The Challenge And Promise Of Workplace Pension Reform
We have seen the headlines, followed the political debates, and maybe even worried to ourselves about our own financial futures. Clearly, a renewed conversation about Canadians' retirement has begun in this country. It has centred not only on the need to take another look at government-sponsored retirement income programs, but also on the current state and the future of workplace pension plans. To my mind, this conversation is both timely and greatly needed. The fact is, substantive reform and revitalization of workplace pensions is necessary if more Canadians are going to enjoy a financially secure retirement.
The good news is, workplace pension reform in Canada is not only possible, but happening. And that means there is good reason for hope. There's even better reason for hope if all of the various stakeholders – employers, employees, plan administrators, legislators, regulators, and so on – actively work together to make effective, meaningful reform happen. By making the playing field more accommodating of today's realities, we can help preserve the pension programs we already have and expand the scope of coverage to more workers.
To understand the challenge to workplace pensions today, it is useful to begin by considering the four pillars of retirement income for Canadians. The first pillar is Old Age Security (OAS) and the Guaranteed Income Supplement (GIS), which are designed to keep incomes for the elderly above the poverty line. Funded by general tax revenues, the OAS/GIS pillar is quite strong and has ensured that Canada has a very low senior poverty rate. The second pillar is the Canada Pension Plan (CPP) and Quebec Pension Plan (QPP), which are funded by equal employer/employee contributions and are designed to create a basic income for retired workers. Based on years in the workforce and pay, the maximum benefit under CPP/QPP is around 25 per cent of the average Canadian wage. The third pillar is comprised of tax-assisted pension and savings plans, including RPPs, group RRSPs, DPSPs, TFSAs, and so on. The fourth pillar consists of other savings and capital including home equity, rental income, business equity, inheritances, and so on.
Those first two pillars are government-sponsored and compulsory. The last two are not and, therefore, participation is lower.
Concerns And Issues
There are certainly a number of concerns and issues with the first two pillars. The GIS, after all, was intended to be a temporary measure when it was introduced in the mid-'60s, and the CPP is currently a topic of heated debate between some provinces, which want it expanded, and the federal government, which does not. But for pension industry participants, what seems clearly to be a vital concern is the third pillar because it has come under intense pressure from a number of sources.
When we look at workplace pensions, it's immediately apparent that overall coverage is low. While approximately 86 per cent of public sector workers have a workplace pension, only roughly 24 per cent of private sector workers do. In total, about two-thirds of Canadian workers have no workplace pension at all.
The fact is, many existing workplace pension plans are under strain because the load borne by this third pillar of retirement income has gotten much heavier. There are a few reasons for this. For one, we are faced with historically low interest rates which increase the purchase price of a future income stream. Second, expectations for future investment returns are lower than they previously were. And, finally, retiree longevity has increased. Actuarial tables from the 1970s indicated that a 65-year old male had a 15-year life expectancy and a female had a 19-year life expectancy. Today's estimates are 22 and 23 years, respectively.
These factors add up to one unavoidable conclusion: retirement is not only expensive, but far more expensive than it used to be. No wonder so many pension plans are under pressure. And at the most basic level, there are only two remedies: either increase contributions to support the heavier load or reduce the load by reducing benefits.
How, and how well, are industry stakeholders responding to these pressures? Generally, public sector stakeholders are working hard to preserve their plans by adjusting benefits, contributions, or both. But private sector employers have been less likely to stay on the defined benefit (DB) playing field. Considering the rising costs, solvency funding requirements, legal battles over transient funding excesses, and mark-to-market corporate accounting rules, it's not surprising that private sector employers have been more likely to abandon defined benefit plans for defined contribution plans. While DC is certainly better than no plan, it is less cost-effective and shifts the risks to individual plan members.
As for employees, they obviously place a high value on their post-retirement lifetime income and view their DB pension benefits as a deferred wage, but they are also willing to pay to help sustain them. When faced with a choice between paying more versus receiving less, DB plan members have repeatedly answered that they would rather pay higher contributions than receive lower benefits. They are also willing to put certain benefit features at risk, as long as priority is given to securing their core lifetime benefits.
So while employers and employees approach the challenge from different perspectives, there appears to be common ground in both their desire and flexibility to develop solutions. The current pressures have helped bring clarity to their priorities and there are many cases where employers and employees have successfully resolved how to modify their existing programs to improve their sustainability.
The other good news is that they are doing this in an environment where real regulatory reform is occurring. In almost every jurisdiction in Canada, pension legislation is being amended (or on the path towards being amended) to provide more flexibility in plan design and governance and to address some of the employer disincentives. British Columbia and Alberta, for instance, have both passed legislation (yet to be proclaimed in force) allowing solvency reserve accounts – a very positive step toward addressing one of the employer irritants in our current system.
In the private sector, multi-employer plans with collectively bargained contributions have been thriving in many industries for decades and are still going strong. In British Columbia, for example, there are numerous such plans in forestry and throughout the construction trades. If you are a labourer, shipbuilder, plumber, electrician, heat and frost worker, bricklayer, ironworker, carpenter, sheet metal worker, operating engineer, teamster, or piledriver, you participate in a large, multi-employer plan that aims to deliver a formula lifetime benefit. When properly designed and managed, these plans are exemplary models of robust and valuable workplace pension programs. It's interesting that the apparent new kid on the block, the ‘target benefit plan,' follows a very similar approach to these long-standing plans.
So the bottom line for Canadian pensions is this: While we have managed good coverage for low-income earners thanks to Pillars 1 and 2 of our retirement income system, income replacement for workers earning more than $30,000 is a much bigger challenge. With only one in three working Canadians covered by workplace pensions, we are going to have to continue to work together to find more ways to protect and enhance Pillar 3.
There is reason for optimism. One jurisdiction at a time, we're seeing a trend toward modernized pension legislation that is opening up new, more sustainable plan design possibilities. It's likely that we'll begin to see a broader array of workplace pension plans that will help shore up and grow that vital third pillar because stakeholders will embrace the opportunity they now have to structure new types of arrangements. The net result will hopefully be sustainable workplace pensions for far more working Canadians.
Shelley Engman is a partner for Canadian retirement consulting at Aon Hewitt.