Are you ready to retire?Delpixart/The Globe and Mail
According to a 2016 survey, 64 per cent of working Canadians either don't know or don't believe the Canada Pension Plan (CPP) will be there for them when they retire. The survey was carried out by the Canada Pension Plan Investment Board (CPPIB), the people that manage the more than $300-billion in assets in the CPP pension fund.
The first question that should come to mind is: why do so many people think the CPP is on shaky ground? The second question: are they wrong?
The CPP started out in 1966 as a pay-as-you-go system not unlike a Ponzi scheme; the contributions being made by younger workers were being used to pay the benefits of older workers. The problem of funding the benefits of those younger workers as they aged was continually kicked further down the road. As long as enough young people were coming into the work force, the CPP would remain viable.
The trouble is that the work force was slowly maturing. The number of workers per retiree has been dropping continuously since the 1960s and will continue to do so for the foreseeable future. And that is not the only demographic problem. A falling birth rate and ever-increasing life spans have both put a further strain on the system. To make matters worse, the CPP assets were being lent out at below-market interest rates to the provincial governments to be used as they saw fit.
In 1993, the chief actuary of the CPP predicted that the CPP fund would be exhausted by 2015 unless action was taken. He also estimated that if pension promises continued to be funded on a pay-as-you-go basis, the contribution rate would need to rise by 2030 to 14.2 per cent of covered pay. By comparison, the actual contribution rate from inception until the 1980s was just 3.6 per cent of pay.
According to Paul McCrossan, a former Tory MP who handled the CPP file starting in the mid-1980s, the government of the day had become aware of the problem but also realized there was no easy way to fix it. Fortunately for us, it succeeded. It was a bipartisan effort that took 20 years to accomplish and involved four basic steps.
The first step was to ramp up the immigration rate and to give priority to younger independent immigrants rather than older family members. Remember, the CPP was a quasi-Ponzi scheme so an influx of younger immigrants helped to stabilize CPP costs. Canada has had a higher immigration rate ever since the 1980s and this is one reason why that policy has to continue.
The second step was to trim benefits such as CPP disability benefits and the earnings base used to calculate pensions. This measure saved considerable money and since the changes were rather technical, they flew below the radar, thus avoiding a public outcry.
The third step was to get the government out of the business of investing the CPP fund. The CPPIB was created in 1997 as a body that operates at arm's length from the federal and provincial governments. Its mandate has been, and continues to be, to achieve the best possible return for the fund for a given level of risk. In this regard, it has generally succeeded by investing in large infrastructure projects and private equity around the globe.
The final step was to change the pay-as-you-go funding method. This was the tricky part. Clearly, a contribution rate of 3.6 per cent of pay wasn't going to be enough but there was no way that Canadians would tolerate the 14.2-per-cent contribution rate that would eventually be needed. The Chief Actuary had determined that gradually raising the contribution rate to 9.9 per cent would stabilize the fund. With 9.9 per cent going in, the CPP assets could continue to grow for decades to come. Anything less and the fund would eventually dry up, while anything more would be unfair to the current generation of contributors. The CPP chief actuary calls this funding formula "steady-state funding."
The 9.9-per-cent contribution rate was fully phased in by 2003 and has not increased since then. According to projections carried out by the Office of the Chief Actuary, it would have been sufficient to fund the existing CPP benefits for at least the next 75 years.
The rate will start to rise again in 2019, but for a different reason. The CPP enhancements that were announced in 2016 will require higher funding. By law those new benefits have to be fully funded so as to avoid passing the costs along to the next generation.
So do current working-age Canadians need to worry about their CPP pensions? The short answer is no. Workers will definitely get a CPP pension. The ultimate cost of CPP pensions may end up being a little higher than what the chief actuary has estimated but it also might be a little lower. The factors that affect cost are the unemployment rate, immigration, the birth rate or and changes in life expectancy. Essentially all of these factors are hitting Quebeckers harder than the rest of Canada, which is why Quebec's pension fund is already more expensive than the CPP.
If the CPP cost does go up eventually, the increase will probably be modest and one of two things will happen. First, the provincial and federal governments might agree to increase the contribution rate and keep the benefits intact. Alternatively, benefits might be reduced a little with the most likely change being to increase pensions after retirement by less than the inflation rate.
The scenario of a drastic reduction in CPP benefits is extremely unlikely. Consider the sort of events that might cause it – a world war, an alien invasion or a global health epidemic. If any of these came to pass, the reduction in CPP benefits would be the least of your worries.
Frederick Vettese is a partner at Morneau Shepell.