Modeling Journey

"And no one in power wants to talk about the problem."

That is the stark message in the latest of the Globe & Mail's significant series of articles on the miserable state of the country's pension plans.

The Cat's challenge to Michael Ignatieff is to dare to be innovative, and emulate Hotspur – he of the "Out of the nettle, danger, we pluck this flower, safety" quote.

The G&M goes on to say:

"Despite the middle-class retirement shortfalls that are obvious to pension experts, politicians and business leaders seem fixated on patching up existing systems.
Attention and resources get focused on underfunded corporate plans, and on a tired debate over the merits of defined-benefit schemes, where the employer makes good on shortfalls, versus defined-contribution plans, which shift market risk to employees.
There is very little talk about enhancing pensions for the majority of the population that lacks any retirement safety net. University of Toronto pension guru Keith Ambachtsheer says: “Rather than defending old faulty designs, why haven’t pension industry leaders been searching hard for designs better suited to delivering 21-century retirement living standards that are adequate, universal and sustainable?”"

Let's examine who is covered by pension plans, and what kinds of plans there are, before going on to my recommendation to the Liberal Party for an innovative solution.

One key is to understand the buzzwords in the industry, starting with DB and DC:

"Traditional pension plans are DB, defined benefit. A retiree covered by the plan is guaranteed a given level of income. If the plan falls short, the employer is on the hook.

The new model, increasingly favoured by employers, is DC, defined contribution. In this approach, the employer’s responsibility is limited to making a certain (“defined”) contribution to the employees’ pension plan. Contributions made by both the employer and employee go into an individual account for the employee, who makes his or her own investment choices. If the plan falls short, the employee is on the hook."

Instead of using the word 'defined', I find that it helps to use the word 'definite'.

The difference between a Definite Benefit company pension plan and a Definite Contribution company plan is where the risk lies.

Under a Definite Benefit plan, the company promises or commits to the employee that he or she will get a definite pension amount each year upon retirement. The company bears the risk that it has not made enough investments, or the markets (stock and/or real estate) have fallen, so that there are not enough assets available to pay the definite pension amounts.

Companies – aided and abetted by governments at the federal and provincial levels (Conservative and Liberal), long ago decided they did not want that risk, and so stopped the DB plans and moved to the Definite Contribution plans, which shifted the risk of inadequate assets on to the shoulders of the employees.

So we have had a major shifting of pension risks from the corporate sector to the employees over the years, put in place by the economic and political elites of Canada.

The second major shift that the political and economic elites in Canada have brought about in the past quarter of century is to allow a big whack of Canadians to fall between the cracks, ending up without any corporate pension plans.

In 1945, when the Second World War ended, 19% of workers in the private sector had company pension plans. In 1960 this had risen to a whopping 40%. But by 1977 35.2% of workers in the private sector had pension plans; this has fallen by about a third, to 25.5% in 2007.

From 40% in 1960 to 25.5% in 2007. Down by 38% in 47 years, a drop of almost 1% per year. A time when both Liberal and Conservative parties ran our central government.

And so we have a large majority of workers in the private sector in Canada who do not have a pension plan.

The economic and corporate elite finessed this debacle by introducing the concept of retirement savings plans (RRSPs). Canadians who did not have public sector or company pension plans could provide for their retirement by making investments, with the ability to deduct such payments (up to a certain annual limit) from their taxes.

People can take care of themselves, the argument went.

There is no need for the Nanny State to step in and sort out the mess.

And that right wing framing of the issue still reigns today.

Imagine how different we would have been if instead of buying into the right wing Nanny State framing of the pension issue, we had instead adopted the framing of what a responsible state would need to do.

For example, leaving it up to the individual sounds good, right?

But only 31% of those who do not have public sector or company pension plans actually do invest in RRSPs.

That means more than two thirds do not – and that is a measure of the failure of the RRSP substitute for company pension plans if you need any measure!

Some have advocated using a third type of company pension plan, a hybrid one combining elements of the DB and DC plan, called by some a 'target benefit plan':

"In this model, plans target a certain level of benefit payout that appears safely achievable. But if long-term investment performance makes that target unreachable, funding is not increased. Rather, the benefit level is lowered. Conversely, if investment returns exceed the target, the benefits can be increased."

The risk that the assets will not be enough to pay an adequate pension should be shared between employers and employees in a hybrid, but (as the plan quoted by the G&M in the above article shows), such hybrids can shift most of the risk of non-performance onto the employees:

"Another key feature of the plan is that the member companies make a flat contribution on behalf of workers, set as a percentage of their wages. That is their only funding requirement: If the plan is short of money, employers don’t have to cough up more to repay shortfalls. Instead, the plan has to cut benefits for workers or retirees."

In order to properly protect workers in hybrid plans, there is a need to invest the funds in assets which are relatively immune to stock and real estate market risks (such as government bonds).

How big is this problem?

We have 17.6 million Canadians working. Of those, 11 million (63%) have no pension plans. Of those 11 million, only 4 million have RRSPs (leaving 7 million without even RRSPs, and totally dependent on the CPP and OAS payments when they retire. More than half (55%) of the pension plans of the 4.5 million workers with pension plans have DB (defined benefit) plans that guarantee the pension income of retirees until they die, are held by public sector employees.

And the average pension per year is $25,000.

Back to Michael Ignatieff, and the opportunity he now has to solve the problems of so many seniors in a decisive way.

The opportunity for the Liberal Party to come up with an innovative solution to the pension debacle is there. My best guess is that such a solution will take this shape:

1. Everyone who earns income (whether employed by a company or self-employed) must be forced to put aside a certain portion in a pension plan. Leaving the choice open to individuals simply shifts the risks that they turn 65 and don't have enough to live on, onto the rest of the taxpayers. You earn, you pay should be the model.

2. A new hybrid model is created, with contributions each year coming from the employer, the employee and the central government. Let's call the new hybrid the Canada Minimum Pension, or CMP.

3. Workers may contribute additional amounts to their own RRSPs, up to some limit.

4. Companies may make additional contributions to employees, if they so wish.

5. The only Defined Benefit (that is, definite benefit or pension payments) will be made from the amounts invested in the CMP.

6. Canadians will still qualify for the existing Canadian Pension Plan (CPP) and Old Age Security (OAS), in addition to the CMP payments.

7. All funds in the CMP will be invested in newly designed Government of Canada bonds of various maturities. The interest paid on such bonds will be re-invested in the new government bonds, so as to build up capital.

8. The total amounts which individuals can contribute to RRSPs will be reduced. This means their tax deductions will be reduced, and the earnings on the investments they might have made under the older higher level will not be made and so not be sheltered from taxes. This will result in the central government receiving more taxes. However, such higher taxes will be partially offset by the payment by the GOC of the interest on the new bonds.

9. Company obligations to pay under funded commitments of company pension plans will rank ahead of all creditors (including secured creditors, who will have to take heed of such liabilities before lending to companies), so as to protect workers upon the bankruptcy of the company (currently, workers rank as unsecured creditors against the assets of bankrupt companies which have failed to fund their company pension plans adequately). Nortel employees, for example, stand to lose one third of their pensions because Nortel went bust.

The major obstacle to reform of pensions is that no level of government in Canada wishes to grasp this nettle, preferring to tinker with changes rather than address the problem that millions of Canadians do not have any pensions (company or RRSPs) other than the CPP and OAS.

How to solve that problem?

One simple solution would be for the Liberal Party to state that should it become the government it will change the law governing the payment of pensions to MPs to one which pays MPs a pension based on the Canadian average pension (let's call this the CAP). In calculating that average, the total amounts paid each year as pensions will be divided by the total number of senior Canadians (including all those who only get the CPP and OAS).

By committing to the CAP for all MPs, the Liberal government will ensure that all MPs pay attention to methods to increase pensions of all Canadians so that all senior might have adequate pensions, rather than having millions with fat-cat public service or corporate pensions, and millions without any pensions other than the paltry $17,000 a year.

How about it, Michael Ignatieff?