Pension Reform in Canada: How to Build a Stronger, Smarter Retirement System

The views expressed in this article are those of the author and not necessarily those of McGill and ICPM.

A well-designed pension system brings enormous social and economic value to its members and society as a whole. Retirees have a reliable source of income during retirement when they are elderly and vulnerable. Retirees are also more inclined to spend and contribute to a healthy economy when they can rely on a steady income source.  In addition, a well-capitalized pension system encourages disciplined savings from an early age, which can lead to significant wealth accumulation over the life cycle and lower financial stress. These savings are invested in businesses, real estate, and infrastructure projects, which further contribute to a healthy economy.  

Unfortunately, Canada’s pension system does not stand out on the global stage. According to the Mercer CFA Institute Global Pension Index, Canada scores a B and ranks 17 out of 48 countries. This is passable but not great. What can Canada do differently to strengthen its pension system? I’ll use the Rule of Three and discuss three distinct strengths of the Canadian pension system, three major problems, and three actionable solutions. 

Strengths of the Canadian Pension System

The Canadian pension system has the distinct advantage of being balanced, providing a combination of safety and flexibility. Programs such as Old Age Security Pension (OAS) and Guaranteed Income Supplement (GIS) are means-tested and provide a social safety net for those with lower incomes. The Canada Pension Plan and its Quebec analog, the Quebec Pension Plan, provide a defined benefit plan for all Canadians. CPP/QPP benefits are portable, indexed to inflation, and cover up to one-third of the average Canadian pensionable earnings throughout retirement. In addition to these government schemes, many employers offer corporate pension plans to their employees. And individuals wishing to save more have a menu of tax-efficient vehicles to invest in.

The financial sustainability of the CPP/QPP schemes presents another distinct strength of the Canadian pension system. Thanks to important reforms passed in the mid-1990s, these national schemes, which previously operated on a pay-as-you-go basis, are now partly capitalized. Over the past twenty-five years, the high return generated from the invested capital has enabled the schemes to stay afloat and keep contributions and payouts stable despite the increased funding pressures resulting from the ageing population. By contrast, pension systems that continue to operate exclusively on a pay-as-you-go basis, such as the system in France, face mounting financial imbalances that are triggering politically unpopular discussions about raising the retirement age.

Another unique strength of the Canadian pension system is the strong governance structure of its large public-sector pension plans, which provide defined-benefit pensions for the military, teachers, and other public-sector workers. These plans operate at arm’s length from their governments, are run like private-sector organizations, and are renowned globally for their cost-efficient investment model, which consists of investing directly in a wide universe of assets ranging from listed equities to private infrastructure. The high returns earned over the past 20 years (about 8% annually on average) have enabled these plans to pay decent pensions to Canada’s public-sector workers and remain open and fully funded.

Challenges Facing the Canadian Pension Landscape

Unlike the public sector, where pension coverage is excellent, pension coverage in the private sector is surprisingly low, which partly explains the B score. Nearly 80% of private-sector workers do not have access to an occupational pension scheme. And for the 20% that do have access, the benefits offered by the plans are often subpar. 

Part of the problem is the high level of market fragmentation. Each province has its own regulator, making it challenging for companies hiring workers in multiple provinces to offer consistent and scalable pension plans. Added to this, most pension plans are tied to employers. This means that individuals relocating to another province or switching jobs may accumulate several pension pots, making it challenging to keep track of the different pots. 

The low household savings rate is another problem: Canadians do not save much for retirement. Canada has the highest household debt-to-disposable income ratio in the G7, at 185%. Furthermore, a survey conducted online with 2,000 Canadians aged 18 and over reveals that 4 in 10 Canadians have less than $5,000 in savings. Almost a third of unretired Canadians aged 55-64 say they expect to continue working in retirement to support themselves.

A third problem is that the governance of our public-sector plans is under threat. The eight largest Canadian pension funds, collectively known as the Maple 8, currently manage over CAD 2 trillion of assets. Increased nationalism and concerns about low productivity growth in Canada have triggered a hot debate about whether governments should exert greater control over the way pension funds invest. Last Fall, the Alberta government abruptly dismissed the entire board and CEO of AIMCo, the large asset manager for the province’s pensions and endowments.

Actionable Reforms for a Stronger Pension System

The more assets public-sector pension plans accumulate, the more tempting it will become for fiscally constrained governments to control the way the plans’ capital is invested. Stronger guardrails must be established to ensure the plans remain operationally independent.

One such guardrail is the adoption of an independent committee to identify and nominate new pension fund board directors who are appointed by the government. This will maximize the likelihood that new directors are highly qualified and non-partisan. Another guardrail is the requirement that the legislative branch confirms the new directors. This will ensure the appointments are made with parliamentary review and scrutiny. Finally, governments should not have the ability to terminate board directors before the end of their term under regular circumstances. This will ensure the directors have the freedom to act with a long-term focus, free from political pressures. 

For private-sector pension plans, the priority is to bring them up to par with the public-sector plans. For this to happen, we need to create scale. One path forward is to adopt a common set of standards and regulations for registered pension plans across provinces, which goes above and beyond the current CAPSA guidelines established by pension regulators to promote the coordination and harmonization of regulatory principles and practices across provinces. A common set of standards and regulations will level the playing field, provide an easier, more consistent, and scalable environment for employers, and reduce costs. 

Another pathway to creating scale is to promote pension plan arrangements that do not require an employer-employee relationship. This is the pathway pursued in Australia, where employees can request their employer to direct pension contributions to the pension plan of their choice. These plans do not offer the same degree of customization as employer-based plans, but are much more scalable and specialize in handling a large number of small accounts efficiently. In Canada, such a structure does not exist. One exception is the Saskatchewan Pension Plan (SPP), a defined-contribution plan created by the Saskatchewan government that is available to all Canadians, is portable, operates at arm’s length from government, and does not require an employer-employee relationship. 

In addition to creating scale, we need to improve the quality of private-sector pension plans. Most private-sector organizations provide a standard defined-contribution plan where employees are on their own and bear all the risks. The challenge is how to reduce risks for members without transferring those risks to employers.

One solution is to encourage the growth of jointly sponsored pension plans such as CAAT Pension Plan, Healthcare of Ontario Pension Plan (HOOPP), OPTrust Select and University Pension Plan (UPP). Jointly sponsored pension plans allocate risk across a broader membership base than single-employer plans and provide a “DB-like” stream of retirement income for employees without exposing employers to a significant risk of rising contributions. Another solution is to promote the growth of Variable Payment Life Annuities (VPLAs). These new types of annuities, which were recently proclaimed into law in Canada, provide an opportunity for pension fund members to pool a part of their retirement savings. In doing so, members can reduce important risks such as their own longevity risk in a cost-efficient way without putting employers on the hook. 

Building the Political Will for Change

Scoring an A on the Mercer CFA Institute Global Pension Index is possible. We know what the issues are and how to fix them. It’s a matter of building political will and coordination, and learning from other countries that have reached near-universal pension coverage and offer cost-efficient pension solutions for the private sector. Pushing forward these changes is a no-brainer, as a more robust pension system will improve financial well-being, reduce senior poverty and dependence on government, and encourage long-term investments. 

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