The current crisis in financial markets has exposed several structural weaknesses in Canada’s system of retirement pension provision. For example, we have known that problems of under-funding of pension plans at Air Canada and BCE could significantly compromise their strategic options. Today the BCE pension fund is $3bn under-funded compared with $0.9 billion just a year ago. It is now coming to light that a significant number of Canada’s corporate and public pension plans have a growing gap between present funding and future obligations.

According to the June 2008 report of the Office of the Superintendent of Financial Institutions, around 70% of plans under federal regulation were under-funded - even before the recent stock market crash. We can expect the bad news to continue as more pension funds declare their valuation shortfalls, something they are mandated to do by regulators. Meanwhile, anyone in their early 60s without a corporate plan behind them, but who believe their RRSPs will fund their retirement are just waking up to the fact that the rather modest provisions of the Canada Pension Plan might now have to figure more prominently in their retirement planning than they had ever thought.

The response to this situation will undoubtedly be greeted with one of three reactions. Individuals suffering serious personal losses in their RRSPs and insurance-based investments will be extremely disappointed if not downright angry. Pension fund administrators will pray for recovery – because “we have been here before”. And politicians will likely run for cover, offering ‘muddle through’ breaks for under-funded plans in the hope that market capitalism will get back on track in due course. Unfortunately, none of these responses actually addresses the systemic and structural issues which now need to be faced if we are to avoid severe social problems in coming decades for our aging population.

What are the options for overhauling our creaking system of pension provision? The answers to two fundamental questions are keys.

What does the present crisis mean for Canadian public policy and including the Canada Pension Plan?

Pension investments (including pension funds and insurance products) matter a lot in today’s capital markets. In many jurisdictions, pension funds dominate the ownership structure of publicly traded stocks and indeed entire stock exchanges. In 2006, pension investments in OECD countries were worth $25 trillion. $16 trillion of these dollars were invested directly in pension funds; $9.7 trillion was invested in the US. A further $4.1 trillion is invested in Sovereign* and Public Pension Reserve Funds such as the Canada Pension Plan. So when stock markets slide, so do pension assets.

Countries vary enormously in the size and nature of their pensions investments. Some jurisdictions fund pensions almost entirely from current tax revenues; others have sovereign reserve funds to provide some level of insurance against future liabilities. And of course individuals may make personal provision through private schemes (ie RRSPs in Canada). As well, employers may provide occupational coverage.

Governments around the world have widely differing policies on how to underwrite retirement incomes for their aging populations. Demographic change, most notably increasing life expectancy, is making so-called ‘pay as you go’ pension policies increasingly non-viable. As the proportion of working population compared to retired population declines, the ‘dependency ratio’ rises and it becomes untenable for governments simply to hope for the best – ie that future taxation receipts might cover social security and pension obligations over time.

In response to this phenomenon, many countries are keen to offset state liabilities by encouraging participation by the citizenry who otherwise - because of a lack of knowledge or forethought - might not provide anything whatsoever for themselves. The question is how to determine the correct level of public versus private and individual provision.

In global terms, Canada is relatively well positioned, with approximately 100% coverage (compared to GDP) in pension investments of various types. 53% of that coverage is in pension funds. But the proportion of coverage in sovereign funds also varies widely, and here there may be more of a challenge for Canada.

In Canada we have a lower than average commitment to state pension provision. The public component of the pension provision mix is the Canada Pension Plan (CPP). In 2006, the CPP was less than 10% of Canadian GDP. As of June 30th, 2008, the value of the CPP Fund totalled $127.7 billion. According to the Office of the Chief Actuary, the CPP fund needs a real rate of return of 4.2 per cent over a 75-year projection period to sustain the plan at the current contribution rate. As we have seen, this is a reasonable assumption provided the 21st century works out just like the 20th century. And as long as climate change, water shortages, international terrorism, economic instability and disputes over natural resources do not get in the way too much, the assumption might just prevail.

But rather interestingly, coincident with the bets being placed on the future of market capitalism via the RRSP system, the Canada Pension Plan has also exposed itself very significantly to stock markets in recent years. From almost no exposure to stocks in 2000 (ie at the end of the period when such exposure would have been really useful), the CPP is now 62% vested in stock markets. We will know what the price for this will be in mid-February when the fund next reports. It is entirely feasible that the CPP may have lost as much as $20bn in the turmoil of recent months.

So, taken together, private (RRSP) and public (CPP) pension provisions have placed a very large bet on the stock markets on behalf of ordinary Canadians. No other jurisdiction in the OECD has done this. For example, in the US every cent of the $2 trillion Social Security Trust Fund is invested – by law - in bonds and government securities.

What does this mean for the ordinary Canadian and his or her employer regardless of what the government does?

The majority of Canadian employee pension funds (more than 90% total assets) are defined benefit schemes rather than defined contribution. This means the risk stays with the employer rather than the retiree who is guaranteed a fixed proportion of their working income when they retire. This provides a reasonably high level of protection provided the employer stays in existence or doesn’t file for bankruptcy - in which case all bets are off. In contrast, defined contribution occupational schemes place nearly all the risk on the employee and individuals may find themselves somewhat stranded if they retire during a period of stock market doldrums with just their defined contribution plan behind them.

Similarly, despite the current problems of investments held by the Canada Pension Plan, the government of Canada is obliged to deliver the 25% or so of individuals’ pension needs that the plan is designed to cover.

So individuals approaching retirement with a combination of defined benefit occupational schemes and CPP coverage together with something in personal savings and home equity to fall back on should not die in severe poverty. At the other end of the spectrum, individuals running up to retirement today with an over-reliance on RRSPs, who hope that these will adequately supplement the CPP and other social security provisions, may be in for a shock.

But lest we think that the only generation with cause for concern is the generation facing imminent retirement, we should consider the size of the post-dated cheque which is currently being signed on behalf of the younger members of today’s workforce. The fact is pension liabilities are building exponentially – exacerbated by an aging population with ever-escalating social and health care needs. We are transferring a potentially massive burden to future taxpayers because of several factors: i) bail outs of underfunded corporate pension funds; ii) the CPP depending increasingly on contributions of future taxpayers; iii) the possible chronic underperformance of RRSPs and insurance products over the next 2 decades; and iv) the need to guarantee government pensions.

So the only advice that anyone needs to take, whatever their age and circumstances is to become ‘pension literate’ immediately. Canadians need to ask employers and financial advisors exactly how many of their investments will provide guaranteed incomes on retirement and exactly how much these incomes will be. And they need to ask their elected representatives and union representatives how they are going to ensure that the workers and taxpayers of tomorrow will not be crippled by the massive demands of the retired population in the middle decades of the 21st century. Meanwhile, anyone thinking of moving funds out of a defined benefit scheme should think long and hard about what they may be giving up if stock markets do not rebound quite as well as the optimists hope.

And what about employers? Faced with a growing gap between funds and liabilities, now may be the time to think about consolidating risks and benefits. Perhaps now is the time to move to a more efficient and accountable pension system for public sector pension funds.

In the private sector consolidation may be an option for small and medium sized firms - British Columbia currently has such a proposal under development. For larger firms it is more complicated, but they certainly have a case to make for more consistent and coherent public policy on pensions. This one is a train wreck in the making and employers and governments must start to get their act together soon and perhaps rely rather less on the salesmanship of RRSP providers to secure the wellbeing of ordinary Canadians in their retirement.

David Wheeler, Dean 
Faculty of Management
Dalhousie University
Halifax, Nova Scotia.