Review of the 26th Actuarial Report on the Canada Pension Plan

Document Properties

  • Conducted by the CPP Actuarial Review Panel: 7 March 2014
  • Date Published: 1 May 2014

Table of Contents

Acronyms Used in This Report

AR25
25th Actuarial Report on the CPP
AR26
26th Actuarial Report on the CPP
CIA
Canadian Institute of Actuaries
CPP
Canada Pension Plan
CPPIB
Canada Pension Plan Investment Board
CRA
Canada Revenue Agency
ESDC
Employment and Social Development Canada
GAD
Government Actuary’s Department
IAA
International Actuarial Association
ISAP
International Standard of Actuarial Practice
OCA
Office of the Chief Actuary
OSFI
Office of the Superintendent of Financial Institutions
OASDI
Old Age, Survivors and Disability Insurance (the U.S. Social Security program)
QPP
Québec Pension Plan
YMPE
Year’s Maximum Pensionable Earnings

Executive Summary

Authors

This report was prepared by a review panel of three independent actuaries:  Robert L. Brown, Mark W. Campbell and Thomas D. Levy, all Fellows of the Canadian Institute of Actuaries.

Terms of Reference

The panel conducted its review of the 26th Actuarial Report on the Canada Pension Plan in accordance with the following terms of reference:

 

The Canadian peer reviewers will review the work of the Chief Actuary in completing the 26th Actuarial Report on the Canada Pension Plan as at 31 December 2012 and, following the review, provide a report to the Chief Actuary and the United Kingdom Government Actuary’s Department (GAD). GAD will then provide its opinion of the peer review to the Chief Actuary.

The review report should contain opinions on the following questions:

  1. Is the professional experience of the Chief Actuary and his staff who worked on the report adequate for carrying out the work required?
  2. Has the work been completed in compliance with the relevant professional standards of practice and statutory requirements?
  3. Did the Chief Actuary have access to the information required to perform the valuation, and were relevant tests and analysis on the data completed as might be expected?
  4. Were the actuarial methods and assumptions used in completing the report reasonable?
  5. Does the 26th Report fairly communicate the results of the work performed by the Chief Actuary and his staff?
In providing opinions on the questions listed above, the Canadian peer reviewers will also provide such recommendations as the peer reviewers deem appropriate with respect to future actuarial reports on the Canada Pension Plan prepared by the Office of the Chief Actuary.

 

26th Actuarial Report

AR26 was prepared as at 31 December 2012.  It presents a best-estimate projection of pay-as-you-go contribution rates for the Plan, rising from 8.78% of contributory earnings in 2013 to 11.50% in 2060, and then hovering thereafter.

It also presents a minimum contribution rate to be paid from 2016 and thereafter of 9.84% of contributory earnings.  The full funding rate in respect of the 2008 amendments to the Plan (providing enhanced eligibility for disability benefits for long-term contributors) is now deemed to be 0.0% since its value is less than 0.02%.

Using this minimum contribution rate, AR26 projects ratios of assets-to-expenditures rising from 4.7 in 2013 to 5.3 by 2025, and to be the same fifty years later in 2075.  Under a continuation of the current 9.9% contribution rate, AR26 projects ratios of assets-to-expenditures rising from 4.7 in 2013 to 5.4 in 2025 and then rising more slowly to 5.9 in 2075.

AR26 also presents the results of several sensitivity tests that show how different the results would be if particular assumptions, either individually or in combination, were varied.

All of the results are estimates.  All but the sensitivity tests present the Chief Actuary’s “best estimates”, with no deliberate margins of conservatism or other intentional bias.

It is essential to recognize that these results are not predictions.  They simply present what the outcome will be if all of the actuarial assumptions are realized.  These assumptions are about demographic and economic parameters over the next 75 years that are unknowable and, therefore, are not amenable to precise prediction.  Readers of AR26 should look at the sensitivity tests to understand that the range of potential results is wide, and could even be wider than is illustrated by the sensitivity tests.

Opinions

With respect to the five questions listed in the terms of reference it is our opinion that:

  1. The professional experience of the Chief Actuary and his staff who worked on AR26 was adequate for carrying out the work required.
  2. The work on AR26 complied with all relevant professional standards of practice and statutory requirements.
  3. The Chief Actuary had access to the data he required to perform the valuation, and he completed such relevant tests and analysis on the data as might be expected.
  4. The actuarial methods used in completing AR26 were reasonable and the assumptions were also reasonable, both individually and in the aggregate.
  5. AR26 fairly communicated the results of the work performed by the Chief Actuary and his staff.

Recommendations

We compliment the Chief Actuary and the staff of his Office who prepared AR26 on their competence, commitment and professionalism. They were unfailingly helpful in clarifying issues raised by the review panel and in providing additional information. In the spirit of seeking to help the Chief Actuary and his staff to continue improving their work, our report includes the following recommendations:

Recommendation 1: We recommend that the terms of reference for future peer review panels allow the appointment of non-Canadians as peer reviewers.

Recommendation 2:  We recommend that the OCA continue to work with its data providers to address items on the OCA’s list of data enhancement priorities. In particular, we recommend that the $99,999 limit on contributory earnings from a single employer in the Record of Earnings file be lifted to make cost estimates for future proposed changes to the YMPE possible.

Recommendation 3: We recommend that the Chief Actuary’s sensitivity tests show the impact of longer periods of economic underperformance.

Recommendation 4: We recommend that the Chief Actuary continue to apply the stochastic element of the sensitivity tests but that he freely complement the stochastic considerations with his professional judgement, particularly in relation to the migration and mortality sensitivity tests.

Recommendation 5:  We recommend that the Actuarial Report be made shorter and less technical by:

  • performing and presenting more of the analysis in the series of Actuarial Studies published by the OCA,
  • relying on the availability of the CD-ROM that contains the detailed projection tables for the Actuarial Report to meet the needs of more technical readers, and
  • publicizing the availability, upon request, of the CD-ROM that contains the detailed projection tables.

Recommendation 6:  We recommend that the Chief Actuary consider the issuance of annual interim Actuarial Valuations, prepared on a simplified basis, to update stakeholders on material developments, such as changes in government policy and economic performance.

Recommendation 7: We recommend that the Chief Actuary analyze the incremental investment expenses incurred over time to implement the CPPIB’s active management strategy to assess whether added value is being consistently and reliably earned over the long term and, using that experience analysis, refine his assumption regarding the incremental rate of return from the active management strategy.

Recommendation 8:   We recommend that the Chief Actuary:

  • maintain his programs of research and consultation with experts,
  • continue the CPP-related seminars with presentations from an array of appropriate experts covering a range of viewpoints, and
  • maintain the effective two-way communication with the CPPIB, with the goal of achieving continual improvements in the process of setting best estimate assumptions.

Section 1 – Introduction

This report presents the results of an in-depth review we conducted into the 26th Actuarial Report on the Canada Pension Plan and the detailed actuarial examination on which it was based.  This is the sixth such review that has been conducted.

Rather than “re-inventing the wheel”, in this report we have borrowed extensively from the descriptive and explanatory portions of the previous review reports.  The observations, conclusions and recommendations, however, are entirely our own.

1.1 Terms of Reference

In accordance with our terms of reference, our review focused on the actuarial work done on the Plan.  We were not asked to, and did not, review the merits of the current design, administration or investment arrangements of the Plan. Our review of those aspects was confined to how they interact with, and are reflected in, the actuarial work.

The terms of reference for our review were as follows:

 

The Canadian peer reviewers will review the work of the Chief Actuary in completing the 26th Actuarial Report on the Canada Pension Plan as at 31 December 2012 and, following the review, provide a report to the Chief Actuary and the United Kingdom Government Actuary’s Department (GAD). The GAD will then provide its opinion of the peer review to the Chief Actuary.

The review report should contain opinions on the following questions:

  1. Is the professional experience of the Chief Actuary and his staff who worked on the report adequate for carrying out the work required?
  2. Has the work been completed in compliance with the relevant professional standards of practice and statutory requirements?
  3. Did the Chief Actuary have access to the information required to perform the valuation, and were relevant tests and analysis on the data completed as might be expected?
  4. Were the actuarial methods and assumptions used in completing the report reasonable?
  5. Does the 26th Report fairly communicate the results of the work performed by the Chief Actuary and his staff?

In providing opinions on the questions listed above, the Canadian peer reviewers will also provide such recommendations as the peer reviewers deem appropriate with respect to future actuarial reports on the Canada Pension Plan prepared by the Office of the Chief Actuary.

 

We note that the terms of reference stipulate a panel of “Canadian peer reviewers”. Yet the pool of qualified and interested Canadian peer reviewers is small. For example, each of the current peer reviewers has served either once or twice on prior review panels. Relaxing the terms of reference to allow non-Canadian peer reviewers could expand the pool of qualified reviewers and increase the breadth of perspectives brought to each review.

1.2 Procedures Followed

Our review was conducted as a close collaboration of the three panel members.  The review work took place over the months from October 2013 through March 2014.

We received copies of some of the working papers in November 2013, in advance of the report.  We received the report on 3 December 2013, the day it was tabled in Parliament.  We received the balance of the working papers a few days later.

We interviewed the Chief Actuary and senior members of the Office of the Chief Actuary (OCA), a Division of the Office of the Superintendent of Financial Institutions (OSFI), for one and one-half days. We met with officials of the Economic Analysis and Forecasting Division of the Department of Finance Canada, the Demography Division of Statistics Canada, the Canadian Economic Analysis Department of the Bank of Canada, and various functional areas within the Canada Pension Plan Investment Board (CPPIB). In all, we made over 150 requests for information or clarification to the various parties. All of these parties responded promptly and fully to each request we made.

We also reviewed the papers presented at the CPP Seminar held in Ottawa on 28 September 2012, and a QPP seminar held on 29 November 2012.  Further, we reviewed four presentations, three made by the Chief Actuary:

  • to Statistics Canada (November 2012) on Population Projections,
  • to Finance Canada (April 2013) on Preliminary Economic Assumptions, and
  • to the CPPIB (June 2013) on Investment Assumptions, and one presentation (November 2012) on the Economic and Financial Market Outlook made by the CPPIB.

We made use of the historical documents that are maintained on the website of the Office of the Chief Actuary, which we found to be useful.

We reviewed the Rules of Professional Conduct and the applicable Standards of Practice of the Canadian Institute of Actuaries, and the applicable International Standards of Actuarial Practice of the International Actuarial Association.

We reviewed key provisions of the statute establishing the Canada Pension Plan.

We held several meetings in person and by teleconference, and corresponded extensively by e-mail.

After reviewing all of the information, and after much discussion among ourselves, we were able to reach agreement on all of the opinions and recommendations presented in this report.

The Canada Pension Plan is a complex Plan that provides benefits on a variety of bases (part earnings-related and part flat-rate) on the occurrence of three different events (retirement, disability and death) and with different qualification criteria for each event.  The actuarial computer model used to produce the results in AR26 is extremely complex.  It projects the intertwining of the Plan provisions and current population statistics with projections of future demographic and economic experience.

In our work, we have tended to concentrate on what we consider to be the most important issues – in particular, the data used, the major methodology issues, ten key actuarial assumptions and the quality of the reporting by the Chief Actuary. As described in Section 4 (Data) of this report, we reviewed the sources of the data, and the processes used by the Chief Actuary to test and analyze the data, but our mandate did not include a detailed audit of the data. Similarly, we reviewed the procedures used by the Chief Actuary to test the actuarial computer model, but our mandate did not include a verification of the accuracy of the model.

1.3 The Canada Pension Plan

The CPP is a social insurance program that provides monthly income benefits and some lump sum benefits upon the retirement, death and disability of participants.  Virtually all working Canadians outside Québec contribute to the Plan.

Before 1997, contribution rates were set at a level that created relatively little advance funding of benefits and the funds not used for immediate benefit payments and expenses were loaned to the provinces at federal government borrowing rates of interest.  The Plan was amended in 1997 to:

  • require an increased measure of advance funding,
  • add a sunset clause regarding the investment of CPP assets in provincial revolving 20-year bonds,
  • require that the funds not used for immediate benefit payments and expenses or for investment in those provincial bonds be invested in a diversified portfolio of investments, and
  • establish an Investment Board to manage these investments.

1.4 Statutory Actuarial Requirements

Section 115 of the Canada Pension Plan statute requires that an actuarial review be conducted once every three years and that it report:

  • projected pay-as-you-go contribution rates (that is, each year’s contribution rate is just sufficient to cover that year’s benefit payments and expenses), and
  • a contribution rate, calculated by combining
    1. a contribution rate, calculated in a prescribed manner, in respect of steady-state funding excluding changes that require full funding
    2. a contribution rate, calculated in a prescribed manner, in respect of full funding for post-1997 benefit improvements.

Section 113.1 of the Canada Pension Plan Statute requires a financial review of the Canada Pension Plan every three years by the federal Minister of Finance and ministers of the included provinces.  This review is to take into account the most recent report of the Chief Actuary under Section 115 and two financing objectives – full funding for benefit improvements and steady-state funding for all other benefits.  Section 115 states that projections must extend for at least 75 years into the future.

The Calculation of Contribution Rates Regulations, 2007, describes two funding objectives:

  1. The steady-state funding objective by prescribing a contribution rate calculated as the lowest constant rate for which the projected ratio of Plan assets-to-expenditures 10 years after the end of the review period matches the corresponding projected ratio 60 years after the end of the review period.
  2. The incremental full funding objective that requires full funding of post-1997 benefit improvements.

1.5 25th Actuarial Report

AR25 was prepared as at December 31, 2009.  It presented a best-estimate projection of pay-as-you-go contribution rates for the Plan rising from 8.65% in 2010 to 11.22% in 2060, then hovering thereafter.

It also presented a minimum contribution rate to be paid in 2013 and later of 9.86% of contributory earnings for years 2013 to 2022 and 9.85% for years 2023 and thereafter.  This consisted of a steady-state contribution rate of 9.84% to finance the Plan without new (post-1997) benefits and additional contributions to fully fund the expanded eligibility for disability benefits for long-term contributors (2007 Plan amendments).  The full funding rate was 0.02% for years 2013 to 2022 and 0.01% for years 2023 and thereafter.  Using this minimum contribution rate, AR25 projected ratios of assets-to-expenditures rising from 3.9 in 2010 to 4.7 in 2022, and to be the same fifty years later in 2072 (2022 and 2072 being the key years for that actuarial report).  Under a continuation of the current 9.9% contribution rate, AR25 projected ratios rising steadily from 3.9 in 2010 to 4.7 in 2020 and to 5.2 in 2050, then hovering thereafter.

1.6 Improvements Since 25th Actuarial Report

The actuarial review panel for AR25 made 15 recommendations arising from its review, plus numerous other observations or suggestions for improvement, which the Chief Actuary has taken into account.  In preparing AR26, the Chief Actuary has made numerous improvements in the work and reporting, and many of these improvements are a direct response to the recommendations, observations and suggestions of the prior actuarial review panel.  Where the recommendations of that panel have not been fully adopted, the Chief Actuary has provided a discussion of the partial progress made and/or has explained and supported any discrepancies.

However, our terms of reference do not call for, nor did we make, a detailed evaluation of the appropriateness of the response of the Chief Actuary to the findings of the prior actuarial review panel.

1.7 26th Actuarial Report

AR26 was prepared as at 31 December 2012.  It presents a best-estimate projection of pay-as-you-go contribution rates for the Plan rising from 8.78% in 2013 to 11.50% in 2060, then hovering thereafter.

It also presents a minimum contribution rate to be paid of 9.84% (rounded to the nearest 0.01%) of contributory earnings for years 2016 and thereafter.  This consists of a best-estimate steady-state contribution rate of 9.84% to finance the Plan without the 2007 Plan amendments and a contribution rate of 0.00% (any contribution rate less than 0.02% is deemed to be zero) to fully fund the benefit improvements introduced by the 2007 Plan amendments.

Using this minimum contribution rate, AR26 projects ratios of assets-to-expenditures rising from 4.7 in 2013 to 5.3 by 2025, and to be the same fifty years later in 2075.  Under a continuation of the current 9.9% contribution rate, AR26 projects ratios rising steadily from 4.7 in 2013 to 5.4 by 2025, to 6.0 by 2050, then hovering thereafter.

AR26 includes a reconciliation of the changes to the minimum contribution rate between AR25 and AR26.  The principal factors that increased the minimum contribution rate were:

  • changes in the real wage increases assumptions,
  • changes in the mortality assumptions, and
  • changes in investment assumptions.

On the other hand, the minimum contribution rate was reduced as a result of:

  • improvements in methodology,
  • changes in the assumptions other than real wage increases, mortality and investments, and
  • favourable plan experience during 2010 to 2012.

The impact of each of the above factors was small, that is, close to or less than 0.1% of contributory earnings.  The positive impacts were nearly offset by the negative, so the steady-state rate in AR26 remained the same as in AR 25 at 9.84%.  However, the full funding rate that in AR25 dropped from 0.02% during 2013 to 2022 to 0.01% in 2023 and thereafter is deemed to be 0.0% in AR26 because its calculated value for AR26 is less than 0.02%.  As a result, the improvement in benefits resulting from the 2007 Plan amendments is financed entirely by the steady-state approach.

1.8 Interpretation of Results

AR26 presented:

  • the projected pay-as-you-go contribution rates and asset-to-expenditure ratios by year to 2045 and then every fifth year through to 2090, under both the current legislated contribution rate and the minimum contribution rate,
  • the minimum contribution rate calculated at the current valuation date and how that rate is projected to evolve over the next four triennial valuation reports, assuming that the Chief Actuary’s best-estimate assumptions are realized,
  • a number of sensitivity tests, which illustrate the results that would be obtained under various changes in either future experience or actuarial assumptions,
  • a CPP balance sheet showing estimates of the assets as a percentage of the liabilities under an open group approach as at 31 December 2012 and 2022,
  • a calculation of the internal rate of return of each cohort of CPP participants (that is, the projected rate of return each cohort is expected to achieve on its combined employee and employer contributions if the Chief Actuary’s best-estimate assumptions are realized).

The current minimum contribution rate is the most significant of these results.  The federal Minister of Finance and ministers of the included provinces are to take it into account in their triennial financial review of the CPP.  If the minimum contribution rate is higher than the legislated rate, and the federal and provincial governments do not take action, the insufficient rates provisions in Section 113.1 of the Canada Pension Plan statute will apply to automatically increase the contribution rate and/or freeze benefits.  The other results are also useful because they provide information as to the long-term pattern of costs under the Plan and the unpredictability and variability of the costs if the assumptions are changed or not realized.  They also allow comparisons to be made with other countries’ social security programs.

All of the results are estimates.  All but the sensitivity tests represent the Chief Actuary’s “best estimates”, with no deliberate margins for conservatism or other intentional bias.

It is essential to recognize that these results are not predictions. They simply present what the outcome will be if all of the assumptions are realized.  The parameters involved (for example, fertility rates, net migration rates, mortality rates, disability incidence rates, rates of labour force participation, retirement rates, rates of price increase, real rates of wage increase, real rates of return on investments, each projected from 2013 for 75 years) are forecasts of unknowable future events and, therefore, are not amenable to precise prediction.

The estimates in AR26 and in previous reports are essential outputs to provide guidance in financing the Plan and in performing other planning and management tasks.  Yet, no matter how carefully they are prepared, they are still only estimates.  Thus, it is important that readers of the actuarial reports look at the sensitivity tests to understand that the range of possible actual outcomes is wide, and could even be wider than illustrated by the sensitivity tests.

1.9 Outline of this Report

Sections 2, 3 and 4 of this report address the first three questions in our terms of reference regarding Professional Experience, Professional and Statutory Requirements, and Data.

Section 5 (Methodology) and Section 6 (Assumptions) address question 4 in the terms of reference.

Section 7 (Communication of Results) addresses question 5 in the terms of reference.

Section 8 (Other Issues and Recommendations Thereon) provides further important commentary.

The Executive Summary provides an overview of our findings.

1.10 Recommendations

Recommendation 1: We recommend that the terms of reference for future peer review panels allow the appointment of non-Canadians as peer reviewers.

Section 2 – Professional Experience

In this Section we address the following question:

“Is the professional experience of the Chief Actuary and his staff who worked on the report adequate for carrying out the work required?”

2.1 Background

The Chief Actuary submitted AR26 to the Minister of Finance on 21 November 2013, and it was tabled in Parliament on 3 December 2013. The Chief Actuary is Jean-Claude Ménard, a Fellow of the Society of Actuaries (1985) and of the Canadian Institute of Actuaries (1985). He accepted the position of Chief Actuary for the federal government on 15 August 1999, following 18 years (the last four as Chief Actuary) with the Régie des rentes, the agency of the Québec government responsible for the Québec Pension Plan (QPP). Mr. Ménard was responsible for preparing the actuarial reports on the QPP from 1990 to 1999. Few actuaries can match his 32 years of experience in social security actuarial work, especially with respect to the Canadian context.

The professionals who worked most closely with Mr. Ménard on AR26, and co-signed the report with him, are Michel Montambeault and Michel Millette, both Senior Actuaries in the Office of the Chief Actuary, a Division of OSFI.

Mr. Montambeault is a Fellow of the Society of Actuaries (1992) and of the Canadian Institute of Actuaries (1992). He is also Senior Actuary (Old Age Security Program) in the Office of the Chief Actuary.  He spends his time on Canada Pension Plan and Old Age Security Program affairs.  He has worked on actuarial reviews of the Canada Pension Plan and the Old Age Security Program in the Office of the Chief Actuary for the last 24 years.

Mr. Millette is a Fellow of the Society of Actuaries (1986) and of the Canadian Institute of Actuaries (1986).  He joined OSFI in May 2000, following 12 years of experience working on social security programs with Mr. Ménard at the Régie des rentes du Québec. He is also Senior Actuary (Canada Student Loans Program, Employment Insurance) in the Office of the Chief Actuary.  He spends 40% of his time on Canada Pension Plan affairs and is responsible for the liaison with the staff of the Canada Pension Plan Investment Board.

The other professional staff who worked on AR26 are:

Name Actuarial
Designation
Years of Experience
In Actuarial Work In Social Security
Assia Billig PhD,
FSA, FCIA
17 years 6 years
Mounia Chakak ASA 2 years 2 years
Yu Cheng ASA 16 years 14 years
Mathieu Désy FSA, FCIA 7 years 4 years
Patrick Dontigny ASA 18 years 18 years
Christine Dunnigan FSA, FCIA 11 years 2 years
Laurence Frappier FSA, FCIA 17 years 2 years
Alain Guimond ASA 33 years 18 years
Sari Harrel FSA, FCIA 14 years 11 years
Jonathan Petrin FSA, FCIA 6 years 6 years
Louis-Marie Pommainville FSA, FCIA 34 years 14 years
Annie St.-Jacques FSA, FCIA 13 years 11 years

The three senior actuaries reviewed the work of the staff and co-signed the report.

2.2 Observations

There are very few actuaries working in Canada with experience in valuing and costing social security programs like the CPP and the QPP. The data sources, macroeconomic modelling and range of assumptions involved in actuarial valuations of social programs are more complex than for employer-sponsored pension plans.  Therefore, occupational pension plan experience is useful but not as useful as previous experience with social programs like the CPP and the QPP. Messrs. Ménard, Montambeault and Millette have considerable experience and understanding of the issues involved in valuing the Canada Pension Plan.

The staff of the Office of the Chief Actuary is of sufficient size to spend adequate amounts of time on CPP matters, such as improving methodologies and data sources, performing inter-valuation studies, improving documentation and liaising with other government departments and other social security actuaries, all of which contribute to the quality of the work and of the report.

We are pleased to observe that staff levels are being maintained and that there appears to be a program of staff recruiting and succession planning in place. There is a mix of more experienced and newer personnel on the staff of the OCA, and staffing continuity has been excellent.  We would also note that staff are moved from one technical area to another in their primary work and/or peer review work.  Thus, staff are gaining in-depth knowledge of the entire workings of the Plan and the actuarial models.

We are satisfied that Mr. Ménard and the staff who assisted him in preparing AR26 have the relevant experience and are qualified to carry out the actuarial valuation.

2.3 Opinion on Professional Experience

In our opinion, the professional experience of the Chief Actuary and his staff who worked on AR26 was adequate for carrying out the work required.

Section 3 – Professional and Statutory Requirements

In this Section, we address the following question:

“Has the work been completed in compliance with the relevant professional standards of practice and statutory requirements?”

3.1 Background

To address this question, we have considered each of the following:

  • Canadian Institute of Actuaries Rules of Professional Conduct:  The Chief Actuary and his co-signatories are Fellows of the Canadian Institute of Actuaries (CIA), the professional body governing the education, qualification, conduct and work of actuaries in Canada. The CIA promulgates the professional rules and ethical standards with which a member must comply and thereby serve the public interest.  The Rules of Professional Conduct are the Institute’s highest level of guidance to its members.  Failure to adhere to the rules results in disciplinary proceedings.
  • CIA Standards of Practice:  These standards govern the work performed by actuaries in Canada. There are general standards governing all areas of practice and practice-specific standards governing work in specific areas, namely: insurance, occupational pensions, workers’ compensation, actuarial evidence and post-employment benefit plans.  Currently, there are no practice-specific standards of practice governing work on social security programs, so only the General Standards of Practice are relevant to this review.
  • International Actuarial Association International Standards of Actuarial Practice for General Actuarial Practice (ISAP 1) and Financial Analysis of Social Security Programs (ISAP 2):  The International Actuarial Association (IAA) is a worldwide association of professional actuarial organizations. The IAA promulgates model standards of actuarial practice. These standards are not binding on actuaries in a particular country except to the extent that their national actuarial organization makes them so or the terms of the actuary’s engagement require their application. As of the date of this review report, the IAA has issued two International Standards of Actuarial Practice:  ISAP 1 General Actuarial Practice and ISAP 2 Financial Analysis of Social Security Programs.  The CIA has not made either of these IAA International Standards of Actuarial Practice binding on its membership. However, since these IAA standards provide guidance specific to social security programs, and since the Chief Actuary has voluntarily applied these standards to his work, we have considered both ISAP 1 and ISAP 2 in this review.  An area of issue here is that ISAP 2 was not passed by the IAA Council until its meeting in Singapore on 13 October 2013.  This would have been too late to have expected the Chief Actuary to specifically refer to ISAP 2 in AR26.  However, the Chief Actuary was a member of the drafting committee for ISAP 2 and knew its contents fully while he was doing his work on AR26.
  • Canada Pension Plan:  This statute provides the terms of reference of the Chief Actuary when preparing an actuarial report in relation to the CPP. Section 113.1 identifies the actuarial information required by the federal Minister of Finance and ministers of the Crown of the participating provinces when recommending changes to CPP benefits or contribution rates, or both. Section 115 stipulates the timing, contents and certain other aspects of the Chief Actuary’s triennial report.

In the Subsections below, we consider each of these in turn.

3.2 Canadian Institute of Actuaries (CIA) Rules of Professional Conduct

The following Rules of Professional Conduct of the CIA are particularly relevant to this review:

  • Rule 1:  A member shall act honestly, with integrity and competence, and in a manner to fulfil the profession’s responsibility to the public and to uphold the reputation of the actuarial profession.
  • Rule 2:  A member shall perform professional services only when the member is qualified to do so and meets applicable qualification standards.
  • Rule 3:  A member shall ensure that professional services performed by or under the direction of the member meet applicable standards of practice.

We are satisfied that the Chief Actuary and his staff have met the requirements of the CIA Rules of Professional Conduct.

Further to Rule 2, Section 2 of this report expands on our assessment of the professional experience of the staff of the Office of the Chief Actuary. Under the auspices of Rule 2, the CIA has also promulgated Continuing Professional Development (CPD) requirements that are applicable to practising actuaries. These requirements oblige an actuary to obtain at least 100 hours of CPD over a two-year period, and the CPD activities should be relevant to the actuary’s area of practice. The actuary must devote required minimum amounts of CPD time to technical skills and professionalism. At least 24 hours of CPD time must be obtained biennially by participating in “structured” activities such as participating in professional meetings or seminars. We have reviewed the CPD records of the Chief Actuary and his two co-signatories to AR26, as well as the professional staff of the OCA who are Fellows of the Canadian Institute of Actuaries, and confirmed that they all met the CIA’s CPD qualification requirements as of 21 November 2013, the date that the AR26 report was completed.

Further to Rule 3, the next two Subsections expand on our assessment of the Chief Actuary’s compliance with the CIA General Standards of Practice and the IAA ISAP 1 and ISAP 2.

3.3 Canadian Institute of Actuaries (CIA) General Standards of Practice

The General Standards of Practice of the CIA are extensive and detailed. The topics covered include numerous matters relevant to AR26 such as:

  • materiality,
  • knowledge of the circumstances of the case,
  • approximations,
  • subsequent events,
  • data sufficiency and reliability,
  • control procedures,
  • reasonableness of results,
  • documentation,
  • actuary’s use of another person’s work,
  • selection of assumptions,
  • provision for adverse deviations,
  • comparison of current and prior assumptions, and
  • reporting.

The CIA standard on assumptions requires that the assumptions, individually and in the aggregate, should be appropriate. We have concluded that the assumptions adopted for AR26 were reasonable, both individually and in the aggregate, and are therefore appropriate.

The CIA standard on provision for adverse deviations (such a provision is sometimes referred to as a margin for conservatism) states that the actuary “should not include a provision [for adverse deviations] if the related work requires an unbiased calculation.” Section 113.1 of the Canada Pension Plan Statute requires that the Chief Actuary determine the lowest constant contribution rate that, if maintained over the foreseeable future, results in specified projected asset-to-expenditure ratios that are constant. The Chief Actuary interprets this requirement as necessitating an unbiased calculation, and we agree.

Accordingly, the Chief Actuary uses assumptions that represent his “best estimate” for each relevant variable. The consequence is that the overall valuation results, other than the sensitivity tests, are likewise the Chief Actuary’s “best estimates” and do not include any provision for adverse deviations.

In our view, the work on AR26 complies with the relevant portions of the CIA General Standards of Practice.

3.4 International Actuarial Association (IAA) ISAP 1 General Actuarial Practice and ISAP 2 Financial Analysis of Social Security Programs

The IAA ISAP 1 on General Actuarial Practice is very similar (but not identical) to the CIA General Standards of Practice.  In our view, the work on AR26 complies with the relevant portions of the IAA ISAP 1 General Actuarial Practice.

At its 13 October 2013 meeting, the Council of the IAA approved ISAP 2 Financial Analysis of Social Security Programs.  While this approval was most likely after the OCA had finished AR26, Chief Actuary Jean-Claude Ménard was part of the drafting team for ISAP 2 and had in-depth knowledge of its contents while completing his work on AR26.  Thus, we have reviewed AR26 to see if the work thereon complies with the new IAA ISAP 2. The topics covered by ISAP 2 include the following:

  • Appropriate Practice — Data, Assumptions, Independent Peer Review
  • Communications — Report on Financial Analysis, Opinion
  • Possible Report Content (in an Appendix, strictly speaking not part of the ISAP)

The work of the Chief Actuary and his staff complies with all these requirements.

The appendix to ISAP 2 that outlines possible report content is particularly extensive. Fifty different disclosures are suggested, ranging over areas such as methodology, data, assumptions, results and analysis. AR26 provides all the relevant suggested disclosures.

3.5 Canada Pension Plan Statute

The Canada Pension Plan stipulates the frequency, approximate timing and certain contents of the Chief Actuary’s triennial reports to the Minister of Finance and ministers of the Crown of the participating provinces. In AR26, the Chief Actuary and his staff have complied with all of these statutory requirements.

3.6 Opinion on Professional and Statutory Requirements

In our opinion, the work on AR26 complied with the relevant professional standards of practice and statutory requirements.

Section 4 – Data

In this Section we address the following question:

“Did the Chief Actuary have access to the information required to perform the valuation, and were relevant tests and analysis on the data completed as might be expected?”

4.1 Background

Appropriate data are required for “current status” data inputs into the computer model, for “validation” (back-testing) of the model, and to develop appropriate actuarial assumptions for future years.  Data from ESDC and CRA normally flow to the OCA through Service Canada.  Examples of such data are:

Purpose Examples of Data Source
current and past status data
  • population by age and sex
  • earnings of contributors
  • contributions
  • benefits paid
  • assets
  • labour force
 
  • 2006 census, Statistics Canada estimates
  • ESDC
  • CRA, ESDC
  • ESDC, Statistics Canada
  • CPPIB
  • Statistics Canada
validation data
  • CPP financial transactions
  • benefit statistics
  • earnings statistics
  • CPPIB, ESDC, CRA
  • ESDC
  • ESDC, CRA
data for assumptions
  • current mortality rates
  • future mortality improvement rates
  • fertility rates
  • migration rates
  • disability statistics
  • labour force participation
  • asset mix policy
  • bond yields
  • economic indices
  • investment policy and performance
  • various topics
  • Statistics Canada Life Tables and historical deaths, Canadian Human Mortality Database (CHMD)
  • Statistics Canada,  Social Security Administration  Trustees Report (U.S.), Office for National Statistics (U.K.)
  • Statistics Canada
  • Statistics Canada
  • ESDC
  • Finance, Statistics Canada, OCA seminars, economic forecasts
  • CPPIB, large public and private pension plans
  • CPPIB, PC Bond Analytics
  • Statistics Canada, Canadian Institute of Actuaries, ESDC, Bank of Canada, others
  • CPPIB, asset allocations and operating expenses of other large Canadian pension funds
  • OCA seminars, QPP seminars

The status and validation data, and the historical data used to develop assumptions, appear to be factual and up to date.

The valuation data on benefits, earnings and contributions received from ESDC are tested in detail for internal consistency and reasonableness.  The data from other sources are reviewed for internal consistency and consistency with past data.  Any irregularities are checked out with the data source and any data errors are corrected.

The Chief Actuary has advised us that he had access to sufficient data to complete his work, and in AR26 has provided his opinion that “the data on which this report is based are sufficient and reliable”.

4.2 Observations

We have the following observations:

  • The Chief Actuary appears to have had access to the data he required.
  • The data are extensive and appear to be reasonably complete and available on a timely basis.
  • The data are tested for reasonableness by the OCA and any deficiencies are resolved before the data are used.
  • The Record of Earnings (ROE) file of all workers who ever made a contribution to the CPP appears to be sufficiently complete (except for recent transactions) and accurate, including dates of birth, although there is some concern about the inability to verify survivorship with respect to those residing outside of Canada.
  • The Canada Pension Plan Investment Board (CPPIB) has a Reference Portfolio that is its baseline policy for determining asset allocations.  Actual asset allocations can and do deviate systematically from the Reference Portfolio as the CPPIB seeks to achieve incremental returns at reasonable risk. When the CPPIB decides to deviate from the Reference Portfolio it conducts a risk-budgeting analysis to determine that the deviation is justified on an expected risk-adjusted basis. The Chief Actuary made assumptions as to future asset allocations based on the Reference Portfolio, the risk-budgeting policy, the current actual asset allocation, the asset allocations of other large Canadian pension funds, and his judgement with respect to possible future CPPIB asset allocations
  • Since 1991, the Bank of Canada and the Minister of Finance have jointly established inflation-control targets.  These targets have been agreed on for five years at a time.  The current target (range: 1% to 3%; mid-point and monetary policy target: 2%) expires on 31 December 2016.  There is currently no government policy in place regarding inflation-control targets after 2016 that the Chief Actuary can take into consideration when establishing his assumption regarding future inflation rates beyond 2016.  However, the Chief Actuary has assumed that the 2% target will be renewed up to 2019.  In the view of a number of experts with whom we spoke, future inflation targets are likely to be similar to the current target, will most likely extend beyond 2019, and will likely continue to be managed successfully.
  • The CPP and QPP seminars have provided much useful information and improved in relevance over time (for example, shift to longer-term focus). These seminars should continue to engage presenters who are known to hold divergent views and encourage presenters to summarize the range of plausible viewpoints while still providing support for their own conclusions.
  • The OCA maintains contacts with other Departments and Agencies such as the CPPIB, ESDC, CRA, Statistics Canada and Finance Canada, and with external agencies such as the Régie des rentes du Québec, the Conference Board, the CD Howe Institute, and the University of Toronto’s Policy and Economic Analysis Program.  All of this provides helpful input.
  • The OCA has identified its priorities for data enhancement that could lead to improved analysis.

One of the OCA’s data enhancement priorities pertains to the current limit of $99,999 that applies to contributory earnings from a single employer in the ROE file. In 2014, the YMPE cap on contributory earnings under the current provisions of the CPP is $52,500, well below this $99,999 limit. However, changes to the CPP have been proposed by various parties, including substantially raising the YMPE. It is possible that the OCA will be asked, in coming years, to make cost estimates for proposed changes to the YMPE. The data needed to make such projections will need to be available.

4.3 Opinion on Data

In our opinion, the Chief Actuary had access to the data he required to perform the valuation, and he completed such relevant tests and analysis on the data as might be expected.

4.4 Recommendations

Recommendation 2:  We recommend that the OCA continue to work with its data providers to address items on the OCA’s list of data enhancement priorities. In particular, we recommend that the $99,999 limit on contributory earnings from a single employer be lifted to make cost estimates for future proposed changes to the YMPE possible.

Section 5 – Methodology

In this Section, we address the following question:

“Were the actuarial methods used in completing the report reasonable?”

5.1 Background

The results presented in AR26 are based on a macro-simulation model of the Plan’s operations, which projects the elements of income and outgo and the accumulation of the fund year by year up to the year 2090. Those projections are used to determine projected pay-as-you-go contribution rates and the minimum contribution rate based on the financing objectives set out in Section 113.1 of the Canada Pension Plan statute.

5.2 Macro-simulation Model

The macro-simulation model starts with current and past statistics on the population (numbers of people distributed by age and sex) and earnings (distributed by age, sex and broad earnings levels) of residents of Canada outside of Québec. The model projects each of the following, in turn, for each calendar year during the projection period:

  • the number and characteristics (for example, age, sex, earnings) of the population of Canada less Québec,
  • the number and characteristics of eligible CPP contributors and beneficiaries,
  • the amount of CPP contributions made and benefits received by eligible CPP contributors and beneficiaries,
  • the investment income,
  • the expenses, and
  • the assets accumulating in the CPP fund.

Thus, the model combines the projections of the contribution income and benefit outgo with the projections of investment income and expenses to arrive at total projected asset amounts.

The model projects anticipated experience in future years based on demographic and economic assumptions related to the CPP as a whole. These assumptions include demographic parameters such as fertility, migration and mortality, and economic parameters such as labour force participation rates, price inflation, wage escalation and investment returns.

The Record of Earnings (ROE), the data file for each individual who has ever made a contribution to the CPP, is not used for the valuation itself.  Certain assumptions and adjustments are set based on a review of the ROE file, and certain back-testing is done against the ROE file.  However, the benefit and contribution projections themselves are built on population forecasts.  Thus, the fundamental valuation concept differs from that used for actuarial valuations of occupational pension plans.  Further, actuarial valuations of occupational pension plans effectively assume a closed population. The CPP valuation, on the other hand, has a constantly changing population.

The model is calibrated using a back-testing procedure. Model output for years prior to the valuation date is compared against historical values. Discrepancies are investigated and resolved. Resolution may include the development of adjustment factors to better calibrate the model to historical experience.  These experience adjustment factors are generally modest, but they serve the important function of “truing up” the projected results to past observed values, so that minor inadequacies in virtually any assumption do not unduly distort the overall results.

The model relies principally on a deterministic, rather than a stochastic, approach. That is, for each year in the projection period, each run of the model produces:

  • a (deterministic) single set of projected results

    rather than

  • a (stochastic) probability distribution of possible results derived from projections of the expected results and of the underlying volatility of one or more of the parameters of the model (this allows estimates of probability to be assigned to ranges of outcomes, thereby increasing the information available).

The results of the stochastic analysis appear in the individual sensitivity tests, which are described in Subsection 5.4.7

Moreover, once an assumption reaches its ultimate value, each subsequent year’s projected results are based on that assumption. There is no provision in the model for assumptions to deviate from the ultimate value. As a consequence, the model gives the impression of smooth changes in most of the model outputs, without reversals. It is likely that future experience will be more varied than is reflected by the projections.

5.3 Form of Output

The model produces the following outputs which are discussed in Section 5.4:

  • projected demographic and financial results, including the pay-as-you-go contribution rates, the asset-to-expenditure ratios based on the current statutory contribution rate, and other income and expenditure details for each year up to 2045 and thereafter every fifth year up to 2090,
  • the current minimum contribution rate, which in AR26 is also the steady-state rate, as well as projected minimum contribution rates for each of the next four triennial actuarial reviews,
  • a CPP balance sheet showing estimates of the assets as a percentage of the liabilities under an open group approach as at 31 December 2012 and 31 December 2022,
  • internal rates of return for various year-of-birth cohorts of Plan members, each of which is the rate of return the report estimates will be realized by that cohort when comparing its projected benefits to its total (employee and employer) contributions to the Plan,
  • reconciliations of AR26 results with the results in AR25, and
  • sensitivity tests showing the results of applying alternative assumptions.

5.4 Actuarial Cost Analysis

The actuarial cost analyses presented in AR26 are described in this Section.

5.4.1 Pay-As-You-Go Basis

When the CPP was initially established, it was financed on a “pay-as-you-go” basis with a small reserve. Although that financing approach was replaced in 1997, the projected pay-as-you-go costs provide useful information about the future financial status of the Plan.  Paragraphs 115(1.1)(a) and (b) of the Canada Pension Plan require the Chief Actuary to present “pay-as-you-go” projections year by year for the first 30 years and thereafter every five years up to at least 75 years after the valuation date.  In AR26, the projection extends to the year 2090.

5.4.2 Minimum Contribution Rate

The methods used to compute the minimum contribution rate involve a combination of “steady-state funding” and “full funding”.  Thus, the “minimum contribution rate” is computed as the sum of:

  1. the contribution rate determined by the steady-state method for all benefits other than benefit improvements resulting from changes to the Canada Pension Plan statute that occurred after 1997, and
  2. the contribution rate determined by the full funding method for benefit improvements due to post-1997 changes to the Canada Pension Plan statute.

The steady-state method produces a contribution rate that is the lowest constant rate that, if maintained over the foreseeable future, results in projected asset-to-expenditure ratios that are generally constant.  The asset-to-expenditure ratio for any year is the ratio of the projected assets at the end of the year to the projected expenditures in the following year.  In practice, the steady-state rate is computed as the lowest level contribution rate, starting three years after the review date (called the “review period”), that produces the same projected asset-to-expenditure ratios in the 10th and the 60th years following the review period.  In AR26, the asset-to-expenditure ratios for 2025 and 2075 are used for this purpose.

Paragraph 113.1(4)(d) of the Canada Pension Plan statute requires that post-1997 benefit improvements be separately identified and funded on a “full funding” basis.  That is, the steady-state contribution rate must be augmented to reflect benefit improvements that are deemed to be earned in the future, and there must also be a temporary increase in the contribution rate to liquidate any unfunded liability resulting from the benefit improvement. The temporary increase is to apply for a number of years that is consistent with common actuarial practice; the Chief Actuary has chosen 15 years for this purpose.

The full funding rate is deemed to be 0.0% in AR26 because its calculated value is less than 0.02% (amounts smaller than 0.02% are rounded down to zero pursuant to the Calculation of Contribution Rates Regulations, 2007).  As a result, the improvement in benefits in 2008 is financed entirely by the steady-state approach.

5.4.3 Actuarial Balance Sheet

An actuarial balance sheet compares Plan assets to actuarial liabilities for contributors and beneficiaries under the present Plan provisions as at 31 December 2012 and 31 December 2022 on an open group basis.  In an open group actuarial balance sheet, it is assumed that the Plan is ongoing into the future, and the balance sheet takes into account future contributions of current and future members as well as benefits of future members. Benefits and contributions are discounted at the assumed rate of return.  Under the open group approach, the assets are 99.6% of the liability at 31 December 2012 and 99.5% as at 31 December 2022.

We concur with this paragraph in AR26 “The Plan is intended to be long-term and enduring in nature, a fact that is reinforced by the federal, provincial, and territorial governments’ joint stewardship through the established strong governance and accountability framework of the Plan. Therefore, if the Plan’s financial sustainability is to be measured based on its asset excess or shortfall, it should be done on an open group basis that reflects the partially funded nature of the Plan, that is, its reliance on both future contributions and invested assets as means of financing its future expenditures.  The inclusion of future contributions and benefits with respect to both current and future participants in the assessment of the Plan’s financial status confirms that the Plan is able to meet its financial obligations and is sustainable over the long term.”  AR26 does disclose the closed group actuarial liability and current service cost of the Plan in a footnote.

5.4.4 Internal Rates of Return

AR26 shows internal rates of return by cohort, which are stable for cohorts born after about 1970. This confirms that the Plan is sustainable in its current form. Earlier cohorts are expected to receive even higher value from the CPP. This is because they began their contributions before the current partial funding regime was implemented.

5.4.5 Reconciliations

Detailed reconciliations are conducted of the current results against the results in AR25.  These identify the principal causes of the changes in results from AR25 to AR26, and measure the impact of each on the results.  The detailed reconciliations also serve as a check on the results of AR26.

5.4.6 Sensitivity Tests

In addition to the results based on best-estimate assumptions selected by the Chief Actuary, a number of sensitivity tests are produced.  These show the results using alternative assumptions and thereby give information on the possible range of future actual results.

The first area examined for sensitivity is that of investment policy. AR26 shows the impact of six alternative asset allocations, compared to the best-estimate asset allocation, on the minimum contribution rate. This shows that the minimum contribution rate is expected to decrease as more investment risk is taken, but that this expected decrease comes at the price of escalating risk (measured in AR26 by the standard deviation of one-year portfolio returns).

The next sensitivity test presented in AR26 shows the impact of portfolio return volatility on the growing CPP asset base and, in turn, on the minimum contribution rate. This is accomplished by showing the effect on three different asset allocations (lower-risk, best-estimate and higher-risk) of abnormally high or low portfolio returns in 2015 followed by a resumption of expected returns thereafter.  A range of portfolio returns for 2015 was developed based on a one in 10 year event and a one in 50 year event.

Unfortunately, this material failed to highlight for the reader the differing risk related to the alternative asset allocations. This is because the single year of poor assumed returns is offset by the assumed resumption of expected returns in all other years. For the higher-risk portfolio in particular, those future returns are all expected to be more favourable than for the best-estimate asset allocation. The result is a projected minimum contribution rate for the higher-risk portfolio that tends to be lower than the best-estimate asset allocation, and is only marginally higher than the best-estimate asset allocation even after a one in 50 year event. This section of AR26 might have been improved by examining the impact of more or longer bouts of capital market underperformance, which would not be out of the ordinary over a 75-year projection period. This would highlight the genuinely higher risk of more aggressive asset allocations.

AR26 includes two sensitivity tests of an economic slowdown in 2014/2015 followed by an economic recovery that gradually reverts to the best-estimate assumptions. One test examines the impact of rising unemployment and falling real wage increases. The second test combines these with poor investment returns in 2015 only. Since the scenarios examined involve only temporary economic slowdowns, the projected impact on the minimum contribution rate is modest. As above, this material might have been improved by showing the impact of a more severe slowdown.

Seven sensitivity tests in AR26 examine one parameter at a time and an eighth test examines three interrelated parameters simultaneously. The tests illustrate the effect of changes, both lower-cost and higher-cost, in each of ten key parameters.  These tests are discussed in detail in Subsection 5.4.7.

Another set consists of two “combined” sensitivity tests: the “Younger Population Scenario” and the “Older Population Scenario”. The first is based on generally more optimistic and the second on generally more pessimistic demographic assumptions than the best-estimate assumptions.  Both of these scenarios were presented to test possible combinations of key demographic assumptions (considering the interrelationship of the various parameters) that provide a reasonable range of possible future outcomes.

5.4.7 Individual Sensitivity Tests

The individual sensitivity tests examine the effect of changes, both lower-cost and higher-cost, in each of ten key assumptions (fertility, mortality, migration, unemployment/labour force participation/retirement rates, price increases, real-wage increases, real rates of return and disability).  Except for the sensitivity test that examined unemployment/labour force participation/retirement rates on a combined basis, stochastic considerations were used to provide estimates of low-cost and high-cost scenarios within an 80% probability range for each underlying variable.  That is, alternative scenarios are presented using the defined variable at its projected 10th and 90th percentile.  We like this use of stochastic modeling and the use of the 10th and 90th percentile.  We encourage its continuation but feel that for the migration assumption, which is perhaps subject to more political than statistical volatility, the resultant stochastic range is dubiously narrow.  This is simply to say that any stochastic analysis has to be augmented by considerable professional judgement.

Another example of the need for professional judgement is the mortality assumption, where the Chief Actuary has assumed a fairly rapid slowdown in the historically observed mortality improvements. His range of stochastic variability around this expectation is symmetric, so that the putative variability is assumed to be higher or lower than his assumption with equal likelihood. However, since his best-estimate assumption is already positioned somewhat low in the reasonable range, we believe that higher mortality improvement rates (compared to the Chief Actuary’s best estimate) are actually more plausible than lower mortality improvement rates.

The resulting high-cost and low-cost values for each assumption were used as inputs into the model to project revised (a) minimum contribution rates (b) pay-as-you-go rates, and (c) asset-to-expenditure ratios if there were no change in the current 9.9% rate.  The report also shows the first year that expenditures exceed contributions. There is a lot of material presented on this in AR26 that might be pared back by just focusing on the impact on the minimum contribution rate, as is the case with the other sensitivity tests.

The approach to the individual sensitivity tests used in AR26 is the same one that was used in AR25.  Each report shows how much variation should be expected, with equal plausibility, in each direction and for each parameter.

We believe that individual sensitivity tests are a valuable tool, if used prudently.  They give the reader information that may be used to estimate the financial impact of a change in a particular best-estimate assumption.  However, the reader should be cautious in interpreting the information provided about the likely variations in the parameters. In particular, the reader should be aware that actual outcomes can range more widely than is shown by the sensitivity tests and that the likelihood of doing so may be even higher than is projected. This is due to the inherent unknowability of many of the key variables rather than any defect in the Chief Actuary’s analysis.

5.5 Opinion on Methodology

In our opinion, the actuarial methods used in completing AR26 were reasonable.

5.6 Recommendations

Recommendation 3: We recommend that the Chief Actuary’s sensitivity tests show the impact of longer periods of economic underperformance.

Recommendation 4: We recommend that the Chief Actuary continue to apply the stochastic element of the sensitivity tests, but freely complement the stochastic considerations with his professional judgement, particularly in relation to the migration and mortality sensitivity tests.

Section 6 – Assumptions

In this Section, we address the following question:

“Were the assumptions used in completing the report reasonable?”

6.1 Background

The actuarial review that is required to be made every three years under Section 115 of the Canada Pension Plan requires that the Chief Actuary look back in time, to review the operations of the program, and also look forward, to make an estimate of its future operations.  For the forward-looking part of the process, the Chief Actuary builds a model that incorporates the details of the benefit, contribution and investment elements of the CPP and reflects the expected behaviour of the factors that determine the year-by-year development of the benefit costs and the contribution and investment income.  The model for a plan as complex as the CPP is necessarily complex itself.  The assumptions incorporated into the model for a particular actuarial review reflect the Chief Actuary’s judgement, based on his interpretation of past experience and the available evidence about the likely course of future experience.

The nature of the actuarial process is to make projections (not predictions) about the future based on the evidence available and then to review them periodically.  Where appropriate, the actuary makes “mid-course corrections” in the assumptions as the emerging experience of the plan deviates from the previous assumptions and the expectations for likely future experience change.  In assessing whether to change an assumption and if so, by how much, the actuary must weigh:

  • long-term historical data,
  • short-term historical data,
  • recent amendments to the Canada Pension Plan,
  • policy (for example, CPPIB investment policy, ESDC administration policies and government policies on inflation control and immigration levels),
  • academic research, and
  • other external sources of relevant information.

The assumptions are intended to apply over the long-term future, so the actuary will normally give substantial weight to long-term historical data.  However, where the actuary judges that more recent data for a particular assumption indicate a shift or a trend that is likely to continue for the long-term future, the actuary will recognize that shift or trend in the assumption.

For many of the assumptions used in the model, the Chief Actuary has adopted a method that actuaries describe as “select and ultimate”.  Under this approach, the particular assumption gradually changes over a period of years (the “select period”) from one that initially is very close to actual recent experience to one that reflects the actuary’s best-estimate of the long-term future (the “ultimate” assumption).  The length of the select period can be different for different assumptions.  The choice is based on the actuary’s judgement and depends partly on the nature of the parameter involved and partly on how significantly the ultimate assumption differs from recent experience.

The results of the actuarial process at any given time do not yield a “right” answer but should lie somewhere within a range that can be regarded as “reasonable”.  Previous actuarial reports on the CPP have focused on several key assumptions.  All assumptions used in those reports can be described as “best-estimate”, that is, the assumptions were, in the judgement of the Chief Actuary, such that adverse or favourable deviations of actual future experience from each of those assumptions are about equally likely.  AR26 follows this same approach.

The Chief Actuary spends time gathering expert opinions on the report assumptions from a variety of sources.  The review panel did the same.  This is a difficult and sometimes frustrating exercise.  If one visits, say, five experts, one can expect to come away with five answers sometimes covering a wide spectrum of possibilities.  How one decides what the best estimate should be is not based on absolute science.  There is no mathematical formula that guarantees that one arrives at the “best” estimate.  The most one can do is to arrive at an estimate that is “reasonable”, or at least “not unreasonable”.  One should remember this background when judging the work of the Chief Actuary (and the Review Panel for that matter).

The major actuarial assumptions in AR26 can be conveniently divided into two groups:

  • “demographic” assumptions that deal with changes in the covered population (for example, fertility, migration and mortality rates) and events (for example, death, disability and retirement) that trigger the starting or stopping of CPP benefit payments or contributions, and
  • “economic” assumptions that deal with such issues as employment, wages, prices and returns on investment.

6.2 Demographic Assumptions and Opinions Thereon

6.2.1 Fertility

Fertility rates varying by age and year are applied to the female population to project the number of births each year. The Chief Actuary assumes that recently observed fertility rates for females under age 30 will decrease in the future, while fertility rates observed from ages 30 to 50 will increase.  The fertility trends are based on historical fertility rates by age of mother.  As for some other assumptions, the approach used in AR26 (and in past actuarial reports on the CPP) is to develop one fertility assumption for Canada and a separate one for Québec.  These assumptions are then used to develop separate population projections for Canada and for Québec.  From these, the projected population of Canada less Québec is derived. In AR26 it is assumed that the total fertility rates of Canada and Québec will converge in the long run.

In the working papers for AR26, it was noted that “Several periods of historical data had been tested for projection in AR25, and it was found that using 30 years of historical data for that report produced results that were the most consistent with recent trends at the time.”  For AR26, “only twenty years of historical data were considered.  Using thirty years was deemed inappropriate judging by the recent trends of the different age groups.  There was a definite break in the trends twenty years ago.  A shorter period of ten years was also considered, but it produced projections with slopes that were too steep, due to significant increases in recent years.”

The total fertility rate is a convenient way of summarizing a set of age-specific fertility rates. It indicates the average number of children that would be born to a woman in her lifetime based on the age-specific rates in a given calendar year. The assumed total fertility rate for Canada in AR26 increases slightly from the 2010 level of 1.63 to an ultimate level of 1.65 in 2015. The AR26 assumed ultimate total fertility rate is the same as that in AR25 (1.65), and the year in which the ultimate rate is reached in AR26 is the same as that assumed in AR25 (2015).

The long-term fertility assumption depends on several factors that are difficult to predict.  Fertility rates at all child-bearing ages declined sharply in Canada in the 1960s and early 1970s as the result of social, economic and medical factors, including improved contraception methods. Since the mid-1970s, fertility rates at ages under 30 have continued to trend downward, while the rates at higher ages have increased, so the average age of motherhood has increased. In the future, fertility rates could decline to the lower levels experienced in several other developed countries (for example, Germany at 1.4), or increase in the direction of the higher rates recently experienced in the U.S. (1.9) or France (2.0).  The assumed ultimate rate of 1.65 in AR26 is lower than the Statistics Canada medium assumption of 1.7.  The United Nations’ assumed rates are 1.76 in 2025 and 1.90 in 2045.  Finally, the Policy and Economic Analysis Program of the University of Toronto assumes an ultimate rate of 1.9 by 2030.

The sensitivity tests for the fertility assumption are a low-cost ultimate total fertility rate for Canada of 1.90 and a high-cost ultimate rate of 1.40.  These rates define the range of values that are expected to occur with an 80% probability.  The test results may be summarized as follows:

Ultimate Total
Fertility Rate
from 2015
Minimum
Contribution
Rate
Pay-As-You-Go Rates
2025 2050 2087
Lower-cost (1.90) 9.53 10.28 10.49 10.50
Best-estimate (1.65) 9.84 10.28 11.01 11.71
Higher-cost (1.40) 10.17 10.29 11.58 13.23

The above table illustrates that changes in fertility can have a relatively large effect on the cost of the Plan. However, all the individual sensitivity test results should be interpreted with caution. Readers should form their own opinion about the plausibility of the low-cost and high-cost assumptions. Moreover, they should assume that changes in parameters are not likely to occur in isolation. For example, a radical change in fertility rates would likely be accompanied by other changes that would mitigate their impact (for example, changes in average ages at retirement, levels of immigration or labour force participation rates).

Opinion on Fertility

In our opinion, the AR26 fertility assumption was reasonable.

6.2.2 Mortality

The mortality rates by age, sex, province and calendar years 1921 to 2009 were obtained from the Canadian Human Mortality Database (CHMD), which is part of a broader database with mortality data from 37 countries.  Although mortality rates are only available up to 2009, both the number of deaths and population are available up to 2012.  As such, the number of deaths and surviving populations are projected for 2013 and thereafter.  General population mortality rates are adjusted to account for the specific mortality experience of CPP retirement and survivor beneficiaries.  Mortality rates for disabled beneficiaries are based on actual experience for that segment of the population.  The CHMD data (which end at age 110) were extended to age 120.  Data were also obtained from the U.S. and U.K. for comparison purposes.

Future mortality rates are then projected by using estimates of future mortality improvement rates. The assumed mortality improvement rates are established in three parts:

  • The initial mortality improvement rates for 2010 are set equal to the actual 15-year average improvement rates ending in 2009, separately for each sex and five-year age band.
  • The ultimate mortality improvement rates, for both males and females, are set equal to 50% of the average of the actual 15-year and 20-year average improvement rates ending in 2009 for females. Specifically, for 2030 and beyond (2025 for Québec) the assumed ultimate improvement rates for both sexes are set equal to 0.8% for ages 0-84, 0.6% for ages 85-89, 0.4% for ages 90-94, 0.3% for ages 95-109, 0.2% for ages 110-114, 0.1% for ages 115-119, and nil for ages 120+.
  • The intermediate mortality improvement rates for 2011 to 2029 (to 2024 for Québec) are generally interpolated between the initial and ultimate rates.

This methodology is very similar to that used in AR25.

The gap between male and female life expectancy is projected to narrow, though at a slower pace after 2030.

It is implicit in these assumptions that there will be no shocks affecting future life expectancies, either positively (for example, a major advance in the treatment of heart disease or cancer) or negatively (for example, an outbreak of a serious infectious disease). Also implicit in the assumptions is that, regardless of future improvements in mortality rates, male life expectancy at a given age will not exceed female life expectancy at the same age.

The AR26 ultimate improvement rates are the same as those assumed in AR25 at ages up to 74, higher at ages 75-89, the same at ages 90 to 109, and lower after age 110. Compared to the improvement rates used in the U.S. Social Security (OASDI) 2012 Trustees Report, the AR26 ultimate improvement rates for males and females are mostly lower than the U.S. rates (but the U.S. starts with significantly higher mortality rates).  Current mortality rates in Canada are generally lower than in the U.K. However, due to the much stronger U.K. mortality improvement rates assumption, the projected U.K. mortality rates become lower than the Canadian ones (for ages 80 and over in 2030, and for ages 45 and over in 2050).

The sensitivity tests for the mortality assumption were implemented by adjusting the assumed rates of mortality improvement through a combination of deterministic and stochastic methods.  Based on the best-estimate assumptions, the life expectancy at age 65 in 2050 would be 23.0 years for males and 25.3 years for females. The low-cost assumption is that those life expectancies would be 20.7 years for males and 22.9 years for females.  The high-cost assumption is that those life expectancies would be 25.6 years for males and 27.7 years for females.  The test results may be summarized as follows:

Life Expectancy at Age 65
in 2050
Minimum
Contribution
Rate
Pay-As-You-Go Rates
2025 2050 2087
Lower-cost (M 20.7, F 22.9)   9.46 10.13 10.54  10.97
Best-estimate (M 23.0, F 25.3)   9.84 10.28 11.01 11.71
Higher-cost (M 25.6, F 27.7) 10.22 10.45 11.49 12.41

Opinion on Mortality

In our opinion, the AR26 mortality assumption was reasonable. We would have chosen slightly higher mortality improvement rates, which would have slightly increased the minimum contribution rate.

6.2.3 Migration

The rate of net annual migration to Canada since 1998 (assuming no annual net increase in the number of non-permanent residents) has varied from a low of 0.39% of the population to a high of 0.68%.  Variations in the earlier years of the 20th century were much more extreme.  Migration varies from year to year in response to demographic, economic, social and political changes.  Over 2010 to 2012, the average net migration rate for Canada was 0.63% of the population (assuming no annual net increase in the number of non-permanent residents).

Historically, the average annual net flow of non-permanent residents was assumed to be equal to zero because of the large variations (both positive and negative) in this variable.  However, the annual net flow of non-permanent residents has recently increased significantly and remains at high positive levels.  In 2012, the number of non-permanent residents in Canada increased by 55,000.  This results in a net migration rate, including non-permanent residents, of 0.77% in 2012.

The AR26 assumption for net annual migration to Canada, including non-permanent residents, starts at 0.77% in 2012 and then decreases uniformly from 2012 to 0.60% in 2017, remaining at that level for the remainder of the projection.  These rates are higher than the net migration rates assumed in AR25, which started at 0.62% and graded down to 0.58% (in 2023 and thereafter).

Statistics Canada considers migration to be a major driver of population growth.  The assumed ultimate net migration rate in AR26 (0.60% in 2017) is lower than the medium projection rate used by Statistics Canada in its projections (0.64% in 2036).

The sensitivity tests for the net migration variable are again based on an 80% confidence interval. The assumptions are an ultimate low-cost annual net migration rate for Canada of 0.65% and a high-cost rate of 0.55%.  The test results may be summarized as follows:

Ultimate
Average Annual
Net Migration Rate
from 2023
Minimum
Contribution
Rate
  Pay-As-You-Go Rates
2025 2050 2087
Lower-cost (0.65%)   9.75 10.22 10.83 11.51
Best-estimate (0.60%)   9.84 10.28 11.01 11.71
Higher-cost (0.55%)   9.93 10.35 11.19 11.92

Opinion on Migration

In our opinion, the AR26 migration assumption was reasonable.

6.2.4 Disability Incidence

The assumption about the incidence of disability takes the form of rates that vary by age, sex and year.  These can be summarized as an aggregate rate based on the current population distribution.  The experience indicates aggregate rates for 2012 of 3.10 new disabilities per thousand eligible male workers and 3.59 new disabilities per thousand eligible female workers.  The AR26 assumption is that disability incidence will increase over time to produce aggregate rates for years 2017 and later of 3.30 for males and 3.75 for females.  The adjusted ultimate rates in AR25 were 3.3 for males and 3.6 for females for years 2015 and beyond.

The use of historical data as the basis for assumptions about the future must always be done carefully.  In this case, very little weight can be given to experience data for the years before 1995, when there were major changes in the administration of the disability provisions that led to a significant decline in disability incidence rates.  The Chief Actuary must also take into account the effect of changes in the law, such as those introduced by the 2007 Plan amendments, which relaxed the minimum qualifying period, effective 3 March 2008, for those with 25 or more years of contributions.

The sensitivity tests for this assumption are an ultimate (2017 and beyond) low-cost rate per thousand eligible workers of 2.50 for males and 2.85 for females, and an ultimate high-cost rate of 4.10 for males and 4.65 for females.  This is again based on an 80% probability range.  The test results may be summarized as follows:

Ultimate
Disability Incidence
Rate from 2015
Minimum
Contribution
Rate
Pay-As-You-Go Rates
2025 2050 2087
Lower-cost (M 2.50, F 2.85)   9.65 10.12 10.79 11.50
Best-estimate (M 3.30, F 3.75)   9.84 10.28 11.01 11.71
Higher-cost (M 4.10, F 4.65)   10.03 10.45 11.22 11.91

Opinion on Disability Incidence

In our opinion, the AR26 disability incidence rate assumption was reasonable.

6.2.5 Retirement

The contributions to the Plan and benefits paid from the Plan are affected by the ages at which individuals start their CPP pension.  Prior to the implementation of the 2009 Plan amendments, contributions to the Plan by individuals, and by employers on their behalf, stopped when the individual started to collect a retirement pension, and neither contributions nor benefit accruals were resumed even if the individual returned to employment.  The amount of an individual’s retirement pension depends in part on the age at which it starts.  The Plan’s normal retirement age is 65, the earliest commencement age is 60, and the latest commencement age is 70.  Prior to the implementation of the 2009 Plan amendments, pensions were reduced by 0.5% for each month by which the pension start age was below 65, or increased by 0.5% for each month by which the pension start age was after age 65.

The 2009 Plan amendments amended the CPP, effective 1 January 2012, by removing the need for those under age 65 to cease working for the month before and the month of benefit commencement.  Those who choose to receive the retirement benefit while continuing to work must still participate in the CPP by making continuing contributions (matched by their employer) until age 65, and they receive commensurate benefit increases. Between ages 65 and 70, pensioners who are working can opt to contribute to the CPP and, if so, their employers must also contribute, with commensurate benefit increases to the pensioner.

Further, the early and late retirement pension adjustment factors are gradually being changed to factors that do not involve a subsidy.  From 2016, the Pre-65 Downward Monthly Adjustment Factor will be 0.6% and the Post-65 Upward Monthly Adjustment Factor will be 0.7%. In accordance with subsection 115(1.11) of the Canada Pension Plan, the Chief Actuary will recalculate the pension adjustment factors and specify them in every third triennial report, starting with the next triennial report as at 31 December 2015.

In AR26, the retirement rate represents the ratio of the number of individuals who elect to start receiving their retirement pension at a particular age to the total number of individuals who are eligible for a retirement pension at that age. Separate retirement rates are assumed for each year, each sex, and each age from 60 to 70 inclusive.

AR26 reflects the expected impact of the 2009 Plan amendments. AR26 states that the removal of the work cessation test in 2012 and the increase in the early retirement reduction factors from 0.5% to 0.6% over the period between 2011 and 2016 may have contributed toward the observed increase in retirement rates at age 60 in 2012. Starting from 2013, the age 60 retirement rates are assumed to gradually decrease to their pre-2012 levels as the higher actuarial adjustments are phased in and the effect of the removal of the work cessation test diminishes.  For cohorts reaching age 60 in 2016 and thereafter, the retirement rates at age 60 are assumed to decrease to 34% (males) and 38% (females) and to increase at age 65 to 41% (males) and 39% (females).  The overall impact of these changes in assumptions is to assume more early retirements during 2013 to 2015, followed by fewer early retirements thereafter, compared to what was assumed in AR25 (which also anticipated the effect of the 2009 Plan amendments  but without the advantage of hindsight regarding emergent experience).  The change in assumption was made to reflect the emergent and still-future impact of the 2009 Plan amendments.

Some observers suggest that, because of improvements in health and life expectancy together with the prospect of tight labour markets associated with the retirement of the baby boomers, there could be a tendency for individuals to retire at older ages in the future.  Others suggest that these considerations must be balanced against entrenched social expectations of early retirement.

There is no sensitivity test for the retirement rate assumption. With the new actuarially neutral Pre-65 and Post-65 Adjustment Factors, the minimum contribution rate is no longer as sensitive to the retirement rate assumption so we have no objection to the lack of a sensitivity test.

Opinion on Retirement Rates

In our opinion, the AR26 retirement rate assumption was reasonable.

6.3 Economic Assumptions and Opinions Thereon

6.3.1 Unemployment and Labour Force Participation Rates

The development of projected numbers and profiles of contributors begins with the development of calendar year labour force participation rates by age-sex groups and the application of these rates to the projections of the total population in each of those groups.  The participation rates are “cohort-based” to reflect expected changes in participation as a result of longer periods in education and training, the trend of postponing childbearing to later ages, better wages and more plentiful job opportunities as the demand for labour increases, and a move toward later retirement.

The resulting labour force projections are then used in combination with projections of assumed net jobs created to give projections of employed and unemployed workers.  The assumptions for net job creation are established so that the assumed rate of unemployment, 7.2% in 2012, decreases to a constant 6.0% from 2023 onwards for Canada (compared to an ultimate assumption of 6.1% from 2022 onwards in AR25).

There are two sensitivity tests for this assumption, both expressed as changes in the post-2030 assumptions for Canada as a whole.  A probabilistic range was not used for these assumptions as the pressures from an expected tight labour market as the baby boom retires seem unlike any labour situation experienced in the past. Instead, the low-cost ultimate assumed unemployment rate is 4.0%  together with an ultimate aggregate labour force participation rate for ages 15 to 69 of 81.8% (a 5 percentage point upshift) while the high-cost ultimate assumed unemployment rate is 8.0% together with an ultimate aggregate labour force participation rate of 72.9% (a 4 percentage point downshift). The ultimate unemployment rates are applicable from 2023. The aggregate labour force participation rates are for 2030.

Unemployment (U) and
Participation Rates (PR)
for Canada
Minimum
Contribution
Rate
Pay-As-You-Go Rates
2025 2050 2087
Lower-cost (U 4.0%, PR 81.8%)   9.59   9.50 10.73 12.30
Best-estimate (U 6.0%, PR 76.8%)   9.84 10.28 11.01 11.71
Higher-cost (U 8.0%, PR 72.9%) 10.12 11.02 11.30 11.43

Opinion on Unemployment and Labour Force Participation Rates

In our opinion, the AR26 assumptions as to the rates of unemployment and labour force participation were reasonable.

6.3.2 Real Wage Increases

Both contributions and initial benefits under the CPP are affected by wage increases.  Subsequent benefit increases are affected by inflation. The wage increase assumption is separated into two parts: the inflation assumption (discussed in Subsection 6.3.3 below) and the real wage increase assumption (the portion of wage increases above inflation) which is discussed here.

In AR26, the real wage increase assumption is applied to both average annual earnings (AAE, used to project contributory earnings) and to average weekly earnings (AWE, an index used to adjust the Year’s Maximum Pensionable Earnings).

The real increase in AAE is assumed to increase at the same rate as the real increase in AWE. An ultimate real wage increase of 1.2% has been assumed in years 2020 and thereafter for the best-estimate projections. Rates increase linearly from 0.5% in 2013 to 1.2% in 2020.

The OCA also considered real wage differential forecasts from three expert agencies:  the Conference Board of Canada, the University of Toronto Policy and Economic Analysis Program and Towers Watson’s Economic Expectations Survey, 2013.  These agencies forecast real wage increases from 0.8% to 1.7% with an average forecast of 1.1% ultimate.  The OCA ultimate assumption in AR26 is lower than the ultimate assumption in AR25 of 1.3%.

Several factors point to upward pressure on real wage growth:  the Government of Canada’s implementation of productivity-boosting measures, the upcoming expected tight labour market as well as the expected increase in participation rates and productivity of future generations of older workers.

The sensitivity tests for the ultimate real wage increase assumption with respect to 2020 and beyond was based on an 80% probability range.   This gave a low-cost scenario of 1.9% versus a high-cost scenario of 0.4%. The results of these tests are shown below:

Ultimate
Real Wage
Increases from 2019
Minimum
Contribution
Rate
Pay-As-You-Go Rates
2025 2050 2087
Lower-cost (1.9%)   9.26   9.77   9.87 10.46
Best-estimate (1.2%)   9.84 10.28 11.01 11.71
Higher-cost (0.4%) 10.51 10.94 12.55 13.46

Opinion on Real Wage Increases

In our opinion, the AR26 real wage increase assumption was reasonable.

6.3.3 Price Increases

The rate of price inflation is a necessary assumption for an actuarial review of the CPP.  CPP contributions, benefit payments and investment returns are all affected by inflation.  However, the extent and timing of these effects are not offsetting. The net result is that an increase in the inflation assumption results in a decrease in the pay-as-you-go rates and minimum contribution rate, and vice versa.

The price increase assumption in AR26 is 1.5% in 2013, 2.0% from 2014 to 2019, 2.1% in 2020 and then to remain at an ultimate level of 2.2% from 2021 onward. This reflects an expectation that the Bank of Canada will maintain and achieve its inflation control target during the near term, but that in the long term there will be challenges such as pressure from U.S. inflation, potential tight labour markets and uncertainty about future energy costs.

The sensitivity tests for this assumption are a high-cost scenario with an ultimate price increase rate of 1.6% and a low-cost scenario with an ultimate rate of 2.7%, from 2021 onward. This is again based on an 80% confidence interval. The results of these tests may be summarized as follows:

Price Increases
from 2021
Minimum
Contribution
Rate
Pay-As-You-Go Rates
2025 2050 2087
Lower-cost (2.7%)   9.74 10.24 10.86 11.59
Best-estimate (2.2%)   9.84 10.28 11.01 11.71
Higher-cost (1.6%)   9.97 10.34 11.20 11.88

Inflation in Canada was extremely volatile during the 20th century, with long runs of both very high and very low inflation. The present system of Bank of Canada five-year inflation targets has been in effect since 1991. Since this framework was introduced it has been remarkably successful at keeping the inflation rate in Canada generally within a range of +/-1% around the policy target. Our inquiries lead us to believe that this framework will continue for a long time and that there is no reason to expect an upward revision to the current target of 2%.

Our review of the opinions of some economists and financial forecasters found a concentration of views of long term inflation rates around 2%. Thus, we see the decrease in the long-term assumption from 2.3% in AR25 to 2.2% in AR26 as a cautious move in the right direction.

Opinion on Price Increases

In our opinion, the AR26 price increase assumption was reasonable. We would have chosen a slightly lower ultimate rate of price increases, which would have slightly increased the minimum contribution rate.

6.3.4 Real Rate of Return on Investments

If the CPP were totally unfunded (that is, if the contributions each year were just enough to cover that year’s benefit payments and operating expenses), then the CPP contribution rate would be equal to the pay-as-you-go rate and no assumption for the rate of investment return would be required.  However, under the steady-state contribution rate approach to financing the Plan, a sizeable fund will accumulate (eventually reaching more than five years’ benefit payments, according to AR26) and the rate of investment return becomes a material factor in determining the contribution rate for the Plan. The CPP assets totalled $175 billion at the end of 2012 and are projected to grow over the coming decades.

As with assumed increases in employment earnings and benefit payments, part of the assumed nominal rate of investment return is attributable to general price inflation.  Here we focus on the real rate of investment return (that is, net of the rate of inflation).

The best-estimate real rate of return assumption in AR26, net of investment expenses, is 2.7% in 2013, rising slowly to an ultimate assumption of 4.0% in 2019 and later.  The ultimate rate reflects a “building block approach” whereby, in real terms:

  • Long-term Government of Canada bonds are assumed to yield 2.8% per year.
  • Marketable bonds (government and corporate bonds of varying duration) are assumed to return 2.9% per year.
  • Canadian and foreign equities are assumed to return 2.2% per year higher than the yield on long Government of Canada bonds (emerging market equities 3.2% higher). This results in a lower-than-historical equity risk premium and an ultimate total real equity return of 5.0% per year for Canadian and foreign equities (6.0% per year for emerging market equities).
  • Real estate and infrastructure investments are assumed to provide a return calculated as 50% of the return on marketable bonds and 50% of the return on Canadian equities, resulting in a real return of 3.9% per year.
  • The actual CPP portfolio also holds non-marketable provincial bonds of steadily diminishing duration and importance since this component of the portfolio (14% of the total) is being gradually wound down by 2044. These bonds are assumed to earn varying returns over the intervening period consistent with the actual make-up of the portfolio and Chief Actuary’s expectations for future changes in bond yields.

The asset mix of the CPPIB as at 31 December 2012 was 50% equities, 33% fixed income securities and 17% in real estate and infrastructure.  The CPPIB does not adopt long-term asset mix targets.  The Chief Actuary postulated an assumed ultimate allocation of assets as 50% equities, 30% fixed income securities and 20% real estate and infrastructure reflecting the CPPIB’s planned near-term increase in commitment to real estate and infrastructure.  The Chief Actuary also assumes that annual investment management expenses will equal 0.2% of total CPPIB assets (excluding any added costs or added value from incremental risk-taking by the CPPIB, which are assumed to offset each other until such a time as a long-term track record has been established).

The sensitivity tests for this assumption are to increase or decrease the rate of return on all of the CPP assets to reflect an 80% confidence interval.  This gives a range from 2.5% to 5.5% with 80% probability. The results of these tests are summarized below and show the sensitivity of the minimum contribution rate to this assumption (pay-as-you-go rates are not shown since they are unaffected by the assumed real rates of return on CPP assets):

Real Rate
of Return
Minimum
Contribution
Rate
Lower-cost (5.5%)   8.97
Best-estimate (4.0%)   9.84
Higher-cost (2.5%) 10.73

From the Canadian Institute of Actuaries Report on Canadian Economic Statistics 1924-2012,real rates of return on Canadian equities have been approximately 6.6% per year over the last 89 years. Over the same period, the real return on long-term Government of Canada bonds has been approximately 3.2% per year, and the Canadian equity risk premium relative to returns on long Canada bonds has been about 3.4%. There is considerable variation in these results depending on the period chosen and the ending date. There is also considerable debate about the sustainability of these returns, particularly given the changes in the investment environment that have occurred during the last century (changes in laws and regulations, technological innovations, demographic shifts, globalization, incipient climate change, shifts in the relative returns to labour and capital, and so on).

The real rate of return assumptions adopted by the Chief Actuary are within the reasonable range, but his assumed equity risk premium is lower than the historical average for both Canadian and international markets, and lower than the risk premium postulated by many (but not all) experts. However, it should be noted that there is a wide range of expert opinion on this issue and much debate about both the relevance of the past and the prospects for the future.  We expect that the Chief Actuary will continue his research and consultation concerning the size and sustainability of the equity risk premium.  Such analysis should not be confined to the Canadian marketplace, since the CPP fund may be increasingly invested in non-Canadian assets.  Also, the analysis should not be confined to a review of the past, since the future may differ substantially.

Finally, the assumptions do not include any specific additional allowance for the CPPIB outperforming the normally expected returns for the chosen asset classes.  We understand that CPPIB staff compensation includes a significant reward for such outperformance, which may lead to higher real rates of return.

In this regard, it is important to understand that the 4.0% rate of return used in AR26 is not a target for the CPPIB to attain.  It is what the Chief Actuary estimates the returns will ultimately be given assumptions as to asset mix and rates of return for several classes of assets.  The mandate of the CPPIB is to earn a maximum rate of return within its stated risk tolerance levels regardless of what the Chief Actuary assumes ultimate real rates of return will be.

Opinion on Real Rate of Return on Investments

In our opinion, the AR26 real rate of return assumption was reasonable. We would have chosen a slightly higher ultimate real rate of return, which would have slightly decreased the minimum contribution rate.

6.4 Assumptions in the Aggregate and Opinion Thereon

The Chief Actuary’s actuarial assumptions are his best estimates, based on his review of past experience and his judgement about the likely course of future experience. For most assumptions, there is considerable room for actuarial judgement and the range of values that would be considered reasonable can be quite wide. In our review of the major actuarial assumptions, we concluded that each of them is within the reasonable range.

For only three of the ten major assumptions (mortality, price increases and real rate of return), we would have chosen assumptions slightly different from those chosen by the Chief Actuary. At our request, the OCA re-ran the actuarial valuation results using the alternative assumptions we would have chosen. The resulting minimum contribution rate was not materially different from that reported in AR26, although the projected assets-to-expenditures ratios were slightly higher.

Notwithstanding all this, we caution the reader that since the range of reasonable assumptions is wide, so too is the range of reasonable valuation results. The sensitivity tests in AR26 present plausible ranges of results but actual results could be even wider.

Opinion on Assumptions in the Aggregate

In our opinion, the assumptions in completing AR26 were, in the aggregate, reasonable.

Section 7 – Communication of Results

In this Section, we address the following question:

“Does the 26th Report fairly communicate the results of the work performed by the Chief Actuary and his staff?”

7.1 Background

AR26, as tabled in the House of Commons on 3 December 2013, is a bound soft-cover book, separately published in English (139 pages) and French (148 pages).

AR26 is available from the OSFI website at:
http://www.osfi-bsif.gc.ca/Eng/oca-bac/ar-ra/cpp-rpc/Pages/cpp26.aspx

Supporting information for AR26 is also available in great detail. The OSFI website provides links to:

  • all current and prior “Actuarial Reports” produced since the inception of the CPP,
  • “Actuarial Studies”,
  • documents relating to the “CPP Actuarial Peer Review”,
  • “Speeches and Presentations” by the OCA staff,
  • material presented at CPP-related and QPP-related “Inter-Disciplinary Seminars”, and
  • various other CPP-related documents.

In addition, the supporting working papers for AR26 are comprehensive. Detailed projection tables are available, in CD-ROM format, to the public upon request and are also provided to all provincial governments. We believe that the information in AR26 together with the supporting CD-ROM is sufficient for any reader to get a full understanding of the analysis.

7.2 Observations

AR26 is a very informative document. It includes a great deal of detail, a comprehensive Executive Summary, and many useful tables and charts. The overall conclusions are clearly set out.

AR26 has both a broad audience and a technical audience. The broad audience is mainly interested in the high-level results of the actuarial review. The technical audience of actuaries, economists, demographers, policy analysts, and others is interested in more extensive detail regarding the Plan provisions, data, methodology, assumptions, demographic projections and financial projections.

The Chief Actuary recognizes the dual nature of the audience and has changed the layout of the report to include the high level results in the main body of the report, while placing the more technical information in appendices.  Thus, the form of the report continues to be a compromise, containing more detail than is needed by the broad audience, and less than may be desired by technical readers.

We believe that the Actuarial Report could be made shorter and less technical by:

  • performing and presenting more of the analysis in the series of Actuarial Studies published by the OCA,
  • relying on the availability of the CD-ROM that contains the detailed projection tables for the Actuarial Report to meet the needs of more technical readers, and
  • publicizing the availability, upon request, of the CD-ROM that contains the detailed projection tables.

Actuarial Reports are prepared at three-year intervals. Interim reports are produced only if there is an amendment to the Plan. Yet interim reports prepared on a simplified basis could:

  • determine the approximate effects of important developments in Plan experience (such as the impact of a major recession, a major change in federal immigration policy, or a revision to the Bank of Canada’s inflation control targets),
  • give advance warning to stakeholders of potential future changes in the minimum contribution rate, and
  • provide an updated basis on which to evaluate potential changes to the Plan when such are under consideration by the stakeholders.

Given that interim reports have been produced when triggered by Plan amendments, the capability exists to produce them.

7.3 Opinion on Communication of Results

In our opinion, AR26 fairly communicated the results of the work performed by the Chief Actuary and his staff.

7.4 Recommendations

Recommendation 5:  We recommend that the Actuarial Report be made shorter and less technical by:

  • performing and presenting more of the analysis in the series of Actuarial Studies published by the OCA,
  • relying on the availability of the CD-ROM that contains the detailed projection tables for the Actuarial Report to meet the needs of more technical readers, and
  • publicizing the availability, upon request, of the CD-ROM that contains the detailed projection tables.

Recommendation 6:  We recommend that the Chief Actuary consider the issuance of annual interim Actuarial Reports, prepared on a simplified basis, to update stakeholders on material developments.

Section 8 – Other Issues and Recommendations Thereon

In this Section, we address twoother issues that we considered in our review, namely:

  • CPP expenses, and
  • external guidance in selecting assumptions.

8.1 CPP Expenses

AR26 includes Table 7, which shows the projection of Plan operating expenses, as well as Tables 9 and 88, which relate those expenses as percentages of contributory earnings and total earnings, respectively. Plan operating expenses have been, and are projected to be, mostly stable with the exception of a one-time expense that arose in 2012. Plan operating expenses include those incurred by ESDC, CRA, Service Canada, OSFI, and the Department of Finance.

CPPIB expenses are not included in Plan operating expenses in AR26, but are now reported as allocated to the CPPIB assets and accounted for separately in the investment expenses assumption.  We support this change from previous CPP actuarial reports.

From the AR26 working papers, we have the following information regarding total CPPIB expenses, measured as a fraction (in basis points, or bps) of average assets under CPPIB management:

Fiscal Year Ending March 31 External Management Fees and Transaction Costs (bps) Internal Operating Expenses (bps) Total CPPIB Expenses (bps)
2007 20 11 31
2008 29 13 42
2009 42 16 58
2010 53 20 73
2011 49 24 73
2012 57 28 85

The upward trend in total CPPIB expenses reflects a progressively more active investment management strategy.  Intuitively, one would expect that, over time, as operations become more established and as assets under management grow, expenses as a percentage of assets under management will stabilize, if not decrease.

We have been advised by the CPPIB that they are still building their active management capabilities but that the total expense ratio is projected to decrease from 85 bps in 2012 to 74 bps by 2017.

Fiscal year 2007 was the first year of implementation of the CPPIB active management strategy.  At that time, the CPPIB also created the CPP Reference Portfolio which is a hypothetical portfolio against which the value added returns from active management are measured.  In general, the objective of active management is to generate returns in excess of those from this benchmark portfolio, after reduction for the additional expenses incurred from active management.  Thus, the additional returns from a successful active management program should at least equal the cost incurred to pursue active management.

The following table compares the CPPIB added value calculated by the OCA (from which external management fees and transaction costs have already been deducted) with the internal operating expenses of the CPPIB. The net added value, after all CPPIB expenses, is then shown.

Fiscal Year Ending March 31 CPPIB Added Value Calculated By The OCA (bps) Internal Operating Expenses (bps) Net Added Value After All CPPIB Expenses (bps)
2007 235 11 224
2008 243 13 230
2009 0 16 -16
2010 -540 20 -560
2011 196 24 172
2012 200 28 172
Average 56 19 37

Over the period 2007-2012, the net value added averaged 37 bps but was extremely variable, with both large positive and large negative amounts. However, the CPPIB does not expect a large negative value like that of 2010 to occur again.

Consistent with accepted actuarial practice in Canada, AR26 reflects an assumption that the added value from active management will exactly equal the incremental expenses incurred to pursue that active management strategy. That is, no net value added is assumed to be either gained or lost. This assumption is a default position that will be maintained until it is clear that the active management strategy consistently and reliably produces added value over the long term. We agree with this approach and believe that it is important to closely monitor the relationship between incremental returns and incremental expenses with a view to refining this assumption in the future.

8.2 External Guidance in Selecting Assumptions

AR26 is a vitally important document.  Its audience is not only the federal and provincial governments, who are responsible for the governance and administration of the CPP, but also the millions of present and former contributors who rely on the CPP for their financial security.  The assumptions used in the report should be, and be seen as, the best available unbiased forecasts of future events.

Because of the wide range and complexity of the assumptions and methodologies involved in actuarial reviews of the CPP, it is desirable for the Chief Actuary to seek out the advice and guidance of experts, including actuaries, demographers and economists, in order to help ensure that a wide range of analysis and opinion is considered and to improve the credibility of the actuarial reviews.

To this end, the Office of the Chief Actuary hosted the 5th CPP Seminar on Demographic, Economic and Investment Perspectives for Canada, Years 2012 to 2050 on 28 September 2012.  Representatives of the OCA also attended a seminar hosted by the Régie des rentes du Québec on 29 November 2012. Participation at these events helped the OCA to formulate best-estimate assumptions and methodologies for AR26.

After the tabling of each of the last five triennial actuarial reports on the CPP (AR17, AR18, AR21, AR23 and AR25), OSFI engaged a panel of three independent actuaries to conduct a post-release review of the actuarial reports, similar to the review described in this report. All of these actuarial review panel reports have included a number of recommendations for improvements in, or revised approaches to, the processes, sources of data, methodologies and assumptions utilized in preparing actuarial reports on the CPP. This process provides a level of assurance to the public and also helps the Chief Actuary in gathering a range of views regarding the complex methodologies and assumptions involved.

The Chief Actuary has developed rigorous processes for the selection of assumptions. All decisions on assumptions are made in consultation with his internal staff, including two other actuaries who co-sign the report.  He draws upon the expertise of officials from other government departments and agencies who participate with him in interdisciplinary seminars, maintains effective two-way communication with the CPPIB, and devotes a considerable amount of time to keeping abreast of experts’ views on demographic and economic matters.  He also reflects the comments and advice contained in the reports of the actuarial review panels that reviewed the previous actuarial reports.

8.3 Recommendations

Recommendation 7: We recommend that the Chief Actuary analyze the incremental investment expenses incurred over time to implement the CPPIB’s active management strategy in order to assess whether added value is being consistently and reliably earned over the long term and, using that experience analysis, refine his assumption regarding the incremental rate of return from the active management strategy.

Recommendation 8:   We recommend that the Chief Actuary:

  • maintain his programs of research and consultation with experts,
  • continue the CPP-related seminars with presentations from an array of appropriate experts covering a range of viewpoints, and
  • maintain the effective two-way communication with the CPPIB, with the goal of achieving continual improvements in the process of setting best-estimate assumptions.

Signatures

This report has been prepared in accordance with accepted actuarial practice in Canada, and is respectfully submitted on 7 March 2014 by

Robert L. Brown, Mark W. Campbell, Thomas D. Levy; Signatures