“Federal retirees’ pensions are too expensive. They are unsustainable!”
I’m sure that sounds familiar to anyone who has spent time scrolling through the comments section of any article that mentions public sector pensions. There is anger and confusion out there about just who pays for these pensions and whether they are sustainable — not just among the general public but also among politicians and even some of our own members.
We’re going to try to address these concerns and, hopefully, clear up some misunderstandings.
Private sector defined benefit pension plans are funded by contributions from both employers and employees. The funds are invested in capital markets, independent of the employer’s operating budget. The contributions and investment returns are used to pay for pension benefits. Historically, the Public Service Superannuation Plan (PSSP) and the plans for the Canadian Armed Forces and the RCMP have been a bit different.
It’s easiest to consider the plans as two distinct funds: the fund for pre-2000 service, and the fund for post-2000 service. As interpreted by the Supreme Court of Canada, before the turn of the millennium the pension plan essentially was just an accounting record that worked as a “pay-as-you-go” system.
In the pre-2000 context, employees, by reservation of salary in the range of 5 to 7.5 per cent (determined by legislation), would pay contributions into the Consolidated Revenue Fund (CRF). This fund is the federal account into which taxes and revenues are deposited and from which services are paid. Once money becomes part of the CRF, it can be used by the government for public purposes. The balance of payments in and out of the plan was kept through a “Superannuation Account.”
The government, for its part, would record credits, matching employee contributions, to the Superannuation Account — but no actual payments or transfers of funds were made. There are no real assets in the Superannuation Account.
The Superannuation Account balance was then treated as if it had been invested in Government of Canada 20-year bonds held to maturity, and the “interest” that was calculated would be added to the Superannuation Account.
Since 1966, the plan would undergo actuarial valuations every few years. If the plan was ever considered to be in a deficit position, the government would be required to make additional contributions, which happened from time to time. However, in the 1990s the opposite happened — the plan had a surplus (the credits exceeded the estimated cost of providing benefits). The government adopted the practice of amortizing the surplus (gradually using it over several years to reduce the overall federal deficit), effectively reducing its pension liabilities. By 1999-2000, the amount amortized had reached $18.6 billion (and the total surplus would reach $30.9 billion).
Things changed in 1999 with the passing of Bill C-78. First, the determination of contributions rates was taken out of legislation and handed to the Treasury Board. It would determine both employee and employer contribution rates based on actuarial valuations for each plan. This can be both a blessing and a curse, as it allows the plans to be more responsive to required changes but leaves decision-making in the hands of the president of the Treasury Board.
Second (and this is more important), the benefits that were payable with respect to service before April 1, 2000, continued to be paid from the CRF and charged to the Superannuation Account. But for other pension amounts earned going forward, an arm’s-length organization named PSP Investments was created to invest funds for the pension plans of the Public Service, the Canadian Armed Forces, the Royal Canadian Mounted Police and the Reserve Force.
PSP Investments is now one of Canada’s largest pension investment managers, with more than 700 employees. The plan consistently posts investment gains that exceed expectations. However, in 2014, even an actuarial process called “smoothing” was applied — and the plan was therefore deemed to be in a deficit position of $3.6 billion. The federal government was on the hook for hundreds of thousands of dollars in additional contributions a year. This was highly controversial.
Asset smoothing is used by actuaries to moderate the volatility in the reported market value of pension plan assets. Plan investment returns tend to fluctuate; smoothing diminishes the spikes caused by large deficits and surpluses that can happen with market fluctuations.
Former Chief Actuary Bernard Dussault believes using asset smoothing in this case is inappropriate. He says actuarial valuations already have to rely on a number of economic and demographic assumptions, and in the midst of this, asset smoothing takes a value we don’t have to project, and reshapes it into a projection. In other words, he says, it favours fiction over reality. It also — as was the case in 2014 — requires additional contributions when the plan is in a surplus position.
So who pays for federal public sector pensions?
Members of the PSSP who retired before 2000 would continue to be paid through the CRF. To oversimplify: They paid money into the larger “Canadian revenues” pot and — through a complicated process involving accounting records and assets that aren’t assets — they are owed a statutory defined benefit.
But if they retired after 2000, a portion of their pension would be paid from the revenues made up of contributions from employees and employer, and the investment returns of PSP Investments — much more like a private sector pension plan.
Are federal retiree pension benefits sustainable?
Yes. While the portion of the plan that continues to be paid from the CRF will always be referred to as a liability, that liability will gradually decline while revenues from PSP Investments continue to grow. Were it not for the inappropriate application of asset smoothing in 2014, the plan would have been in a surplus position — and PSP Investments continues to provide investment gains year after year.
PSP Investments recently announced its annual results for the year ending March 31, 2017: its portfolio return was 12.8 per cent net of all costs. PSP Investments had $135.6 billion of net assets under management at fiscal year end and expects to manage $200 billion by 2025.
The plan is sustainable from a financial standpoint. The political sustainability of federal public sector pensions might be another question.