February, 2006

1. February, 2006 Canada Pension Plan (CPP):An examination of the 1997 reforms • Réal Bouchard • International Conference on Social Security Reform, Washington

2. Success and observations 1997 CPP reforms The CPP and the retirement income system (RIS) Challenges facing the CPP prior to reforms 1 3 2 4 Content

3. Canada’s Retirement Income System • Old Age Security (OAS) & Guaranteed Income Supplement (GIS) • Guaranteed minimum income for seniors, regardless of employment history; publicly funded through taxes • Canada Pension Plan (CPP) • Public plan, partially funded, defined benefits and mandatory contributions based on employment • Tax Deferred Private Savings • Mixture of mandatory and optional savings, funded by individuals and employers

4. 160% Two-income couples 140% One-Income couples Single 120% 100% 70 per cent replacement 80% 60% 40% 20% 0% 15,000 30,000 60,000 90,000 Pre-retirement earnings (C$) Proportion of pre-retirement earnings replaced by OAS and CPP in 2005

5. Canada’s Retirement Income System Tax-assisted private savings 43% Old Age Security32% Total: $80 billion for 2003 Canada Pension Plan 25%

6. The Canada Pension Plan (CPP) • Provides all workers in Canada with a taxable basic earnings-related retirement pension indexed to prices • Also survivor, disability and death benefits • Benefit replaces 25% of average pensionable earnings up to the average industrial wage • Maximum annual benefit C$10,135 (2006). • Financed by: • Mandatory employer/employee contributions split equally ( 9.9 %) on employment earnings between C$3,500 and C$42,100 (2006); • Investment earnings on excess contributions in 2022 on.

7. The CPP: Unique Features • Decision making is joint federal and provincial responsibility • Federal legislation but changes require provincial agreement • CPP revenues, expenditures and assets are not part of the public accounts of the federal government, i.e., • No impact on the financial position of the governments in Canada.

8. Public Pensions in Canada & US (2006 figures) Old Age Security Max :C$5,816 No Program Equivalent Supplemental Security Income (SSI) Max : US$7,236 Income-tested benefits Guaranteed Income Supplement Max: C$7,128 for single Old-Age Security & Disability Insurance (OASDI) Max: US$24,636 if started at age 65 and 8 months Contributory public pension plan CPP/QPP Max: C$10,135 if started at 65

9. Success and observations 1997 CPP reforms The CPP and the retirement income system (RIS) Challenges facing the CPP prior to reforms 1 3 2 4 Content

10. The CPP: From 1966 to1996 • Pay-as-you go system with a small reserve • Reserve invested solely in non-marketable provincial government bonds below market rates (with federal government as default borrower). • Contribution rates remained modest despite benefit enrichments and rising cost pressures • From 1966 to 1987 combined contribution rate of 3.6 per cent • Rose gradually to 5.6 per cent in 1996 – well below pay-as-you-go (PAYGO) rate (8.3per cent). • Future generations were to pay far more –contribution rates scheduled to rise to 10.1 per cent (2016) and projected to rise further.

11. 1995 Actuarial Report Raised Concerns The Actuarial Report projected • the Plan’s small contingency reserve would be depleted by 2015 – i.e., in just 20 years. • By then, the CPP would be unable to pay promised benefits even at the scheduled 10.1% contribution rate. • Costs would continue to rise – would require pay-as-you-go rate of over 14 per cent by 2030.

12. Main problem facing the Plan: RISING COSTS • Shifting demographics, notably a declining ratio of contributors to beneficiaries; • Slower earnings growth; • Successive benefit enhancements since inception; and • Escalating disability benefit expenditures in the previous decade due to looser administration and eligibility requirements.

13. Consultations • Sought Canadian’s views on solutions. • Broad consensus on: • CPP should remain a public defined benefit pension plan; • Contribution rates over 14 per cent unacceptable – current contributors should pay a “fairer” share of Plan costs; • Some pre-funding desirable provided assets invested like other pension plans; • Avoiding significant benefit reductions particularly for those already receiving a benefit.

14. Success and observations 1997 CPP reforms The CPP and the retirement income system (RIS) Challenges facing the CPP prior to reforms 1 3 2 4 Content

15. The Reform Package • Three-pronged approach to restoring financial sustainability • Significantly, and quickly, increased contribution rates to a level sustainable over the long term (i.e., 9.9 per cent from 2003 onward) and that permitted partial pre-funding • Adoption of a new investment policy with assets invested in marketable securities at arm’s length from governments • Changes to benefits and their administration to slow expenditure growth.

16. Move Towards Partial Pre-Funding • Increase contribution rate (from 5.6 per cent) to long-term sustainable level - 9.9 per cent by 2003 - and broaden the contribution base. • Contribution rate to cover the actuarially fair cost of new entitlements plus a share of the unfunded burden that has built up. • Allow CPP to build up a reserve fund equal to 5 years of benefits. • Investment earnings to help pay future benefits that otherwise would be financed by higher contributions.

17. New Investment Board and Policies • CPP Investment Board (CPPIB) established to manage assets in best interest of Plan members • Independent from the federal and provincial governments • Governed by a qualified board of directors. • Assets invested in a diversified portfolio of securities (instead of only bonds) to get higher returns • Subject to similar investment rules as other pension funds. • CPPIB to provide quarterly financial statements and annual reports on performance of the investments.

18. Benefits and Administration • No changes to benefits already in payment. • Measures taken to slow the growth of expenditures: • Change to wage indexation of retirement benefit calculation; • Administration of disability benefits tightened; • Eligibility for disability restricted by requiring ‘recent’ contributions and longer labour force attachment; • Death benefit reduced and frozen at C$2,500; • Other. • By 2030, projected expenditures reduced by almost 10%.

19. Considered but Decided Against • Options for reducing growth in retirement pensions (consultation paper), i.e., • Lower replacement rate (25 % to 22.5 %) • Increase in age of entitlement • Increase in years required for full pension through changes to benefit formula. • Move to partial indexing of pensions (consultations). • Replacing the CPP with Individual Retirement Accounts (post consultations).

20. Success and observations 1997 CPP reforms The CPP and the retirement income system (RIS) Challenges facing the CPP prior to reforms 1 3 2 4 Content

21. Tough changes made in part by. . . • The right timing • A sense of urgency • Economic and financial context buttressed reform resolve. • Public consultations framed an acceptable/balanced package. • Concrete measures built confidence that the Plan would be fixed for good • New investment policy was key • Measures to strengthen Plan governance/ accountability. 4) Federal-provincial decision-making held agreement together.

22. CPP Today • Financial sustainability restored: • 9.9 % contribution rate (since 2003) sustainable for at least the next 75 years; • Current/future contributors will receive a positive return on their contributions; • Actuarial projections reviewed by an independent panel of actuaries and results of their reviews are made public. • CPPIB recognized as a model internationally as a model of transparent, arm’s length and professional management of public pension funds • Assets totalled C$92.5 billion (about 7 per cent of GDP) at end 2005 with a total annual return of 8.5 per cent.