On December 17, 2014, the Ontario Government published its consultation paper on key features for the Ontario Retirement Pension Plan (ORPP). Basically, although the current Government is committed to some sort of quasi-universal program for Ontarians, they still have no idea how to design it. I won’t spend time here explaining how bad this idea of the ORPP is since I have already provided that explanation here. Instead I will comment on the first of the three key questions for which they are looking for answers:
What is a comparable plan?
Somehow, the Government has concluded that in order for an employer to consider their plan comparable it must be a defined benefit (DB) or a target benefit (TB) plan. Noticeably absent from the list are the many forms of defined contribution (DC) arrangements that employers use to provide employees with a vehicle to facilitate retirement savings.
In my opinion, this is an ill-founded conclusion. The paper argues that the strength of the DB and the TB plans are the pooling of longevity risk, which is a laudable goal. However, this is a red herring. DC plans offer the pooling of longevity risk through the purchase of individual annuities at retirement from one of Canada’s highly regulated insurance companies. If DC plan members’ are not choosing annuities it might be because they don’t understand annuities or that they don’t want annuities for any number of reasons, not the least of which might be the cost an insurance company has to charge to guarantee a benefit for an individual’s lifetime.
Longevity risk management is not the secret sauce that differentiates these three distinct types of programs. If it were the main feature, then employers would jump on the bandwagon to provide this valuable service to employees. The reality is that each of these three types of programs deals differently with which party guarantees certainty in an uncertain world as the global economy works its way through the decades.
DB plans pool longevity and investment risks among members and place the cost of unexpected events on employers. TB plans pool these risks among members and places the cost of unexpected events on those same members (through higher contributions or lower benefits). DC plans don’t pool longevity risks and, like TB plans, unexpected costs for longevity and investment performance are paid by the member – just individually rather than collectively. As noted above, DC plan members can pool longevity risk by buying annuities. The ORPP will pool longevity risks and will place the cost of unexpected events, in particular, poor investment performance on future taxpayers. I have said repeatedly that whether an expanded CPP or its ugly cousin the ORPP, I am entirely against asking future taxpayers to back this guarantee.
So, if we aren’t going to place the burden of unexpected events on future taxpayers, who should bear the burden? Private employers have already told us that they don’t want to bear very much risk in this deal – that is why defined benefit plans have suffered such a decline in the last two decades. All the provinces were asleep at the wheel while the consulting and actuarial professions were screaming that the regulatory regime introduced in the 1980s was killing these plans. I doubt that they can be saved now and I think having Ontario try to reinvigorate them through the back door of blackmail is offensive. If Ontario wants employers to sponsor DB plans then they should come through the front door of better legislation to entice employers to provide these types of benefits voluntarily.
TB plans create the illusion of guaranteed benefits – but those members that are pooling the risks also need to set aside surplus assets to guarantee the promised benefits – just like an insurance company needs to set aside capital when it promises to pay an annuity for the life of an individual. There is no free lunch here and there is no outside agency providing guarantees. Even if you ignore the fact that Ontario is again asleep at the wheel in introducing legislation that would allow for single-employer TB plans, it is hard to ignore the fact that these plans are not going to be cost effective for smaller employers (those with fewer than 100 employees – maybe 1,000). More importantly, these plans are either going to restrict benefits (and build surplus) to provide guarantees or they won’t provide guarantees at all – in either case making them hardly any better than a well run DC plan.
In a DC plan each member sets aside their own capital to provide the guarantee they desire. While our governments think it is a shame that DC plan members have to take responsibility for their own guarantees they completely ignore the value of letting each citizen choose between paying an insurer to provide the guarantee and self-insuring. Why doesn’t the province demand that every citizen be required to purchase $25,000 in life insurance or else the Province will step in and provide it for them? The answer is that every citizen recognizes that people should be given the responsibility and privilege to make these decisions for themselves reflecting their own circumstances.
I struggle to understand what the Province’s expert technical panel is thinking with this proposal. Save DB? Dream on! Motivate sponsors to setup TB plans? Not going to happen for small employers where there is likely the greatest need for a plan if at all. Create employment for pension actuaries? They might need help but this isn’t a job for government. The only thing that I can come up with is the government wants to quietly exempt themselves from these new taxes but virtually no one else in order to get some sort of critical mass in building the ORPP. Another case of do what I say and not what I do.
Assuming that Ontario doesn’t backtrack on disallowing DC plans as a comparable plan, lets think about what is likely to happen. DC plan sponsors aren’t likely to run to setup a DB or TB plan with a modest contribution rate of 3.8% of pay – and if they did they would be economically inefficient given the small contribution relative to the likely administration costs. DC plan sponsors that are cost conscious (most businesses today) are likely to reduce their DC plan contribution by 1.9% of pay (or maybe just round the reduction to 2%) to net costs. I expect that many employee groups that struggle to make ends meet will lobby their employers to reduce employee contributions as well. In the end, no net new dollars being saved towards retirement and just one more pension vehicle to add to the DB, TB, DC, RRSP, TFSA collage of savings buckets. Spreading out savings into more and more vehicles is the exact opposite of what we should be trying to do.
The Better Way
What should the government do? They should exempt any sponsor of a registered pension plan (DB, DC, TB) provided that the employer contributes at least 1.9% (and a total of 3.8% for employers and employees combined) of pay on the same earnings to which the ORPP will apply. That would exclude Group RRSPs and other types of plans that are not specifically directed to retirement savings but would recognize that the key issue in this discussion is getting more dollars set aside for retirement readiness. This scheme should be targeting employees and employers that aren’t already doing something – not adding a burden to those that are.