Implications of public pension enhancement in CanadaOpportunities and challenges for trustees and sponsors

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May 2016SHARE Toronto Pension and Investment Governance Course

Playing an active role in the provision of retirement security is a critical opportunity for the labour movement

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§ Labour unions have a historical track record of fighting for retirement security and creating/governing pension plans, including some of the world’s best pension plans

§ In addition to advocating for an expansion of public pensions, the labourmovement has an opportunity to use current political / economic moment to deepen its role in the provision of pensionso Providing best-in-class retirement vehicles is an important tool for

unions to attract new members and retain existing ones, adding to value of union membership at a time of declining union density and increasing legal and political challenges to trade unionism

o If unions can be successful in creating viable, effective “portable benefits,” including modern pensions, these can be a critical tool to help support and organize the self-employed and others in the gig economy

o An expanded role for government in providing pensions makes sense, particularly in the private sector. However, labour should avoid ”vacating the space” of pension provision to government and financial institutions, as this could undermine the strength of the labourmovement in the long run.

Importance of complementing advocacy for public pensions with a deepening of labour’s direct role

Pensions are now on the political and public-policy front burner

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Legislative and regulatory activity around pensions has reached a level not seen in decades

§ Expert commissions / reviews in BC, Alberta, Ontario, Nova Scotia, Quebec, and at the federal level

§ Reforms to pension standards legislation in many provinces (Ontario’s reform was the most comprehensive in 20+ years)

§ Fiscally-driven reforms to public sector pensions (e.g., contribution caps, benefit reductions, governance reforms)

§ Ontario proposes Ontario Retirement Pension Plan as alternative to CPP enhancement

§ Ontario creates asset pooling vehicle (Investment Management Corporation of Ontario)

§ Introduction of new plan designs and vehicles (e.g., Pooled Registered Pension Plan, Quebec Voluntary Retirement Savings Plan, New Brunswick “shared risk” plan, target-benefit plans)

§ Increase in Old Age Security eligibility age from 65 to 67 (now back to 65)

§ National debate about CPP enhancement and commitments to expand CPP from all 3 major political parties, including the current Liberal federal government

1980s 1990s 2000s Post 2008 crisis

§ Creation of CPP Investment Board

§ CPP shifts from pay-as-you-go to pre-funded

§ Creation of Ontario Teachers’ Pension Plan

§ Creation of asset pooling entities in Alberta (AIMco), BC (bcIMC), and at the federal level (PSP Investments)

§ Tax reforms to level playing field between DB and other savings plans

§ Reforms to CPP ancillary benefits (disability, child-rearing, spousal, early retirement)

§ Old Age Security “clawback” introduced

§ “Great Pension Debate” in early 1980s, including over 10 government reports, but little concrete reform

§ Creation of Tax Free Savings Account

§ Jointly sponsored pension model introduced in Ontario

Sources: Government of Canada; Government of Ontario; pension fund websites; Bruce Little, Fixing the Future: How Canada’s Usually Fractious Governments Worked Together to Rescue the Canada Pension Plan (2008).

Spotlight on pensions creates an important opportunity for pro-pension organizations such as labour unions

There are two key policy goals underlying the push to enhance public pensions, including the CPP and the ORPP

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Encourage more saving

Encourage greater efficiency

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Studies show that between 17% and 50% of Canadians are not on track to maintain their standard of living in retirement. Mandatory, employer-matched programs such as the CPP and ORPP can encourage Canadians to save more.

Well-run pension plans (e.g., the CPP) are well-documented to be more effective than many individual savings vehicles, which are prone to high fees, suboptimal investor behaviour, and ineffective management of investment and longevity risks. The ORPP and CPP enhancement would shift more of Canadians’ retirement savings into vehicles that are more effective at producing retirement security.

A looming retirement security crisis?

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A significant minority of Canadians are unprepared for retirement

Findings from recent studies on retirement income adequacy

17%

50%

44%

31%

of Canadians not ready for retirement- McKinsey & Co (2015)

of Canadians not ready for retirement- Keith Horner, former Finance Canada official (2009)

of current 25-30-year-olds will face a 25%+ drop in replacement rate- C.D. Howe Institute (2010)

of middle-income earners will face 25%+ drop in replacement rate in retirement

- Michael Wolfson, University of Ottawa, former Assistant Chief Statistician at Statistics Canada 2011)

Sources: Keith Horner, “Retirement Saving by Canadian Households,” (2009); McKinsey & Company, “Building on Canada’s Strong Retirement Readiness,” (2015); Kevin D. Moore, William Robson and Alexandre Laurin, C.D. Howe Institute, “Canada’s Looming Retirement Challenge,” (2010); Michael C. Wolfson, “Projecting the Adequacy of Canadians’ Retirement Incomes,” (2011).

Overview of Canadian retirement assets

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A fragmented market including high-performing large pools and high-fee retail products

Top 10 public funds

$1,112B

RRSPs and related accounts

$959B

DC plans$53B

Other pension plans $541B

~$2.7T in Canadian retirement assets

$ billions

Sources: Statistics Canada; Benefits Canada Top 100 Pension Funds 2015; pension fund annual reports and websites, Canadian Centre for Policy Alternatives, Investment Funds Institute of Canada.

~7,000 plans

$94B

$114B

$152B

$226B

$269B

$72B

$61B

$22B

$18B

Notes: All figures from top 10 funds from most recent version of fund annual reports. Data on assets in other pension plans, DC plans, and RRSPs and other accounts derived from 2013 Statistics Canada tables. Calculations do not include non-financial assets such as housing.

~11,000 plans

$84B

47under-lying plans

§ Includes RRSPs, LIRAs, and RRIFs

§ A large portion of Canada’s $1.3T mutual fund market

§ Average Canadian mutual fund fee is 2.1%

§ Overall ETF market is $95B

Seemingly small differences in fees can make a huge difference for a worker over the long run

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$-

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

1 5 9 13 17 21 25 29 33 37

Assumptions: Starting salary of $30,000 with average annual salary growth of 3%. Annual contributions into retirement savings of 8% from employee and 8% from employer. 7% gross nominal return per year. Expenses of 2.1% for mutual fund and 0.4% for pension. Does not include potential differences in investment performance or differences in retirement income due to differences in now longevity and investment risk are managed.

Year

Pension0.4% fee

Mutual fund2.1% fee

Difference of over

$437,000due solely to higher fees

Pension plan vs. mutual fund case example

There are three potential outcomes from the current debate and policy making process on public pensions

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1 2 3

ORPP only Pan-Canadian CPP enhancement

Hybrid / “flexible federalism”

§ Ontario introduces the ORPP starting in 2018

§ No other province introduces enhanced public pensions

§ Provinces and the federal government agree to enhance CPP

§ Ontario does not proceed with the ORPP and/or agrees to fold the ORPP into the CPP

§ Federal government creates a framework to allow provinces to enhance public pensions on a voluntary basis

§ ORPP is implemented, with other provinces possibly introducing a similar program

Scenario 1: Ontario implements the ORPP in 2018

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§ Government’s policy is broader than just the ORPP; its law would require all provincially regulated employers to enroll their employees in the ORPP or a “comparable” pension plan by 2020

§ ORPP is unlikely to affect most DB plans — most have 0.5% accrual rate and would therefore be considered a “comparable plan” under ORPP legislation

§ DC plans are more likely to need to adjust, given the minimum mandatory contribution rate of 8% (4% of which must come from the employer)

§ For those without comparable plans, sponsors will need to decide whether to create their own plans, improve existing plans, or allow the ORPP to apply

Identify opportunities for

improvement

Perform impact assessment

Ontario’s “pensions 2020” policy as opportunity to expand coverage

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Three-step process for union sponsors

Gather facts on your membership & their

retirement arrangements

§ How many have a pension plan or other retirement savings plan?

§ Who is in what kind of plan?

§ How effective are the plans?

§ Impact of ORPP on existing members

§ Impact on bargaining dynamics and strategy

§ Impact of ORPP on existing pension / retirement arrangements

§ Opportunities could include:

o Creating a new plan

o Enhancing / expanding existing plans

o Promoting the ORPP, while avoiding ”clawbacks” in bargaining

Ten principles underlying good pension plan design

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1. A singular focus on delivering cost-effective retirement security for members

2. Lifetime approach, with accumulation integrated seamlessly with decumulation

3. Members’ interests first (strong fiduciary duty)

4. Low-cost

5. Simplicity through limited investment choice

6. Passive investment management is almost always better than active management, except for the most sophisticated institutions

7. Investment philosophy and asset allocation informed by best international examples and thinking

8. Transparency and benchmarking

9. Governance similar to best public pension plans

10. Plan design optimizes other government benefits and tax efficiency for members

Can help evaluate the effectiveness of existing retirement arrangements

Scenario 2: pan-Canadian CPP expansion

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§ 3 potential options: raise replacement rate, raise Year’s Maximum Pensionable Earnings (YMPE), or hybrid (see next slide)

§ If CPP expansion is universal (covers all workers, as the current CPP does), it will affect plans that are integrated with CPP and/or decide to integrate with an expanded CPP

§ Trustees can be proactive in asking for scenario analysis by actuary or plan administrator in order to inform decisions and planning around any potential adjustments to plan design and administration that may be required

§ Three questions to ask to explore impacts of integration:o How will it affect member benefits? The CPP benefit formula differs from

that of many pension plans.o How will it affect plan funding? Integration will decrease both assets and

liabilities. The net effect will depend on the plan’s demographics and other factors.

o How will it affect the plan’s investment strategy? Integration will mean fewer contributions flowing into the pension fund and could also affect the plan’s liability profile, which could have an impact on the plan’s approach to investments.

Three options for CPP expansion

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Current CPP

Current CPP

Current CPP

Current CPP

Status quo Increase replacement rate

Increase YMPE Hybrid (ORPP-like version)

CPP+

CPP+

Re

pla

cem

en

t rat

e

Earnings~$50k

25%

Re

pla

cem

en

t rat

e

Earnings~$90k

25%

CPP+

CPP+

Re

pla

cem

en

t rat

e

Earnings~$50k

40%

Re

pla

cem

en

t rat

e40

%

Earnings~$90k

Illustrative examples

”Stacking” vs “integration”

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Current CPP

Existing DB plan

9.2%

6.9%

Current CPP cap (~$50k)

Co

ntr

ibu

tion

rat

e

Earnings

CPP+ cap (~$90k)

CPP

Existing DB plan

9.2%

6.9%

Current CPP cap (~$50k)

Co

ntr

ibu

tion

rat

e

Earnings

CPP+ cap (~$90k)

CPP+11.1%

CPP+

CPP+

“Stacking” an enhanced CPP on top of the existing plan

“Integration”of the existing plan with an enhanced CPP

§ Similar overall contribution levels

§ Similar overall benefits

§ Lower contributions / benefits from existing plan

§ Higher overall contribution levels

§ Higher overall benefits

§ No change to contributions / benefits from existing plan

Illustrative example based on ORPP-like CPP enhancement

The importance of coordination and collaboration between trustees and sponsors, while respecting the difference in roles

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Sponsors need Trustees need

§ Data and analysis related to their members’ pension arrangements, and the potential impact of ORPP/CPP

§ Technical assistance on issues of pensions in bargaining and in shaping the union’s overall position on retirement security

§ Help in communicating pension-related information to members

§ To understand the advocacy positions and broader retirement income strategies of their sponsoring organizations

§ To ensure clear communication and consultation with sponsoring organizations on proposed changes to plan design as a result of ORPP/CPP

Recap of key points

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§ The spotlight on pensions creates an important opportunity for labour to defend and expand its role in providing effective retirement security

§ Expanding access to pensions isn’t just about people saving more; it’s also about the effectiveness of the retirement vehicle

§ If the ORPP is implemented as expected, it will likely have little effect on DB plans. But the ORPP does raise a range of questions, opportunities, and risks for sponsors, including the opportunity to create “comparable plans” either by starting new plans or expanding/improving existing ones

§ Trustees/sponsors can begin to prepare for potential CPP expansion now by assessing the impact of different CPP-expansion scenarios on member benefits, funding, and investments

§ Union sponsors should consider taking a “portfolio” view of their members’ retirement arrangements, gathering basic facts, assessing the effectiveness of each arrangement, and developing options for improving retirement security for those who lack a pension plan or are in suboptimal arrangements

About Common Wealth

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Common Wealth is a specialized advisory firm dedicated to strengthening retirement security and expanding access to good pensions. We serve pension plans, unions, governments, and associations in developing integrated, innovative solutions to the investment, management, regulatory, and stakeholder challenges associated with pension security.

About usDesign, build, and support innovative new pension vehicles and products

What we do

Pension strategy, regulatory affairs, and capacity building

Pension plan growth, consolidation, and asset pooling

Contact

Alex MazerFounding Partner

amazer@common-wealth.ca

www.common-wealth.ca

@CWpensions