussions for Canada's pension system overall"? Perhaps one of those repercussions might be a reduction in Hurst's pension consulting business as no-longer-so-necessary private pension savings declined. But is that a reason not to make changes?

His conclusion that Canada merely needs to deploy targeted solutions (harkening back to the notion that there is only a pension problem for a limited few, which I doubt, as expressed in this blog post) and leave aside CPP-enhancement, while somehow boosting employer-sponsored workplace pensions or individual retirement savings, ignores the failures and deficiencies of such options.

CPP enhancement certainly doesn't solve all pension problems. It only pays off gradually over many years as people work and earn a higher pension. Present-day retirees without sufficient savings won't get anything - we'll just have to keep working or buying lottery tickets and/or reduce our standard of living down towards that OAS/GIS level.

I'd like to see arguments more convincing and practical regarding CPP than what looks too much like self-interest or guilt by association from the fact that major labour unions are backing such proposals. Though the labour movement too often itself proposes stupid things merely for ideological reasons, we shouldn't make the same mistake should we?

4 comments:

Greg Hurst said...

As a fairly frequent author of pension articles, mostly for an industry audience, it is rewarding to reach larger audiences through media such as the Financial Post. However, there are some challenges, particularly those of space limitations, which means that a complete airing on a complex topic requires dialogues such as initiated here.

Let me be clear, I believe Canada's pension system is capable of providing pensions that are well in excess of adequate. Public-sector pensions more than demonstrate the adequacy available within our system. However the pension system is under-utilized in the private-sector and has effectiveness/efficiency problems in the area of individual savings. These problems warrant some solutions, but there are much better ones that can be tabled than CPP enhancements. Compulsory workplace pensions, with mandated low fees (0.50% per annum) are practically achievable, with a level of political will (which has yet to practically materialize).

Mr. Lesperance takes particular issue with one of the six myths I presented concerning the adequacy of Canada's pension system. Readers should not rely on his interpretation of the Melbourne Mercer report but should review it themselves. Canada's score on the adequacy subindex, although only a "B" grade is achieved from the report's authors, is only marginally bested by the Netherlands (also only with a "B" grade). Relatively speaking, Canada seems to do very well when it comes to adequacy of the our retirement system.

CanadianInvestor said...

Hello Mr Hurst, thanks for the comment. While I agree that Canada does well in a relative sense compared to other countries, it doesn't do so well in an absolute sense. Yes, it is also true that if people used the system of RRSPs and/or DC savings diligently and with investing skill, the present system could theoretically deliver a good pension. The problem is practical. 1) too many people don't save enough, and saying "just do it" means people "just won't", which points to a mandatory solution. 2) few people have the investing skill due to lack of time and/or interest, which points to professional management (i.e. not RRSPs) 3) fees/costs are too high for many private sector products in Canada e.g. mutual funds which points to a solution with economies of scale and fiduciary duty 4) longevity risk, sequence of returns risk and investment horizon, old age health risk, issuer credit risk (GM/Nortel going bust), widest asset class diversification (i.e including private equity, arbitrage etc) are not well addressed with the current system, which points to a large scale common solution.

The single biggest concern I'd have about a CPP solution is the concentration risk. If CPP were the prime base pension source and it went bad through mismanagement or misgovernance a la Caisse de Depot in Quebec that could be catastrophic. But how would a multi-employer private solution be exempt from that risk? e.g. http://pensionpulse.blogspot.com/2010/12/canadas-largest-mepp-takes-hit.html

I'd love to see better alternatives than CPP but so far no proposal tops it. This is what Jonathan Keeselman concludes in his comparison of "big CPP" with alternatives: "A Big CPP fits well within the overall
retirement income system, with other components adapting to the increased CPP benefits over a
long phase-in period. Alternative reform proposals relating to the regulation of workplace pensions
and new voluntary supplemental or multi-employer pension schemes are potentially useful but no
substitute for the expansion of CPP benefits." see http://policyschool.ucalgary.ca/files/publicpolicy/Kesselman%20CPP%20online.pdf

Greg Hurst said...

Hi Jean,

It appears that we agree on too much to remain formal, you can call me Greg. I unreservedly agree with all of the points in your first paragraph. In respect of the concentration risks of CPP enhancement I am also concerned, but it is not my biggest concern. In fact, there is a slighly different version of the pension myths on my blog, which includes concentration as the 7th myth (www.greghurst.ca/blog).


As for other solutions, I actually have proposed one, which is broadly outlined in a Benefits Canada Online Expert Panel article I wrote in August 2009, The Politics of (DC) Pensions (http://www.benefitscanada.com/pension/cap/article.jsp?content=20090817_162615_2168").

Greg Hurst said...

Hi Jean,

It appears that we agree on too much to remain formal, you can call me Greg. I unreservedly agree with all of the points in your first paragraph. In respect of the concentration risks of CPP enhancement I am also concerned, but it is not my biggest concern. In fact, there is a slighly different version of the pension myths on my blog, which includes concentration as the 7th myth (www.greghurst.ca/blog).


As for other solutions, I actually have proposed one, which is broadly outlined in a Benefits Canada Online Expert Panel article I wrote in August 2009, The Politics of (DC) Pensions (http://www.benefitscanada.com/pension/cap/article.jsp?content=20090817_162615_2168").

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