Bad Idea #17 – Strike Three

Strike Three

In October 2013 I wrote about why expanding the CPP is a bad idea and in December 2013 I followed up with a numerically detailed commentary based upon the recently released 26th Actuarial Report on the Canada Pension Plan Prepared at December 31, 2012.  I was anticipating that this would be my third and ideally my last installment on the subject, hoping that the momentum for this idea had died.  Unfortunately a number of people with whom I have spoken continue to worry that this is a discussion that isn’t going away just yet.

My main argument against expanding the CPP is that it is not an annuity program guaranteed by an insurance company but rather it is a target benefit plan that is not guaranteed.  Future benefits will be dependent on receipt of future contributions.  The current 9.9% contribution rate is a reasonable estimate of the long-term rate of contribution required only if a number of assumptions prove true.  One of the critical assumptions is that the Canada Pension Plan Investment Board will earn a real rate of return after inflation of 4.0% per annum.  This return cannot be earned investing in Government of Canada Bonds.  Earning a return at this level requires investing in more risky assets in the hopes of higher returns.

On June 14, 2012 the Globe and Mail’s Report on Business section headlined a review of the investment of the assets held by the Canada Pension Plan Investment Board (CPPIB) by Tim Kiladze titled Risk Rising!  Is anyone yet uncomfortable?

Quotes from the article that everyone should read and ideally understand:

“In my 15 years as a professional investor, this is by far the most difficult market” Mark Wiseman, CEO, CPPIB

“the CPPIB’s shift away from traditional investments into much-riskier private deals has so far failed to deliver big returns”

“In a sign the new strategy isn’t paying off just yet, the CPPIB has failed to beat its own internal benchmarks two years in a row, falling short by $350 million – and in four of the past six years, amounting to $1.9 billion worth of total underperformance.”

I highly recommend the full article for those keen to really see how this collective nest egg for Canada’s workers is being invested on our behalf.

There is not much more I need to say.  Corporations are getting out of the defined benefit plan business because they have determined that these plans offer too much volatility in contributions in a world where benefits cannot fluctuate in concert with investment market fluctuations.  In the private sector, there is a popular march down the road of de-risking and frankly, taxpayers are now realizing that public sector workers should join that same march by moving to defined contribution plans or target benefit plans like everyone else.

With all this momentum to reduce risk to plan sponsors is unfolding, the CPPIB on all of our behalf is ratcheting up the risk with private placement investments in an effort to generate the returns the actuaries need to see to sustain the 9.9% contribution rate that we have grown accustomed to thinking is fixed.  If we lower the investment risk the actuaries will need to lower the assumed return and we will have to start paying more than 10% right now – no politician wants to see that happen so we taxpayers are staying ‘risk on’.

I am not saying that this collective risk taking is not the right strategy – I am just saying that risk sometimes comes with handsome rewards that we all hope to enjoy in our retirement years – but risk sometimes comes with losses that will require reduced benefits to future retirees or higher contributions by future generations.  Since cutting benefits is very hard, I think we need to be careful about how much risk we take on today that we collectively might be paying for many years down the road – especially when those doing the paying are our children and grandchildren.

On the positive side, two factors that make the CPP a possible home for risky investments are the facts that the program has a super-long time horizon and a guaranteed flow of new members.  Hopefully we win this game, but I just don’t think we should expand the program to bet more than we already have on the table.

 

 

Joe Nunes
Joe Nunes
Joseph Nunes, Co-founder and Executive Chairman of Actuarial Solutions Inc, has practiced in the area of pensions and retiree health plans for over 30 years. He has experience with many types of plans including single-employer, multi-employer, private sector, government, unionized, non-unionized, as well as registered and non-registered executive plans.

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