CPP can weather economic storm

It’s never wise to carry all your eggs in one basket. The Canadian Retirement Income Security System seems to have grasped this truth and armed Canadians with an assortment of private and public pensions.

At a recent seminar held in Geneva by the International Social Security Association (ISSA) — in conjunction with the Social Security Department of the International Labour Organization — ISSA’s chief actuary, Jean-Claude Ménard, noted that compared to countries that use a single funding approach, Canada’s well-diversified funding approach has made its retirement income system much less vulnerable to changes in economic, market and demographic conditions.

International organizations vouch for the Canada Pension Plan’s (CPP) efficacy and have acknowledged the Canadian approach allows it to better adjust to fluctuations in demographic and economic conditions.

Ménard stated that from 2000 to 2019, the net cash flows of CPP — contributions less expenditures — had been and will continue to be positive, resulting in a rapid increase in the plan’s asset/expenditure ratio and funding status.

On the contrary, the average pension funds nominal return for countries belonging to the Organisation for Economic Co-operation and Development was negative 19% for the first 10 months of 2008; the market outlook only looks worse for 2009.

At retirement, most Canadians receive an income from one or more pension schemes, which are financed using different approaches:

• CPP: Financed through contributions paid in equal parts by the employer and employees. The contribution rate of 9.9% in 2009 and thereafter will provide plan assets equal to approximately 25% of the plan’s liability in about 15 years. • Old Age Security: Financed on a pay-as-you-go basis, which means there is no fund. • Occupational private pension plans and RRSPs: Fully funded, individual tax-sheltered saving accounts.

Given these three main sources of income, Ménard said it’s reasonable to claim the Canadian system is funded at about 40% of future liabilities.

“Stabilizing the asset/expenditure and funding ratios over time, the steady-state funding — a form of partial funding — has helped ensure the CPP is affordable and sustainable for current and future generations of Canadians,” he added.

In its last actuarial report, ISSA did a financial sensitivity test, which assumed -10% return on equities over two years. The probability of such returns was estimated at 6% based on past volatility of financial markets — Canadian bonds, Canadian equities and foreign equities — over the past 69 years. It also assumed the CPP is fully funded as at Dec. 31, 2006.

The results showed that under the pay-as-you-go financing, the contribution rate increased by 0.6% in the short term and then gradually returned to the best-estimate level in 30 years. Under full funding, the contribution rate increased 3.3% for the next 15 years as a result of the financial sensitivity test. (The amortization period of 15 years was chosen since it is legislated in Canada for occupational defined benefit pension plans.)

Under a steady-state funding approach, the increase in contributions was only 0.3% over the next 75 years. In this case, both economic and financial sensitivity tests contributed to the rate increase, but the impact was mitigated by the nature of the financing method.

“For a hypothetical contribution of $1,000 under the status quo assumptions, our scenario would result in an increase of $580 under full funding and only $30 under a partial-funding approach,” Ménard said.

The next CPP actuarial report is due at the end of 2009, and it will take into account the current economic environment as well as the long-term demographic outlook.

(04/27/09)