Rushing Toward Retirement

Demographics—and poor planning—could spell pension catastrophe

The publishing business may have seen better days, but you have to give the folks at McClelland and Stewart credit when it comes to The Third Rail: Confronting Our Pension Failures. Their timing, after all, could not be much better, given that they are releasing the book right as Canadian politicians appear finally ready to have a meaningful conversation about how to put this country’s retirement infrastructure on sounder footing. In Alberta, Ontario, New Brunswick and Prince Edward Island, plans are being brought forward to shore up their respective pension frameworks in advance of the arrival of the baby boom generation. As such, co-authors Jim Leech, the head of the Ontario Teachers’ Pension Plan, and veteran business journalist Jacquie McNish might actually get a fair hearing.

They deserve one, too. Their book, which is structured around case studies in New Brunswick, Rhode Island and the Netherlands, manages to take a topic that is defined by a confusing landscape of competing acronyms and accounting jargon—not exactly the standard recipe for a good read, in other words—and turn it into an engaging narrative about the past, present and future of pension programs. And while, in a political culture coloured by accusations of bribery and rogue senators, the comparatively mundane subject of pensions might not seem like a defining issue, that may be about to change very shortly as millions of baby boomers begin to retire and enter the years they had expected to be golden without nearly as much gold as they need.

According to a survey conducted by the BMO Wealth Institute that was released earlier this year, the average Canadian baby boomer has saved less than half of what he or she expects to need in retirement. Worse still, boomers’ expectations of what they will need to replace their current level of income is way, way too low. The generations behind them are not in any better shape either. According to a CIBC report, fully 5.8 million Canadians face a decline in living standards of more than 20 percent when they retire, with those born in the 1980s staring at a 30 percent drop. And while the government of Canada stepped in a generation ago to fill the breach with Old Age Security and the Guaranteed Income Supplement when it became clear that too many of this country’s senior citizens were living in poverty, that is unlikely to happen again. OAS and GIS payments, which come out of current tax revenues, are already the biggest line item in the government’s budget at $30 billion. That figure is expected to more than triple to $108 billion by 2030.

That leaves either an adjustment to the Canadian Pension Plan or the creation of a new retirement savings vehicle as the last line of defence for this country’s soon-to-be cash strapped retirees. That will not come easily, either, given that the demographics will continue to hamstring the ability of both public officials and pension plan managers to raise those resources. Nobody is more aware of that situation than Leech himself. “For the Ontario Teachers’ Pension Plan, which oversees one of the country’s largest and oldest pension memberships, the shift is even more dramatic,” he and McNish write. “Today there are only 1.5 active workers for every retired teacher. That ratio is expected to continue shrinking as more teachers, some of Canada’s healthiest employees, head out the door for a retirement that is projected to last for more than thirty years.” Even for a well-funded and competently managed plan like the OTPP, that is a recipe for trouble. For the rest of Canada’s pension plans, most of which are not nearly as well funded or expertly managed but all of which face the same demographic challenge, it could be a disaster.

It was not always thus, of course. As Leech and McNish describe in their early chapters, Canada has traditionally been a leader when it comes to pensions. Indeed, United Empire Loyalist soldiers who fled to the Maritimes in the wake of the American revolution received one of North America’s first pensions in the early 1800s. Public servants got one of their own in 1870, fully four decades before their counterparts south of the border, while Canada’s banks were also earlier, albeit less dramatically, than their American equivalents in providing pensions for their employees. But perhaps the best example that Leech and McNish provide is that of Egerton Ryerson, the namesake of Toronto’s Ryerson University and a man who, as the chief superintendent of education for Upper Canada back in the 1840s, created a modest pension for teachers who were “worn out in the service of their country.” Those teachers each received £6 for each year served, provided they were “indigent” and “of good moral standing.”

As Leech and McNish observe, “Ryerson’s modest pension ambitions, however, were thwarted by a shortsightedness that would afflict future pension fund managers: he underestimated how much it would cost to fulfil his promise. He anticipated a few dozen teachers would be eligible for the pensions, but by 1858 more than 150 teachers had been approved. He was forced to award teachers only £2 for each year served—perhaps the first pension to adjust benefits because of funding challenges.” In fact, the vast majority of people who were nominally entitled to a pension never collected on it. “The great irony about these conditional pensions is that during the first half-century of pensions most employees did not live long enough to collect their retirement bounty,” Leech and McNish write. “When Grand Trunk [railway] introduced its first pension in 1874, average life expectancy was about fifty-five. The average worker had likely been dead for fifteen years before they were eligible to pocket pensions at the then retirement age of seventy.”

By the end of World War Two, that too had changed. Pensions were no longer a conditional gift to workers but a popular incentive, and one that, due to rapidly increasing life expectancies, was being collected upon more often than not. And while companies and governments were able to fulfil those promises fairly easily for more than five decades due to the demographic gift of a massive generation of baby boomers who contributed far more than their retired parents withdrew, that imbalance between savers and spenders is in the process of shifting in the other direction—with enormous consequences for both groups. As Andrew Coyne highlighted in the National Post in January 2012, “Over the last 50 years, Canada’s labour force grew by roughly 200%, fastest in the developed world. Over the next 50 years, it is projected to grow by little more than 10%. Indeed, over the next decade, as more people leave the work force than enter it, we are in for an absolute decline in numbers. Add it up, and the ratio of available workers to retirees, near 5 to 1 not long ago, is headed toward 2 to 1.”

As such, the two basic conditions that helped build Canada’s pension system—contributors outnumbering beneficiaries, and the retirements of those beneficiaries being substantially shorter than their working careers—no longer exist. And as Leech and McNish document, there are a few jurisdictions where the consequences of that have already begun to play out. The catch, of course, is that the people running the pensions in those jurisdictions have not had the freedom that Egerton Ryerson had to unilaterally reduce or eliminate benefits. Instead, they have had to find ways to take back benefits that were promised to retirees, a process that is inevitably fraught with political and personal tension.

Leech and McNish do an excellent job of documenting that process, and ferreting out the key characteristics that allowed leaders in Rhode Island, New Brunswick and the Netherlands to find a way forward in their respective situations. In each case, the common denominator of success was the existence of political leaders who were willing to have an honest and highly unpopular conversation with the people they represented—be they voters, union members or some combination thereof—that did away with the usual half-measures and horse trading that can define politics in a democracy. In New Brunswick, for example, Marilyn Quinn, the president of the province’s nurses’ union, said that “transparency was essential; we told them what was happening and they trusted us to do the right thing.”

Equally important, as Leech and McNish highlight in the chapter on Rhode Island’s path to pension solvency, was the ability of those politicians to get buy-in from the public. And getting people to that place was not always easy; in Rhode Island it meant allowing particularly intransigent labour leaders to walk their membership off the cliff and into bankruptcy, while in the Netherlands it involved enduring massive public demonstrations,
including one that drew 200,000 into the streets in Amsterdam’s Dam Square. But, in the end, each of the case studies demonstrates that politicians can, in fact, make progress on this issue. As Rhode Island general treasurer Gina Raimondo said after her state (one that tilts heavily toward the unionfriendly Democratic Party) passed a controversial pension reform bill by an overwhelming margin, “Government worked tonight … On one of the toughest, most financially complicated, politically charged issues we face, we did something right.”

The real question, of course, is whether Canadian politicians can do something right when it comes to pensions in this country. Unfortunately, it is a question that, for all of its strengths, this book does little to help answer. While it makes some important prescriptive suggestions, including the merits of a shared-risk model that protects existing benefits but makes future increases conditional on the financial health of the pension plan in question,
it largely ignores the political challenges associated with building support for it. Canada is not New Brunswick, not Rhode Island, not even the Netherlands, all of which are both culturally and politically homogenous. Canada is defined by its fractious federal system, and the changes the authors are suggesting would almost certainly upset not just organized labour but also many of the nearly 10 million baby boomers who vote more regularly than any other demographic in the country. Given the near-hysterical response that greeted the federal government’s modest changes to OAS in 2012 from some quarters (changes that, at most, delayed the age at which people qualify for the program by two years, and that will not take effect until 2023), it is hard to imagine that asking for a bigger contribution from those who are close to retirement—say, making cost-of-living adjustments conditional rather than guaranteed, as the authors suggest—would not spark an even bigger backlash.

And despite Leech and McNish telling CBC’s Anna Maria Tremonti that intergenerational equity was a driving concern, that message is largely absent from the book itself. The authors spend a good deal of time dispatching the widespread idea that the public sector’s so-called “gold-plated” pensions should be subject to review, noting that such notions are “often shaped by envy, anger, and fear.” But they spend virtually none addressing the concerns that people under the age of 45, all of whom have spent the majority of their lives paying CPP premiums that are double what boomers themselves did up until 1993 with no concomitant increase in future payouts, might have about the government reaching into their pocket once again. This looming conflict between retirees and workers is the main event, the centre stage, the feature attraction. It is a shame that it does not get more advance billing—or much of a spotlight—in this book.

Finally, there is the fact that The Third Rail raises a single, overarching question that does not get asked, much less answered. If the retirement model is fundamentally broken, should we be trying to fix it? The authors do a fine job detailing the various ways in which the average pension plan is deficient and how it ought to be modernized, but it is curious that they do not even broach the possibility that we might have to modernize our view of what a retirement should be as well. Is it still reasonable, in an increasingly knowledge-oriented economy and with an aging population that will live longer, on average, than ever before, even to expect full retirement benefits at the age of 65? And what of the notion that people may not need to replace a substantial portion of their pre-retirement income, given the possibility (a mutually beneficial one, as far as workers and their employers go) of post-retirement part-time work and other income streams that were not available to retirees a generation ago? Perhaps these are questions for another day—or another book—but they are ones that deserved at least a passing mention in this one.

There are also some curious oversights, such as the authors’ failure to mention the rise of lowcost exchange-traded funds that have come onto the market in recent years, which render their concerns about the corrosive effect on returns of high mutual fund management fees less relevant if not largely moot. Those ETFs allow investors to track the markets effectively at virtually no cost, a strategy that has historically outperformed the machinations of even the savviest of active managers—even ones who enjoy the economies of scale that Leech and McNish suggest make defined benefit plans like the OTPP a better bet for everyone involved. There is also their conspicuously negative view of the markets as a whole, one that is almost certainly informed by the fact that they were researching and writing the book when the calamity of 2008/09 was still a recent memory. But those markets have more than recovered the losses they suffered during that period, and so too did the pension plans that were—and remained—invested in the market. Markets will rise and markets will fall, but over the longer term—precisely the time frame that anyone saving for retirement ought to calibrate their investing habits for—those who avoid the stock market do so at their own expense.

Nevertheless, and in spite of these oversights, The Third Rail does an excellent job of framing the pensions issue and providing readers with the context they need to understand it properly. Whether Canada’s political class is prepared to act on it remains to be seen. Indeed, therein lies something of a quandary for pension reformers, since, as Leech and McNish point out in two of their three case studies, for things to get better they must first get far worse. Given the gains that pension funds have made in 2013, we may not be there yet, and there is no telling when we will. Leech and McNish’s book will be a helpful road map for both policy makers and the public at large when we get there—provided it is not too late.