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Archived - Annual Report of Canada Pension Plan 2002-2003
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Financing the CPP
As joint stewards of the CPP, the federal and provincial ministers of Finance review the Plan's financial state every three years and make recommendations as to whether benefits and/or contribution rates should be changed. They base their recommendations on a number of factors, including the results of an examination of the Plan by the Chief Actuary. The Chief Actuary is required under the legislation to produce an actuarial report on the CPP every three years (in the year before the legislated ministerial review of the Plan). The CPP legislation also requires the Chief Actuary to prepare an actuarial report any time a Bill is introduced in Parliament that, in the view of the Chief Actuary, has a material impact on the estimates in the most recent triennial actuarial report. This is to ensure that the long-term financial implications of proposed Plan changes are given due consideration.
Changes to the CPP legislation governing the general level of benefits, the rate of contributions or the investment policy framework can be made only through an act of Parliament. All such changes require the agreement of at least two thirds of the participating provinces, representing at least two thirds of the population. The changes come into force only after two years' notice, unless all the provinces waive this requirement, and after Provincial Orders in Council confirming the changes have been passed. Quebec participates in decision making regarding changes to the CPP legislation, even though it has opted out of the CPP and administers its own plan. The Quebec Pension Plan must be involved in changes to the CPP if the two plans are to remain parallel.
In the fall of 2002, Bill C-3, An Act to Amend the Canada Pension Plan and the Canada Pension Plan Investment Board Act, was introduced in Parliament. The Bill is the final step in the investment changes agreed to by the federal and provincial ministers in 1997. The goal is to have CPP assets prudently invested in a diversified portfolio of securities at arm's length from government to better manage risk and return. The Bill enables the transfer of the bond portfolio and the operating balance (which are currently managed by the federal government) to the CPP Investment Board. Consolidating all assets in one professionally managed organization will allow the CPP Investment Board (CPPIB) to determine the best asset mix and investment strategy. The intent is to enhance rates of return and improve risk management for plan members. (The Bill received Royal Assent in April 2003.)
The finance ministers announced the completion of their most recent triennial financial review of the CPP in January 2003. As part of the review, they agreed to leave the schedule of contribution rates unchanged. The Eighteenth Actuarial Report, which was prepared for the review, confirmed the financial sustainability of the Plan (taking into account the projected aging of Canada's population). Further information on the most recent report as well as previous reviews of the Plan can be found at www.cpp-rpc.gc.ca.
The most recent federal-provincial review confirms the success of the 1997 Canada Pension Plan reforms in putting Plan finances on a sustainable track.
It also recognizes the ongoing success of federal-provincial co-operation in this area. This should strengthen the confidence of Canadians in the future health of Canada's retirement income system, of which the Canada Pension Plan is an important part. The federal and provincial ministers must complete the next financial review of the Canada Pension Plan by the end of 2005.
Actuarial Reporting
The Nineteenth Actuarial Report, tabled in Parliament by the Minister of Finance in 2002, projects the effect of Bill C-3 on the long-term financial status of the CPP. As required by the legislation, the Chief Actuary used the same assumptions and methods as in the Eighteenth Actuarial Report (prepared for the most recent triennial financial review of the plan). These were modified to take into account the proposed legislative change.
In the Nineteenth Actuarial Report, the Chief Actuary concludes that the legislated contribution rate (9.9 percent in 2003 and thereafter) should be sufficient to pay for future expenditures. The rate is also expected to accumulate assets of $1,578 billion by 2050, or 5.9 times annual Plan expenditures. The transfer of the bond portfolio and operating balance to the CPP Investment Board is expected to contribute a projected $85 billion over 50 years to asset accumulation. According to the Chief Actuary, the anticipated pool of assets should make it possible to absorb any unforeseen economic or demographic fluctuations without an increase in the contribution rate. Such fluctuations would otherwise have required an increase in the contribution rate above 9.9 percent. The Nineteenth Actuarial Report can be found at http://www.osfi-bsif.gc.ca/osfi/index_e.aspx?ArticleID=497, as can previous actuarial reports.
The Eighteenth Actuarial Report was tabled in Parliament by the Minister of Finance in December 2001. It provides an actuarial examination of the Plan as at December 31, 2000. The Report was reviewed by a panel of independent actuaries, and their conclusions should give Canadians confidence in the actuarial projections on the CPP. The panel concluded that the Report is based on economic and demographic assumptions that are reasonable in the aggregate (though somewhat on the conservative side). It also stated that the Report meets current professional standards of actuarial practice and uses data and methodologies that are appropriate and reasonable. In addition to its conclusions, the panel made a number of recommendations regarding the preparation of future actuarial reports. The panel's report and recommendations can be found at http://www.osfi-bsif.gc.ca/osfi/index_e.aspx?ArticleID=497.
A Fair Approach to Funding
When it was introduced in 1966, the CPP was designed as a pay-as-you-go plan, with a small reserve. This meant that the benefits for one generation would be paid largely from the contributions of later generations. This approach made sense under the economic, financial and demographic circumstances of the time. The period was characterized by a rapid growth in wages and labour-force participation, and low rates of return on investments.
The federal and provincial governments decided to keep contributions at a reasonable level while beginning to pay full retirement benefits as early as the mid-1970s. This was important - many of the seniors who received benefits at that time had been unable to accumulate sufficient retirement savings.
However, demographic and economic developments and changes to benefits in the 30 years that followed resulted in significantly higher costs. When federal and provincial finance ministers began their five-year statutory review of the CPP finances in 1996, contribution rates, already legislated to rise to 10.1 percent by 2016, were expected to have to rise again - to 14.2 percent by 2030 - to continue to finance the Plan on a pay-as-you-go basis.
Continuing to finance the Plan on a pay-as-you-go basis would have meant imposing a heavy financial burden on Canadians in the workforce 25 years down the road, which was deemed unacceptable by the federal and provincial governments. Therefore, in 1997, they agreed instead to change the funding approach of the Plan to a hybrid of pay-as-you-go and full funding. Under full funding, each generation pays for its own benefits.
Steady-state financing
To reduce the burden on future generations, the federal and provincial governments introduced "steady-state" financing in 1998. This approach requires that contribution rates be set no lower than the lowest rate expected to ensure the long-term financial stability of the Plan without recourse to further rate increases. At the time of the reforms, this was determined to be 9.9 percent. Therefore, under steady-state financing, the contribution rate was scheduled to increase incrementally (from 5.6 percent in 1996) to 9.9 percent in 2003, and to remain at this level thereafter.Steady-state financing will generate a level of contributions between 2001 and 2020 that exceeds the benefits paid out every year during this period. Funds not immediately required to pay benefits will be transferred to the CPP Investment Board for investment. As a result, Plan assets will cover an increasing number of years of expenditures over this period. Over time, this will create a large enough reserve to help pay the growing costs that are expected as more and more "baby boomers" begin to collect their retirement pension.
After 2020, as the last of the baby boomers retire, and benefits paid begin to exceed contributions, investment revenues from the CPP's accumulated assets will provide the funds necessary to make up the difference. However, contributions will remain the main source of funding for benefits.
The steady-state financing approach adopted in 1998 is a cross between full funding and pay-as-you-go. Moving to a full-funding approach would have created unfairness across the generations. During the transition, contributors of some generations would have paid higher contributions than others - they would have had to pay for the benefits of current retirees and for the development of a reserve to cover their own pensions. A pure pay-as-you-go approach would also have been unfair, as it would have meant a sharp increase in the contribution rate over the coming decades.
A partially funded CPP not only balances the two approaches to funding, but also contributes to diversifying the funding of Canada's retirement income system:
- the Old Age Security program, funded by federal government revenues, and
- private savings, including tax-deferred, fully funded employer-sponsored pension plans and registered retirement savings plans (RRSPs).
A diversified funding approach allows Canada's retirement income system to be less vulnerable to changes in economic and demographic conditions than are systems in countries that use a single funding approach. In addition, the Canadian approach to pension provision, based on a mix of public and private pensions, is an effective way to provide for retirement income needs, according to international organizations.