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Annual Report of the Canada Pension Plan 2008–09
Ensuring Financial Sustainability
As joint stewards of the Canada Pension Plan (CPP), federal and provincial Finance ministers 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 first year of the legislated ministerial triennial review of the Plan). The CPP legislation also requires that the Chief Actuary prepare an actuarial report any time a Bill is introduced in Parliament that has, in the view of the Chief Actuary, 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 timely 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. Any such changes also 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 of 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 equivalent plan. It is important that Quebec be involved in changes to the CPP to ensure the portability of QPP and CPP benefits across Canada.
Triennial Review Results Announced in May 2009
The results of the most recent triennial review were announced jointly by federal, provincial and territorial Finance ministers on May 25, 2009. This review confirmed that the CPP remains on sound financial footing and is well positioned to weather the recent market downturn. Canadians can count on the CPP to be there for them when they retire. Ministers also proposed a number of changes to the Plan, to be phased in between 2011 and 2016, which are intended to increase fairness, flexibility and participation for older workers who will soon be retiring. Proposed changes include the following key elements:
- eliminating the work cessation test in 2012 so that a person can take their retirement pension as early as age 60 without stopping work or earning less;
- increasing the general drop-out from 15 percent to 16 percent in 2012, to allow a maximum of almost seven and a half years of low or no earnings to be dropped from the contributory period, and to 17 percent in 2014, to allow a maximum of eight years to be dropped;
- requiring a person under the age of 65, who receives a retirement pension and continues working or returns to work, to contribute to the CPP and thereby accumulate additional retirement benefits;
- permitting a person aged 65 to 70, who receives a retirement pension and continues to work or returns to work, to elect not to contribute to the CPP;
- gradually adjusting the pensions for early (age 60 to 64) and late (age 65 to 70) take-up of the CPP to ensure fair actuarial values; and
- requiring that the pension adjustments be reviewed periodically.
More information on the review’s conclusions can be found at
www.fin.gc.ca/n08/09-051-eng.asp.
Actuarial Reporting
The Twenty-third Actuarial Report was tabled in Parliament by the Minister of Finance on October 29, 2007. The report presents the financial status of the Plan as at December 31, 2006, and provides information to evaluate the Plan’s financial sustainability over a long period, assuming Plan provisions remain unchanged. The next statutory triennial actuarial report will present the status as at December 31, 2009; it should be completed before the end of 2010. The Report will take the recent financial downturn into account, as well as any other economic developments. The Report will also take into account the proposed changes recently announced by federal and provincial Finance ministers.
Funding Approach
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 rapid growth in wages and labour force participation, and low rates of return on investments.
However, demographic and economic developments as well as changes to benefits in the following three decades 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. This was deemed unacceptable by the federal and provincial governments.
Therefore, amendments were put into effect in 1998 to gradually raise the level of CPP funding by: increasing contribution rates over the short term; reducing the growth of benefits over the long term; and investing cash flows in the private markets through the CPP Investment Board (CPPIB), to achieve higher rates of return. A further amendment was included to ensure that federal and provincial Finance ministers consider the full funding of any new or increased benefits provided under the Plan. The reform package agreed to by the federal and provincial governments in 1997 included significant changes to the Plan’s financing and funding provisions. The package included:
- the introduction of steady-state funding to replace pay-as-you-go financing, in order to build a reserve of assets, equivalent over time to about five and a half years of benefit expenditures, or about 25 percent of the Plan’s liabilities. Investment earnings from this pool of assets would help to pay benefits when the large cohort of baby boomers retires.
- the introduction of incremental full funding, where changes to the CPP that increase or add new benefits would be fully funded. In other words, their costs would be paid as the benefit was earned and any costs associated with benefits that were paid but not earned would be amortized and paid for over a defined period of time, consistent with common actuarial practice.
Both of these funding objectives were introduced to improve fairness and equity across generations. The move to steady-state funding eases some of the contribution burden on future generations. Under full funding, each generation that receives benefit enrichments is more likely to pay for it in full and not pass on the cost to future generations. These full funding requirements were made operational through new regulations that came into effect with the adoption of Bill C-36 on March 3, 2008.
Financing
According to the Chief Actuary’s Twenty-third Actuarial Report, the level of contributions is expected to exceed the level of benefits paid until 2019. Funds not immediately required to pay benefits will be transferred to the CPPIB for investment. Plan assets are expected to accumulate rapidly over this period and, over time, will help pay for benefits as more and more baby boomers begin to collect their retirement pensions. In 2020 and thereafter, when most baby boomers will have retired, and benefits paid begin to exceed contributions, investment revenues from the accumulated assets will provide the funds necessary to make up the difference. However, contributions will remain the main source of funding for benefits.
The amended financing policy moved the CPP away from pay-as-you-go financing (with a small reserve) towards fuller funding. According to the Twenty-third Actuarial Report, the Plan was 15 percent funded (with an unfunded liability of $620 billion as at December 31, 2006) and projected to be 25 percent funded by 2025 (i.e., Plan assets are expected to cover about 25 percent of obligations), compared to about 7 percent funded at the time of the 1997 agreement.
Moving to full funding instead of steady-state funding would have eventually eliminated the unfunded liability, but would have created intergenerational unfairness. During the transition, contributors of some generations would have had to pay much 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. Continuing with a pay-as-you-go approach also would have been unfair, as it would have meant a sharp increase in the contribution rate over the coming decades. The fuller funding approach is more equitable for each generation.
A meaningful measure of the future financial health of the CPP is the adequacy and sustainability of the 9.9 percent contribution rate rather than the funding level at any particular point in time. According to the Twenty-third Actuarial Report, as at December 31, 2006, despite the projected substantial increase in benefits to be paid as a result of an aging population, the Plan is expected to be able to meet its obligation throughout the projection period. A partially funded CPP not only balances the two approaches to funding, it also contributes to diversifying the funding of Canada’s retirement income system, which also includes:
- the Old Age Security (OAS) program, funded by federal government general 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 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.