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April 23, 2012updated 13 Apr 2017 8:45am

Canada’s changing pensions market

The controversy sparked by the Canadian governments decision in its March 2012 budget regarding Old Age Security (OAS) has put the countrys pensions system firmly in the spotlight. In the budget, announced on 29 March 2012, the federal government said the entitlement age for OAS will gradually rise from 65 to 67 starting from 2013.

By Robin Arnfield

The  controversy sparked by the Canadian government’s decision in its March 2012 budget regarding Old Age Security (OAS) has put the country’s pensions system firmly in the spotlight.

In the budget, announced on 29 March 2012, the federal government said the entitlement age for OAS will gradually rise from 65 to 67 starting from 2013.

The OAS is the first tier of Canada’s three-tier pension system. Canadians who have worked for forty years receive the full amount of OAS.

For low-income Canadians, the OAS is backed up by the means-tested Guaranteed Income Supplement (GIS). The second tier consists of the government sponsored contributory pension scheme known as Canada Pension Plan (CPP) for Canadians outside the province of Quebec, and Quebec Pension Plan (QPP) for Quebeckers.

Established in January 1966 by Liberal Prime Minister Lester Pearson, the CPP, which is a DB social insurance programme, forms the mainstay of pension provision for most Canadians.

Contribution to the CPP, by employers, employees and the self-employed, is compulsory.

The third tier is personal pension plans, corporate pension schemes, and public-sector pensions.

Budget controversy

The federal government caused a lot of controversy by announcing in its March 2012 budget, which was delivered on 29 March that the entitlement age for OAS will gradually rise from 65 to 67 starting from 2023.

Finance Minister Jim Flaherty MP said in his budget statement that, from 1 July 2013, Canadians who want to keep working beyond the retirement age, will be able to defer the start of OAS benefits, and receive a higher payout when they do retire.

The government also provides pensions for workers in the public sector including federal ministries and crown corporations, namely organisations owned by the government, such as Canada Post and the Canadian Broadcasting Corporation.

In the public sector, due to the power of the unions, DB plans are still dominant. Yet these pension funds are suffering from a similar crisis to corporate DB funds.

Applying industry-standard valuations, rather than the government’s own formula, the C.D. Howe Institute, a Canadian think-tank, puts the size of the public-sector pension funding deficit at C$227bn ($227.6bn)

This is C$80bn more than the public-sector funding deficit revealed in the government’s public accounts, reveals the C.D. Howe Institute. In his budget speech, Flaherty said the government “will ensure that government employee pension plans are sustainable and financially responsible.”

The transcript provided by the Canadian Press agency quoted him as saying that the government “will adjust these pension plans to be more in line with those available to Canadians working in the private sector.

We will also increase the cost-share ratio for the pension plan for Members of Parliament and Senators, effective [from] 1 January 2013.”

Over time, MPs and senators will be required to contribute 50 percent of the cost of their pension funding, up from 40 percent.

The C.D. Howe Institute speculates that the government will eventually increase the contribution level for public-sector employees from 40 percent to 50 percent.

It also aims to increase the age at which government employees can take early retirement, says the institute.

Reforming pensions

Reforming public pensions is a matter of great controversy, according to Michel St- Germain, a partner at Mercer. He says: “I see very little movement here away from DB.”

A December 2011 survey of senior executives responsible for Canadian corporate pension plans by consultancy Towers Watson identified a growing pessimism about the Canadian pensions landscape.

Given the market’s fundamentals, it is easy to understand why there is this sense of pessimism. For example, a total of 65% of respondents running DB plans believe Canada is experiencing a long-lasting pension crisis that will likely worsen in the next year.

Towers Watson estimates the typical Canadian DB plan was 86% funded at the start of 2011, and 72% funded at year-end, leading to higher pension deficits.

Canadian DB pension plans also face a triple challenge of low investment returns, highly volatile markets, and an ageing population.

“The number of Canadians reaching 65 is larger than the number of 25-year-old Canadians,” says Michel St-Germain, a partner at consultancy Mercer.

“About 50% of Canadian non-unionised private-sector companies have closed their DB plans and moved to DC plans,” says St- Germain.

“DB plans incur fixed annuity liabilities, yet their funds are invested in volatile assets. Eventually, all non-unionised private-sector firms will move to DC plans.”

Accounting rules

“Accounting rules have recently changed, putting focus on DB plans’ financial volatility,” says Sue Reibel, Manulife Financial Canada’s senior vice-president and general manager for group retirement solutions.

“A plan’s funded status may previously have only been reported in the notes to the financial statements. “From January 2013, the funded status must be disclosed as an asset or liability on the balance sheet and, from then on, changes in the funded status will be recorded in the

Other Comprehensive Income (OCI) statement.” St-Germain says: “The message Mercer gets from Canadian publicly-held companies’ boards is that shareholders should not be required to take the risk of liability for DB pensions.”

Subsequently, St-Germain explains that Canadian pension schemes are ‘de-risking’ – by moving DB plans to DC – or, if staying with DB, moving assets to more conservative and less volatile investments.

One option for pension plan sponsors is to buy longevity insurance.

“Sun Life will remove the longevity risk from DB plan sponsors,” says Tom Reid, Sun Life Financial Canada’s senior vice-president for group retirement services.

“They give us the plan members’ data, and we run sophisticated models, for example, examining the link between postal codes and longevity. Then we negotiate a price with the plan sponsor.”

An option for smaller employers who cannot afford DB or DC plans is to set up group registered retirement savings plans (RRSPs).

These act as tax-deferred savings plans in the same way as individual RRSPs that employees who do not belong to company schemes, and the self-employed, can set up.

Employers deduct employees’ group RRSP contributions from payroll, but aren’t required to contribute themselves. Employees are also not obliged to join. Group RRSPs are portable, and benefit from the lower costs of a larger fund, compared o the high management cost of individual RRSPs.

The downside is that, unlike DC plans, group RRSPs are not locked-in. “Employees can withdraw funds from group RRSPs, making for a lot of churn,” says Ron Sanderson, the Canadian Life and Health Insurance Association’s (CLHIA) policyholder taxation and pensions director.

Uptake of group RRSPs has been low, largely because employers do not want the burden of being the sponsor for the plans.

“Employers, as group RRSP sponsors, have obligations such as ensuring that employees understand the plan and that the investments are appropriate,” says Reibel.

Private sector challenge

“With more and more Canadians working for small private-sector companies, fewer people are covered by pension plans,” says CLHIA president Frank Swedlove.

He adds that “60% of workers in Canada’s private sector have no company pension plan, leaving them with individual RRSPs as the only option.

But the take-up of individual RRSPs by workers not covered by pension plans has been lower than expected.”

In December 2010, Canadian Finance Minister Jim Flaherty MP, in agreement with Canada’s provincial finance ministers, announced a framework for a new pension product – Pooled Registered Pension Plans

(PRPPs) – with the aim of making retirement savings more accessible for private-sector employees.

In November 2011, Bill C-25, the PRPP legislation, was introduced in the Canadian House of Commons.

“The Bill is at second-reading stage, and it will pass,” says St-Germain.

PRPPs will be managed by regulated financial institutions, and will be open to multiple employers across different industries as well as to the self-employed.

“The financial institution offering the PRPP is the sponsor, not the employer,” says Reibel.

“The employer’s role is reduced to selecting which financial institution’s PRPP they will use, managing payroll deductions and telling the financial institution about changes in employees.

Also, now you can put multiple SMEs in the same plan, and, as there are more participants, the cost is reduced.”

Once the House of Commons passes Bill C-25, the small number of private-sector companies subject to federal pension regulations, such as airlines, will be able to introduce PRPPs.

Localised response

However, as each Canadian province has its own pension regulations, the provinces will have to individually legislate for introducing PRPPs.

“The federal government’s legislation says that PRPPs have to be provided at low-cost, although the costs haven’t been specified yet,” says Swedlove.

He explains that the insurance industry believes it can meet the government’s requirement.

“The management cost of large company schemes is 60-80 basis points, and the insurance industry thinks it can offer PRPPs at similar levels.

This compares to the 150-250 basis point cost for individual RRSPs. PRPPs will offer around six different investment options, including target date plans, says Sanderson.

Target date funds shift contributors’ assets to less risky investments as they approach their retirement date.

Although Bill C-25 says that employer participation in PRPPs will be voluntary, individual provinces have to determine in their legislation whether to compel employers to provide the plans.

All employees in a participating firm will be automatically enrolled in a PRPP, but will be able to opt out.

In March 2012, Quebec became the first province to announce plans for PRPP legislation.

In Quebec, all employers with five or more employees and no existing pension plan or group RRSP will have to provide their staff with access to PRRPs , known as voluntary retirement savings plans (VRSPs) in Quebec.

However, firms will not be obliged to contribute to VRSPs. “Quebec will make VRSPs available from January 2013, and from January 2014 every Quebec employer not already providing pension plans will be required to offer VRSPs,” says Sun Life’s Reid.

“Employees will be enrolled at a default contribution rate of 2% in 2013, rising to 4% in 2017. Target date funds will be the default investment option.”

View in ontario

The federal government’s PRPPs plans received a blow in March 2012, when the Ontario government said it was concerned that PRPPs might replace other forms of retirement savings instead of expanding the total amount of retirement savings in Canada.

Ontario is also concerned that compulsory contributions for employees of companies implementing PRPPs might not be sufficiently flexible to allow for life events such as divorce or financial hardship.

It raised doubts as to whether PRPPs will be low-cost, particularly given that provinces would need to create licensing and regulatory regimes for the new pensions, and consequently the cost of which would be passed on to plan-holders.

While stating that it would cooperate with other provinces and the federal government in developing the PRPP model, Ontario said the introduction of PRPPs should be tied to mandatory increases to employee and employer contributions to the Canada Pension Plan (CPP).

However, the federal government has not demonstrated any appetite to expand funding of the CPP, a compulsory state-sponsored scheme to which all employees, employers and the self-employed have to contribute.

It is also important to note that insurers account for 90% of the Canadian capital accumulation plan (CAP) market, with banks and investment firms managing the remainder.

CAPs consist of DC pension plans, group RRSPs, and deferred profit-sharing plans (DPSPs).

Often attached to group RRPSs, DPSPs allow employers to distribute their profits to staff on a tax-deferred basis.

Employees subsequently become liable for tax after withdrawing funds from DPSPs, in the same way as withdrawing from RRSPs.

“The Canadian insurance industry sells around 2,000 CAP plans a year, comprising start-up plans and plans that employers move from one provider to another,” says

Sue Reibel, Manulife Financial Canada’s senior vice-president and general manager,

for group retirement solutions. “Over 500,000 Canadian firms don’t have workforce plans,” says Reibel.

 

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