This week's news that Canada Post had a massive pension shortfall approaching $6.5 billion seem to come as a surprise to some people. Actually, the pension plans for Canada's public sector workers is in far worse shape than what we might think.
A study of Canada's public service employee pension plans by the Canadian Federation of Independent business shows just how pathetic the situation is for future public service pensioners. Most of these public service pensions are of the defined-benefit type where the ultimate pension amount is guaranteed based on salaries earned during the pensioners' working lifetime, not on the returns generated by the assets of the plan itself as in a defined contribution pension. What is particularly frightening about this is that ultimately the Canadian public is on the hook for any funding shortfalls. Part of the problem that taxpayers have with this issue is that public pension statistics are extremely difficult to ascertain in Canada and the actual size of the funding shortfall is a great unknown.
Here is a chart showing the financial position of public sector pension plans in Canada both provincially and federally:
In total, the present value of all public pension plan obligations is $530.4 million. Plan assets total only $313.5 billion meaning that there is an unfunded shortfall of just over $186 billion. On the federal side alone, the net unfunded pension liabilities are a minimum of $146.1 billion. One of the biggest problems that is affecting the real value of pension plan future assets is the discount rate used by pension plans to ascertain their future pension liabilities. Future liabilities are highly dependent on assumptions made on future interest rates or returns on pension assets. The Canadian Institute of Actuaries estimates that a drop of one percentage point in interest rates will increase the cost of supporting pension plans by between 15 percent and 20 percent Currently the federal government is expecting an annual rate of return of between 5.8 percent and 6.2 percent or roughly 4 percent once inflation is accounted for. The problem lies in the fact that this is what has happened to long-term inflation protected bond rates since 2003:
Quite obviously it is almost impossible to have achieved a rate of return of anything approaching 6 percent over the past decade. The C.D. Howe Institute has estimated that, using the real bond rate assumption of 1.1 percent rather than the 4 percent that the federal government is using, means that the federal government unfunded liability tension liability is closer to $227 billion or $80 billion higher than what the government estimates show. To put this number into perspective, this means that the public sector pension funding shortfall is roughly 1/3 of the total net federal debt.
If we want to see just how unrealistic the pension rate of return assumptions are for the provincial and federal governments, here is a chart showing their current discount rate assumptions:
When was the last time that you saw anything close to a 7 percent return on any low risk investment? Yet, governments across Canada suggest that such returns are still realistic.
Using the C.D. Howe Institute's assumed rate of return of roughly 1.1 percent, the combined federal and provincial net underfunded pension plan liability in Canada is somewhere in the $300 billion range. This is equivalent to approximately $100,000 per government employee plan member or, since taxpayers are ultimately on the hook for the shortfall, it will require $9000 from all Canadian men, women and children to negate the current level of pension underfunding.
There are five ways that these pension funding shortfalls can be made up:
1.) increased government employee contributions.
2.) higher top-up payments from government employers (i.e. taxpayers).
3.) a reduction in pension benefits.
4.) higher rates of return for pension funds.
5.) lower inflation and/or wage growth.
Both inflation and the rate of return are factors that are completely out of control of any pension fund manager. As a result, governments at all levels are relying on solving their pension short falls through increased revenue from taxpayers. While this might be a short-term solution, over the long-term it will become an increasingly unpalatable solution, particularly as provincial debt levels rise and the cost of servicing these higher debts also falls on the shoulders of taxpayers. While the provincial finance ministers while away the hours trying to rewrite the Canada Pension Plan, perhaps their time would be better spent trying to fix Canada's looming public sector pension plan crisis, a crisis that they are at least partly responsible for creating.
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