Having explained what an unfunded liability is in part 1, and how healthcare is likely to be affected by its own unfunded liabilities in part 2, I now turn to the problems faced by the Canada Pension Plan (CPP), Old Age Security (OAS), some government defined benefit pension plans.
CPP
The CPP started out in 1966 as a pay-as-you-go system not unlike a Ponzi scheme; the contributions made by younger workers were being used to pay the benefits of older workers. The problem of funding the benefits of those younger workers as they aged was continually kicked further down the road. The belief was that as long as enough young people were coming into the work force, the CPP would remain viable. In a later installment, I will address the ethical shortcomings of this framework but for the present, I will take it as a given and concentrate on the problems it is facing.
As discussed in part 2, Canada’s work force was slowly maturing such that the number of workers per retiree has been dropping continuously since the 1960s and will continue to do so for the foreseeable future. Furthermore, a falling birth rate and ever-increasing life spans have put a further strain on the system. To make matters worse, the CPP assets were being lent out at below-market interest rates to the provincial governments to be used as they saw fit.
According to the actuary Paul McCrossan, a former Tory MP who handled the CPP file starting in the mid-1980s, the government of the day realized it had a significant problem and that there was no easy way to fix it. Nonetheless, to its credit, it enacted a few measures to reduce, but not eliminate, the problem.
First, it ramped up the immigration rate of younger independent people – more Ponzi scheme. This is one of the reasons Canada has had a higher immigration rate ever since the 1980s and why that policy must continue. Second, it reduced CPP disability benefits, and the earnings base used to calculate pensions. These measures saved considerable money and since they were rather technical, they were poorly understood, thus avoiding a public outcry. Third, the government got out of the business of investing the CPP fund. The CPPIB was created in 1997 as a body that operates at arm's length from the federal and provincial governments. Its mandate has been, and continues to be, to achieve the best possible return for the fund for a given level of risk. Finally, it made changes to the pay-as-you-go funding method because the projections showed clearly that a contribution rate of 3.6 per cent of pay wasn't going to be enough in the long term. However, it was also highly unlikely that Canadians would tolerate the 14.2-per-cent contribution rate that would eventually be needed, and a compromise was struck.
The Chief Actuary determined that gradually raising the contribution rate to 9.9 per cent would stabilize the fund. At that rate, the CPP assets could continue to grow for decades to come. Anything less and the fund would eventually dry up, while anything more would be unfair to the current generation of contributors. The CPP chief actuary calls this funding formula "steady-state funding", which is a hybrid between pay-as-you-go and fully funded.
The result was that the CPP funding ratio was 20% in 2014 and expected to rise to 30% by 2075. This should prevent further increases in the contribution rate. At 2015, the CPP unfunded liability stood at $884 billion.
Not surprisingly, the large Ponzi scheme element of the CPP has resulted and will result in grossly different and unfair returns to contributors depending on their year of retirement. For example, the real internal rates of return enjoyed by Canadian workers from their CPP retirement benefits were as follows:
Retirees in 1969 – 45.5%
Retirees in 1989 – 12.6%
Retirees in 2003 - 6.3%
Retirees in 2015 – 3.6%
Retirees in 2037 – projected to be 2.1%
In other words, Canadian workers retiring after 2036 (people born in or after 1972) can expect a real internal rate of return of 2.1 percent from the CPP.
At this point, you’re probably asking how these widely different returns came to be and there are two main reasons. One, the periods of contribution have changed over time. Early on, only 10 years of contributions were required to get maximum benefits whereas now a Canadian worker needs to contribute for 39 years. Two, the contribution rates have also changed over time. When the CPP was started in 1966, the contribution rate was 3.6%. It started to climb steadily in 1987 until it stabilized at 9.9% in 2003. In short, current contributors pay almost three times as much as people did in 1966 for similar benefits. It doesn’t take a genius to recognize that for comparable benefits, someone who only contributes for approximately 25% of the time and only a third as much as someone who came later is going get a much higher internal rate of return.
OAS
OAS originated with the passage of the Old Age Pensions Act of 1927. It had been a plank in the Liberals’ party platform in 1919, but not implemented until 1927, in part because of concern about government debt (much of it generated from the war).
British subjects aged 70 years or older could get up to $20 a month (approximately $300 today) and it was means tested.
In 1951, the Old Age Security Act was passed. It includes the OAS pension benefit, the Guaranteed Income Supplement (GIS), and the Allowance for spouses
It replaced the old age pension system with the establishment of a universal pension plan. Instead of a means test, all Canadians aged 70 and older received a monthly cheque of $40. In 1967, the eligibility lowered from 70 to 65. In 1989, the government ended the universality of OAS, when it announced claw-back provisions for higher-earning seniors, a policy that remains today. Starting in April 2023, the age of eligibility for Old Age Security (OAS) benefits was to shift from the current policy of 65 years of age to 67 years. But as soon as it got in power in 2015 the Trudeau government promptly reversed that decision.
This was done for purely political gains as it was completely ill-advised and financially foolish. For one thing, even upping the age of eligibility to 67 from 65 did not come close to adjusting for changes in life expectancy that have occurred since the mid-1960s. In fact, the age of eligibility for OAS would be approximately 74 years today if OAS were indexed for the increase in life expectancy that has taken place. Interestingly, many European countries have begun increasing the age of eligibility for public pension benefits, including indexing the age to life expectancy gains.
OAS is entirely a pay-as-you-go program and in 2015, the OAS unfunded liability stood at $494 billion.
Public sector pensions
Finally, a study performed by the Canadian Federation of Independent Business estimates that public sector pensions have unfunded liabilities of $300 billion or $100,000 per employee.
Taxpayers, you who often don’t have a defined benefit plan of their own, will have to make up the difference.
In the next installment, I will bring all of this together discussing what it means for the future, the lack of morality of the current framework, how it came to be and more.