Pensions: defusing the ticking time bomb
Jim Leech talks about Canada's looming pension crisis and lessons learned from other countries.
At the CCCA Spring Conference in Calgary, National interviewed the former president and CEO of Ontario Teachers' Pension Plan, about his recent book (co-authored with Jacquie McNish), The Third Rail: Confronting Our Pension Failures. Jim Leech spoke to us about some of the hard choices Canadian governments must make to rescue future retirees from the oncoming pension crisis.
National: Why did you write this book?
Jim Leech: So the Third Rail was written to help Canadians, educate Canadians start to engage in the pension debate. We know that there are issues. Those issues are: One, people are not saving enough; two, we have people living far longer than they thought — therefore they need to save more. And three, we have a low return environment which means, again, you have to save more because there’s less return on your savings. These issues come to fore at a time when many of the plans we have in place are outdated or unsustainable.
So the Third Rail endeavours to address these issues for Canadians. We started with three case studies — one in New Brunswick, which is a negative growth province that was at the edge looking into the abyss of financial ruin because of its pension plan; one in Rhode Island, which had in fact gone over the cliff and was in free fall and [we looked at] what they had to do to get themselves stabilized. And then the Netherlands, which is the Stanley Cup of all pension systems in the world — by far the most sustainable and the one that everyone looks to. [In the book] we do studies of these three jurisdictions then draw lessons learned that can be applied to the Canadian system.
N: And so what is the state of play for pensions in Canada, outside of New Brunswick, which you describe as ground zero of the pension crisis here?
JL: The Canadian system doesn’t rank badly internationally but it can do far better. And the areas where there are concerns are around sustainability. We’re far better off than the United States, particularly in the public sector plans where they’ve just been kidding themselves for years with regard to things such discount rates and valuing the assets, undervaluing the liabilities, etc.
However, we are facing this huge migration of workers as seven million baby boomers of them move into retirement over the next 20 years. That’s putting great strain on the current system. The current system needs updating and some increased flexibility built into it so that we can weather the storms and absorb these major shocks of longevity and greater numbers of retirees.
N: Tell us about the hybrid Dutch model.
JL: There’s been mass migration from defined benefit plans to defined contribution plans. And that has really shifted the risk from the sponsor to the employee. And the employee is probably the least capable, the least ready or equipped to handle that type of risk. What we put forward in the book is a hybrid type of model [based on the Dutch model], which is somewhat in between [the two]. It can take advantage of the economies and the lower cost of defined benefit plans but also has risk sharing between the participant and the sponsor. This is the route that New Brunswick took in its shared risk plan. Clearly this is the route the Alberta government is following and it’s the route that many of the other jurisdictions in Canada are considering. Something that is between defined benefit and defined contribution and in fact has the benefits of both.
N: What do you think about Pooled registered pension plans?
JL: PRPPs which were introduced by the federal government and have been adopted by some provincial jurisdictions over the last number of years are really aimed at those workers who are self employed or the 60 percent of people who do not now have a workplace pension plan. Basically we feel—and that’s our third recommendation—that some type of large pool defined contribution plan is required to address the concerns of those constituents and we think the plan doesn’t go far enough. There are really three things that need to be emphasized. One is it needs to be mandatory, we’ve proven over the years that unless it’s mandatory we won’t save. We saw that with RRSPs, which have been a huge failure in that respect. So it has to be mandatory.
Secondly we need to try to take some of the risk out and again move it a defined contribution plan closer to defined benefit by requiring an annuitization during time so that at the end of the day when you open the box to see how much money you have left to fund your retirement you’ve got a portion of it, 40%, 50%, some portion of it is already locked in as a guaranteed income stream. Finally, there needs to be far more emphasis on cost. These plans need to be large; they need to be pooled so that you can get professional management at low cost.
N: What is it about defined benefit plans? Should they continue to play a role?
JL: It’s irrefutable mathematically that the DB plan is by far the least expensive way to save and provide retirement income… The primary reason is that under a defined benefit plan I can pool the longevity risk of many, many members so that as a plan manager I only need to save enough money to get to the actuarial mean of the pool of people. So if you’re a 65 year-old male today you’re expected to live to about age 86, 87, so I need to save enough money to provide income to that date. Because some of you will die a little earlier and some of you will die a little later. If I’m in a defined contribution plan I need, and I have my own individual account, I need to save enough money to last me to the far right hand side of that distribution. Because there’s a probability that I’m going to live far longer than 86. And it is terribly inconvenient to run out of money two years before you die. So that alone probably represents a 30 percent reduction in the amount of money I need to save. And right up front. So it is irrefutably far cheaper.
This interview was edited and condensed for publication.