Presentations Slides - Intergenerational Balance of the Canadian Retirement Income System

Document Properties

  • Type of Publication: Presentation
  • Subject: Technical Seminar on "Proactive and Preventive Approaches in Social Security - Supporting Sustainability"
  • Date: 2013-02-24
  • Speaker: Jean-Claude Ménard, Chief Actuary

Presentation Outline

  • Intergenerational equity concept
  • Canadian retirement income system
  • Old Age Security Program
  • Canada Pension Plan
    • Creation of the Plan
    • Restoring intergenerational balance
    • Preserving future intergenerational balance
    • Measures of the intergenerational balance of the CPP
  • Private pension arrangements
  • Conclusions

Page: 1


The choice of measures of intergenerational equity of a program depends on a variety of factors

  • The assessment of the intergenerational equity of a program depends on answers to multiple questions:
    • What are the goals of the program?
    • How the program is financed?
    • Who bears the main burden of financing?
    • Etc.
  • Social security programs do not exist in isolation
    • The disruption of the intergenerational balance in one pillar may result in immediate or deferred increased costs for another.

Page: 2


Canadian Retirement Income System is based on a diversified approach to savings

  • Canadian retirement system is a three-tiered system with mixed funding approaches
    • Old Age Security Program – a universal basic pension/supplement financed using pay-as-you-go approach
    • Canada / Québec Pension Plan – mandatory earnings - related partially funded DB plans
    • Occupational Pension Plans and tax-favoured individual savings – voluntary fully funded arrangements
  • First two pillars replace about 40% of preretirement earnings for an individual with average level of earnings
  • Canadian retirement income system is well recognized in the world for its capacity to adapt rapidly to changing conditions.

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Old Age Security Program’s goal is poverty reduction among seniors

  • OAS is an universal old-age program
    • 97% of Canadian population 65 and over receive basic OAS
    • 34% of OAS beneficiaries also receive income-tested supplement (GIS)
    • Benefits are modest: basic OAS is 13% of average earnings, and average GIS paid is 12% of average earnings
    • All benefits are indexed to inflation
  • Financed from Government tax revenues on a pay-as-you-go basis
  • OAS is perceived as fair by Canadians – it provides a minimum amount at retirement.

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OAS expenditures are related to Canada’s economic growth by expressing them as % of the Canadian Gross Domestic Product

  • The stability of the level of expenditures is a good measures to assess the financial burden on different generations of taxpayers of a PayGo scheme
  • The cost of OAS as a % of GDP is very modest compared to other OECD countries
OAS expenditures as a percentage of the GDP (prior to most recent changes)

Source: the 9th Actuarial Report on the OAS as at 31 December 2009

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Planned increases in OAS eligibility age relieve financing pressure stemming from aging

Planned increases in OAS eligibility age relieve financing pressure stemming from aging

Source: the 9th Actuarial Report on the OAS as at 31 December 2009, the 10th and 11th Actuarial Reports Supplementing the Actuarial Report on the OAS as at 31 December 2009

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CPP - the second tier of the Canadian retirement income system

  • CPP and QPP are earnings-related plans providing indexed retirement, disability and survivor benefits to working Canadians
    • Came into effect in 1966
    • CPP/QPP cover virtually all working population of Canada
    • Cover earnings up to Canadian average wage
    • CPP contributions are paid in equal part by employer and employees currently at the combined rate of 9.9%
    • Provide retirement replacement rate of 25% of wage-indexed career average earnings
    • CPP retirement pension is paid at 65, but could be taken anytime between 60 and 70 with permanent down(up)ward adjustment
  • CPP is jointly governed by federal, provincial and territorial ministers of finance.

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To improve rapidly the adequacy of retirement income, the initial design of the CPP favoured cohorts close to retirement at the time of inception

  • The CPP was established as a pay-as-you-go plan with small reserve fund invested in non-marketable provincial securities
  • Several design features at inception affected intergenerational equity of the CPP
    • Combined employer-employee contribution rate was set up to 3.6%
      • 1964 projections predicted the contribution rate necessary to maintain the Plan will be between 4.3% and 5.2% by 2010.
    • The transition period for eligibility for full retirement pension was set to 10 years
      • It was felt that new plan should be meaningful for people close to retirement at inception
  • Low-income rate among seniors fell from 37% in 1971 to 22% by 1981
    • For overall population, the low-income rate went from 16% to 12% over the same period.

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Restoring intergenerational balance: changing economic and demographic conditions jeopardized future of the CPP

  • From mid-1980 CPP started to show signs of weakness
    • Assets were declining and contribution rate increases were necessary
    • In 1993, it was projected that by 2030 the PayGo rate will be 14.2% and the reserve fund will be exhausted by 2015
  • Main reasons for these problems were less births, longer lives, lower productivity and overutilization of disability provisions
  • Younger generations were loosing confidence in the CPP
  • As a result of cross-Canada consultations in 1996, it was decided to amend the CPP based, in particular, on the principle of fairness across generations.

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Restoring intergenerational balance: 1997 changes were aimed at stabilizing the contribution rate

  • Contribution rate increase from 5.6% in 1996 to 9.9% in 2003
  • Slowing of the future growth of benefits
  • Major changes in the financing approach
    • Moving from pay-as-you-go basis to partial funding approach called steady-state funding
      • The goal of the steady-state funding is to stabilize asset to expenditures ratio over time, therefore, calculate steady-state rate
      • Introducing full funding for new or improved benefits
    • Creating an investment board (CPPIB) to invest assets on the markets
  • New funding objectives improve fairness across generations and result in a stable contribution rate
    • Contribution rate remains unchanged at 9.9% from 2003
    • CPP Fund value is $170B at the end of September 2012

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Preserving future intergenerational balance: 1997 amendments strengthened CPP governance framework

  • FTP finance ministers review CPP every three years
    • Actuarial reports prepared by the OCA are one of the main sources of information for these reviews
    • These reports determine the sum of steady-state and full funding rates called a minimum contribution rate (MCR)
    • The actuarial reports are tabled in Parliament
    • The actuarial reports are reviewed by the independent external review panel and results of this review are publicly available
  • At the end of the review, ministers must make recommendations whether benefits and/or contribution rate should be changed, taking into account results of most recent actuarial report
    • The results of the review are shared with Canadians

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Preserving future intergenerational balance: Self-adjustment provisions share the burden of adjustment between contributors and beneficiaries

Insufficient Rates

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Preserving future intergenerational balance: Adapting plan to changing realities

  • Early/late actuarial adjustment factors favoured early and penalized postponed retirement. Updated factors:
    • 0.6%/0.7% per month for retirement pre/post age 65
  • In future, factors will be reviewed at least every 9 years to account for changing economic and demographic conditions
  • Retirement patterns of Canadian are evolving
    • Barriers to working and accruing further CPP benefits after retirement were removed.
CPP Working Beneficiaries as % of all CPP Beneficiaries

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Measures of the intergenerational balance of the CPP: MCR below the legislated contribution rate result in stability of contribution rate and benefits

Evolution of the Asset/Expenditure Ratio

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Measures of the intergenerational balance of the CPP: Internal rate of return is stable for cohorts born after 1970

  • The internal rate of return for a cohort is a rate such that
    • PV of all contributions paid = PV of all benefits earned
  • It is not known till the last member of the cohort has died, but can be estimated
  • The higher IRR for older cohorts is consistent with generous transitional measures at inception
  • For younger cohorts the IRR is stable – there is no anticipated future intergenerational transfer
Internal rate of return is stable for cohorts born after 1970

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Measures of the intergenerational balance of the CPP: CPP open group balance sheet confirms that future contributions revenues based on the current contribution rate in combination with expected investment earnings are sufficient to pay for promised benefits in a long term

CPP open group balance sheet

*Liabilities include administrative expenses.

Source: Actuarial Study No. 10 “Measuring the Financial Sustainability of the Canada Pension Plan”, January 2012

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Private voluntary tax-assisted pension arrangements in Canada are intended to be fully funded

  • Employer-sponsored pension plans (RPPs) cover 39% of Canadian workers (both DB and DC)
    • Proportion of active RPP members in private DB plans decreased from 76% to 52% over the last decade
    RPP coverage of paid workers
  • In 2010, 6 million Canadians contributed to individual Registered Retirement Savings Plans (RRSPs)
    • Share of tax filers contributing to the RRSP decreased from 29% to 24% over the last decade
  • Tax-Free Savings Accounts is a multipurpose saving vehicle introduced in 2009: 4.8 M contributors in 2009, 8.2 M in 2011.

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It is important to provide a favourable and equitable saving environment to each generation

  • In Canada, a majority of private sector employees do not have access to RPPs. Two ways to address this issue are explored:
    • Gradual, modest and fully funded expansion of the CPP (discussion in progress)
    • Recent introduction of Pooled Registered Pension Plans (DC)
      • Expected to have low administrative and investment costs
      • Benefits are fully portable
      • Fiduciary duties are transferred from sponsor to provider.
  • Assessing the intergenerational equity of the third pillar is complicated due to its fragmented nature and partial coverage

Page: 18


While the elderly low-income rate has significantly declined over the last 40 years, it is not clear if it will remain at the same level in the future

Elderly low-income rate

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Conclusions

  • The Canadian retirement income system performs quite well from the intergenerational balance point of view
  • It is an evolving structure and the emerging imbalances are corrected periodically
  • 1997 CPP amendments, 2012 amendments to the OAS, as well as recent introduction of new retirement saving vehicles for the third pillar are examples of such corrective actions

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