Canadians unaware of risks to CPP

Canadians unaware of risks to CPP

Most Canadians are unaware of the risk that Canada Pension Plan (CPP) benefits could be reduced or the contribution rates increased, says Bob Baldwin, chair of the C.D. Howe Institute’s pension policy council and proprietor of Baldwin Consulting.

He said it’s important to understand that the CPP has legislated contribution rates and every three years the chief actuary has to calculate a minimum contribution rate. If that rate rises above the legislative range, and Canada’s finance ministers don't agree to another course, benefits have to be reduced or small contribution rate increases introduced until the chief actuary produces a report that says the minimum rate has dropped back down below the legislated rate. “These default propositions do put the benefits and contribution rate at some risk,” he said. The most likely trigger for this is if actual rates of investment return fall below the estimated rates, creating underfunding for the CPP.”

The other assumption that is “really important” is the real wage growth assumption. “This is a funny one,” he said, because as real wages increase, the base benefits become more easily affordable. However, in 2016, amendments to the Canada Pension Plan created two distinct CPPs under one heading.

There are certain financial aspects where the 2016 benefits are quite different from the benefits that were in place beforehand. And there are also minor differences in the way that benefits are calculated under the two parts of the program. “It's really like two programs operating under the CPP umbrella and that's why the differences in financing are much bigger than the differences in the benefits,” said Baldwin. These additional benefits become less affordable when wages grow. “So when the office of the chief actuary looks at the assumption with respect to real wage growth, they're mindful of the opposite impacts,” he said.

Another consideration is when the CPP assumptions will take into account the increasing number of baby boomers who are going to be retiring over the next decade or so.

The financing of the base benefits and the additional benefits are actually very insensitive to population aging. “In other words, they've set up a financing arrangement where we should be able to have quite stable contribution rates, even as the ratio of retirees to contributors goes up. If all goes according to plan, the contribution rates will remain quite stable,” he said.

However, the recent economic conditions could have a negative impact on financial markets which could, in turn, have an impact on increasing the contribution rate. This won’t be known until December 31, 2024.

The chief actuary has to perform a valuation every three years with the last December 31, 2021. If the experience between the last valuation and the next is not very good in terms of investment returns, a change could result. “What's really interesting in the last two actuarial reports is the gains came primarily from favourable investment returns which were used to make other assumptions more conservative. We won't know until we get there, but there is some chance that the 2024 report may have to show adverse experience because of poor investment returns,” said Baldwin.

However, he said there are solutions.

One is for the federal and provincial finance ministers, who have overall governance responsibility for this plan, to develop a communication strategy that goes beyond saying with every evaluation report that “everything's fine for the next 75 years. They have to find some tactful way of engaging the public in the reality that it’s only a hope that we can keep paying these benefits at the current contribution rate forever. You have to realize there is some risk involved. They should be engaging people to find a tactful way to make it clear that there is some not insignificant risk in the operation of the plan,” said Baldwin.