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Archived - Annual Report of Canada Pension Plan 2003-2004
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Ensuring Financial Sustainability
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 reporting ensures 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 administers its own plan. It is important that Quebec be involved in changes to the CPP to ensure the portability of QPP and CPP benefits across Canada.
The legislation requires that federal and provincial ministers make best efforts to complete the next financial review of the Canada Pension Plan by the end of 2005. Ministers will base their review on a number of factors, including the conclusions of the Twenty-first Actuarial Report on the Canada Pension Plan, prepared by the Chief Actuary of the Canada Pension Plan for the purpose of the review. The previous triennial financial review of the Plan by ministers was in 2002. In the 2002 review, ministers concluded that the Plan was financially sustainable and agreed to make no changes to the Plan. Further information on this and previous reviews of the Plan can be found at www.cpp-rpc.gc.ca.
Actuarial Reporting
The Twenty-first Actuarial Report was tabled in Parliament by the Minister of Finance in December 2004. The report presented the financial status of the Plan as at December 31, 2003, and provided information to evaluate the Plan's financial sustainability over a long period, assuming Plan provisions remain unchanged. The findings of the report are an important element in the federal and provincial finance ministers' triennial financial review of the CPP slated for 2005. The last triennial financial review of the Plan by ministers was based on the findings of the Eighteenth Actuarial Report (as at December 31, 2000). Since this report, the Canada Pension Plan was subject to a series of amendments, the financial implications were outlined in the Nineteenth and Twentieth Actuarial Reports.
Canadians can have confidence in the results of the Twenty-first Actuarial Report and the conclusions reached by the Chief Actuary about the long-term financial health of the Plan. A panel of independent Canadian actuaries, selected through an arm's-length process, will review the report.
Federal and provincial finance ministers have endorsed regular peer reviews of triennial actuarial reports. The Office of the Chief Actuary has meticulously followed this recommendation. Panel reports and recommendations, as well as actuarial reports, can be found at www.osfi.gc.ca.
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 pay-as-you-go approach also allowed the federal and provincial governments 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 as part of the 1997 reform agreement. 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.
According to the Chief Actuary of Canada, steady-state financing will generate a level of contributions that exceeds the benefits paid until 2021. Funds not immediately required to pay benefits will be transferred to the CPP Investment Board for investment.
Plan assets will accumulate rapidly over this period and over time will help pay the growing costs that are expected as more and more "baby boomers" begin to collect their retirement pension.
After 2021, when most of the baby boomers have retired, 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 has moved the CPP away from pay-as-you-go financing (with a small reserve) towards fuller funding. By 2025, the Plan is expected to be about 25 percent pre-funded (i.e., Plan assets cover about 25 percent of benefits in pay and earned to that date). The move to steady-state financing has improved fairness across generations. Moving to full-funding would have contributors during the transition paying much higher contributions—they would have had to pay for the benefits of current retirees and for the development of a reserve to cover their own pensions. Continuing with a 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.
According to the Twenty-first Actuarial Report, as at December 31, 2003, the Plan is 12 percent funded. The relative size of the unfunded liability ($516.3 billion at the end of 2003) will decline over time as Plan assets grow more rapidly than Plan liabilities over the next few decades and at least as quickly thereafter. As a result, by 2025, Plan assets will cover about 25 percent of the Plan's actuarial liabilities. According to the Chief Actuary, the evolution of the funding level and the projected growth rates of assets and liabilities are better measures of the future financial health of the CPP than is the notion of the unfunded liability at a particular point in time.
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.