Canada Pension Plan is it sustainable?

In an article written in March 2021, called Public Pensions: Steady as they Go, the author Yan Barcelo asks the question: Are Canada's pension plans as sustainable as they seem?

 A legitimate question and the first couple of paragraphs lead the reader to consider the idea that these funds are not sustainable.

In the article Yan states:

Canada’s public pension programs appear robust in the long term; retirees can be confident of receiving their monthly pension cheques for 50 more years. However, the programs are subject to stresses that could ultimately affect retirees’ revenues.

Yan goes on to say, “Let’s start with the largest of the pension providers, the Canada Pension Plan (CPP). In the last 10 years, the reserve has grown by $235 billion at an average nominal yearly rate of 9.9%. The fund has done well in the coronavirus market crash and recovery. It closed the 2020 fiscal year (ending March 31, 2020) with a gain of 3.2%, and has made 16% by end of 2020, increasing its asset base to $476 billion.

So far, this reserve has not been used to pay pension benefits, which were entirely covered by employer/employee contributions representing 9.9% of salary, explains Alexandre Laurin, director of research at the C.D. Howe Institute. However, “benefits should surpass contributions in 2022 and then we will start cashing out assets. Still, with returns and contributions combined, the reserve should continue to grow.” The fund should reach $3 trillion (or $1.6 T after inflation adjustment) by 2050, predicts the CPPIB’s 2020 annual report.”

Just when the reader is starting to feel comfortable with the fund's liquidity Yan asks “Is it Enough?” and gives the answer least expected by the reader which is:

Not quite, notes the Parliamentary Budget Officer (PBO) in its November 2020 Fiscal Sustainability Report: Update, which asserts that the CPP is not sustainable over the long term. “Under the current structure, projected contributions and benefits are not sufficient to ensure that, over the long term, the net asset-to-GDP position returns to its pre-pandemic level. Increased contributions, or reduced benefits, amounting to 0.1% of GDP ($1.3 billion in current dollars, growing in line with GDP thereafter) would be required to achieve sustainability.”

Scary thoughts, but here are some questions, what does it mean by “that the CPP is not sustainable over the long term.”  Is the long-term 2050, 2070 or later?

It appears the long term means 2070 or later and in his article, Yan compares the Old Age Security program which is funded by current government revenue, to the Canada Pension Plan which is funded by investments and contributions.

The sustainability of Canada’s public pension programs hinge on many underlying hypotheses which are expected to hold steadfast for 50 to 60 years. A case in point, in its projections for the OAS programs, OSFI calculates that the expected slide back to 2.63% of GDP depends on a lower growth of inflation compared to the growth of salaries and GDP.

 

Really? For the CPP and QPP, projections consider levels of immigration, unemployment, of life expectancies. If any one of these projections varies even slightly, it could significantly change results 50 years down the road – negatively as well as positively.  This is of course true but does not consider the idea that if projections vary then investment strategy will change as well.

 

For example, a key variable is average real annual rates of return (after inflation), which Canada’s chief actuary sets at 3.95% for the CPP. Those are very reasonable assumptions. If ever the CPPIB continues generating a real rate of return close to 8.1% as it did over the last 10 years, then sustainability will cease to be an issue. But not if returns fall below their expected thresholds.

The underlying assumption in the last paragraph appears to be that the Canada Pension Board will not adjust their investment strategy over the next 50 years, Of course, they will as they have done so since inception.

The best news in the article is left until the end. In the article, Yan states that “Comparing 39 pension programs across the world, the Mercer CFA Institute Global Pension Index is arguably the most extensive and in-depth of its kind. Based on three criteria – adequacy, sustainability and integrity – the index ranks Canada’s programs in 9^th position with an overall grade of 69.3%, or B+, behind the top programs of the Netherlands, Denmark, and Australia, but ahead of Germany, the U.K., the U.S. and France. 

On the sustainability sub-index that accounts for 35% of the country score, a key question focuses on the total level of pension assets as a percentage of GDP each country holds. On that count, Canada and Demark alone score a perfect 10. However, for the whole sustainability sub-index, which takes into consideration features like life expectancy, labour force participation rate, recent GDP growth, Canada comes in with a 64.4% score or a C+ note.” What the article does not say is that 64.4% gives us the rank of sixth in the world just below, Denmark, Chili, Australia, Israel and the Netherlands, which is pretty good. So should we as pensioners be afraid, my thought is no, but we should be vigilant and make sure our Canada Pension continues to be one of the best in the world.