St. Augustine famously prayed, “Grant me chastity … but not yet.” Just like the 4th-century saint, Canadians are struggling to get from words to deeds—but in our case it’s our finances. We know saving is good. We know we need to be thriftier, to build our resources and pay down our debts and prepare for retirement. We want to be better. But not yet.
Canada’s household saving rate is less than 4%, and our appetite for housing has made us net borrowers every year since 2001. But we’re not just failing as individuals. Pension plans—the institutions entrusted with our future livelihoods—are also caught between our desire to live well in the future and our reluctance to sacrifice for it now.
All pension plans are struggling with these issues, but there are some lessons to learn from those that are responding.
The iconic Ontario Teachers’ Pension Plan offers several lessons. Teachers’ is widely admired for its investment performance. Among its other merits is a commendable realism about likely investment returns—it benchmarks off the federal government’s real-return bond yield, currently about 0.5%. And it communicates clearly to its members—including repeated warnings about how expensive their retirement expectations are becoming.
Those warnings are lesson one. The average teacher is likely to draw a pension—geared to her best five years’ earnings—for more years than she will work. So the OTPP’s liabilities have been outrunning its investment returns. Its 2011 annual report showed an unfunded liability of $45.5 billion. Scary—not least because non-teachers are also living longer and getting lower investment returns.
The second lesson is about wishful thinking. An OTPP review panel that surveyed the awkward demographics and economics a few years ago ended up recommending that the plan assume a higher rate of return. That’s unhelpful—it allowed contributions to stay too low, meaning too little saving to meet the plan’s obligations.
The third lesson is the subsequent wake-up to reality. The OTPP is not a pure defined-benefit plan, so it can also respond to inadequate funding by reducing the inflation indexation of its benefits. It has trimmed indexation in the past, and has just suspended it entirely for participants not yet retired.
Dozens of Canadian pension plans have no comparable benefit flexibility at all. Rather than trying to get it, they have sought, and often gained, permission to simply not fund their deficits. Government pension plans are the worst: the unfunded liability for federal employees stands at around $270 billion, and some of Ottawa’s plans—notably the one for members of Parliament—hold no assets at all.
Only in the province of New Brunswick does there seem widespread recognition that promises of retirement income are only as good as the saving that backs them. New Brunswick now permits defined-benefit pension plans to convert to shared-risk plans—if projections show inadequate funds, benefits can fall.
Inevitably, some people’s retirement expectations—whether they are in pension plans, or saving on their own—will need to come down. But the key imperative is not to give up on the aspiration, but instead to take real action to meet it. Real yields are likely to stay low for some time. As the crisis in state and local pensions in the U.S. starkly demonstrates, these abstract-looking liabilities on pension-plan balance sheets do inevitably turn into actual demands for cash.
Moreover, both within and outside pension plans, we can work and save for longer—especially if the tax rules became more generous. And Ottawa and the provinces could do more to boost saving by tempting sponsors and participants into defined-contribution and pooled registered pension plans.
The journey to virtue will be long, and fraught with temptation. St. Augustine’s conversion to chastity took time, but he got there. Surely, with a few smart policy nudges, we under-saving Canadians can embrace the virtue of thrift.
William Robson is president and CEO of the CD Howe Institute