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Making The Ontario Retirement Pension Plan Work For Janet And John: What Will It Take

Woman painting and man with grandson fishingOntario’s ORPP is meant to address the looming retirement savings problem facing many middle-income, private sector workers like the Janets and Johns in this paper. The paper argues that the current version of the Plan is problematical in its benefit design, and in how it is targeted. It also argues that enlarging the CPP would not be the panacea many seem to think. Instead, fixing the specific ORPP problems identified in this paper would offer the targeted group of middle income, private sector workers the best hope of achieving the post-work financial security they aspire to.1

What Is The Pension Problem To Be Solved?

If the proposed Ontario Retirement Pension Plan (ORPP) is the solution, what is the problem the Plan is meant to solve? There are in fact two problems: Millions of middle-income private sector workers in Ontario are not members of an employment-based pension plan. As a likely result, many of these workers will not save enough to finance the retirement they aspire to2, and, as another result, many of those who think they are saving enough for retirement on their own, are being advised to pay uneconomically high fees for retirement investment services, which will result in materially lower pensions than they aspire to.3

Ideally then, a well-designed ORPP does two things. First, it gives Ontario’s workers saving insufficiently for retirement easy access to an arrangement that (a) facilitates a simple, systematic approach to accumulating retirement savings, and (b) does so in a highly professional, cost-effective manner. Second, it gives Ontario’s workers who think they are saving sufficiently for retirement access to an effective, much lower-cost retirement savings option currently not available to them.

This paper assesses how effectively the ORPP, in its currently proposed form, is likely to achieve these two goals. The currently proposed form is likely to fall short in two important ways: in plan design, and in how it is targeted. The paper suggests four measures that would make the ORPP a better-designed, better-targeted vehicle.

It’s All About Janet And John

A lot of the commentary we are reading on the ORPP proposal is not about the people it is meant to serve. Federal and provincial politicians are divining the vote-getting potential of pro- and con-ORPP stances. Organized labour keeps beating the single ‘expand the CPP’ drum. The financial services industry is gauging the various options from their own profit potential perspectives. Employer groups worry about mandated increases in their labour costs. The media don’t really understand the issues. Economists call all these perspectives ‘agency issues.’

This paper assesses the ORPP proposal from the perspectives of Janet and John, two middle-income Ontario workers who are not members of an employment-based pension plan. They are the ‘principals’ in this ORPP conversation. Here is a simplified description of their situation:

Where is this second $20K/year for 20 years going to come from?

Financing Janet And John’s Supplementary Pension

The simple answer is that it comes from saving part of the $60K/year earnings. How much needs to be saved to finance 20 years of retirement? That depends on whether or not the retirement savings are invested, and what return they earn. Consider two cases: zero per cent and four per cent:

The calculations also point to two uncertainties facing Janet and John: they don’t know how long they will actually live, and they don’t know what the return on their retirement savings will actually be.

These two uncertainties raise a fundamental question: who will underwrite the shortfall risk between expected and actual longevity outcomes and between expected and actual investment return outcomes?

Decades ago, employers underwrote the shortfall risks in the form of traditional defined benefit plans. At the time, this seemed like a reasonable thing to do. Workforces were relatively young and homogeneous, economic growth was robust, investment returns were strong, and regulatory and financial disclosure requirements were ‘soft.’

These days are gone. Today’s retiree populations are relatively larger, workforces are older and less homogeneous, economic growth is less robust, investment returns are weaker, and regulatory and financial disclosure requirements are ‘harder’.

Not surprisingly, employers are far less keen to be pension risk underwriters today. That is why traditional DB plans are now under siege. It is also the reason why Janet and John are no longer members of an employment-based supplementary pension plan and why an ORPP initiative has merit today.

Three Design Principles For Helping Janet And John

Setting out some ORPP design principles to guide how to best help Janet and John is a good place to start. Here are three:

Next comes an assessment of the ORPP proposal as it currently stands.

Four Current ORPP Proposal Shortcomings

With these three principles in mind, I see the current ORPP proposal falling short in four ways:

In addition to these four ORPP shortcomings, there is a fifth lurking in the background. It is the ongoing lament that if only there was a federal-provincial consensus to expand the Canada Pension Plan, we wouldn’t need the ORPP. This view is being voiced not only by the Ontario government, but also by the two federal opposition parties, by organized labour, and even by the Globe & Mail editorial board. In my view, this broad-based lament suggests a fundamental lack of understanding of the economics of the CPP and of the importance of recognizing the path-dependency principle set out above.

Why CPP Expansion Is The Wrong Way To Go

The CPP was established 50 years ago in response to the recognition that the Canadian seniors’ poverty rate was unacceptably high. The plan was set up as a pay-as-you-go system, with payroll deductions quickly converted into modest pension, long-term disability, and death benefit payments. In the beginning, with all workers contributing and only a few people eligible to collect CPP benefits, it was a low-cost system. However, after 30 years of operation (i.e., by the mid-1990s), the system had matured considerably. By then, rising future CPP benefit payment projections implied future pay-go contribution rates would rise to unacceptably high levels. A federal-provincial consensus was reached to quickly double the CPP contribution rate to its current level of 9.9 per cent of pay. This would create a large-enough reserve fund (to be managed by the CPPIB) so that under reasonable economic, demographic, and investment return assumptions, the 9.9 per cent of pay contribution rate could be maintained into the indefinite future ... and that has been the case so far.7

The reason for this brief recounting of CPP history is to point to the significant wealth-transfer embedded in its 50-year history. Essentially, in the beginning, younger generations of Canadians ‘gifted’ CPP benefits to older generations. The measure to move the CPP from a 100 per cent pay-go system to a 25 per cent prefunded system was intended to prevent any further wealth transfer of this kind in the future. To ensure this, the CPP reformers of the 1990s amended the CPP Act to require that any future CPP benefit enhancements would have to be fully pre-funded. That is, any proposed benefit enhancement today cannot go the ‘pay-go’ route. Instead, it would have to be priced and paid for as the enhanced benefits accrued over time.

All this exemplifies the importance of recognizing the path-dependency principle set out above. As part of the CPP story, the prefunding requirement raises fundamental questions I have not seen addressed by the CPP expansion enthusiasts. Here are three examples:

My suspicion is that consciously or unconsciously, the CPP expansion enthusiasts would like to do an end-run around the ‘no more wealth-transfers’ safeguards put in place by the CPP reformers of the 1990s. This is not a place we should be going.

Making The ORPP Work For Janet And John

The simplest, most direct way to help Janet and John is to enrol them in an understandable, stand-alone ORPP which sits on top of the current CPP/OAS/GIS structure, and has four key features:

A fifth requirement to make the ORPP work for Janet and John is to ensure that it is set up as an arms-length institution with a stakeholder value-creating mindset. Ontario did this in 1990 when it, together with the Ontario Teachers Federation, created the Ontario Teachers’ Pension Plan. Today, OTPP ranks #1 in the world in long-term investment performance and benefit administration quality.13 Janet and John deserve no less.

Keith Ambachtsheer provides strategic advice on pension plan design and on the governance and management of pension and other long-horizon investment institutions through KPA Advisory Services. His primary clients are pension organizations, but also include governments, industry associations, pension plan sponsors, foundations, and other institutional investors around the world. He started a strategic research and education program on these issues through the Rotman School of Management at the University of Toronto in 2004 and is now director emeritus of the International Centre for Pension Management at the Rotman School. At the start of 2011, he was appointed academic director of the Rotman-ICPM Board effectiveness program for pension funds and other long-horizon investment institutions. He is a member of the Ontario government’s technical advisory group on retirement security

1. The paper benefitted from a number of expert reviewer comments. However, the views expressed here are solely mine.

2. ORPP critics observe that the targeted group of middle-income, private sector workers retiring with insufficient savings is relatively small today. The question is: will that still be the case 20, 30, 40 years from now? There is a plausible ‘will not be the case’ scenario that justifies the ORPP initiative (i.e., more student debt, later workforce entry, and no more ‘wind-in-back’ boosts from robust economic growth, and from robust financial and real estate markets, as was the case in the last 20, 30, 40 years).

3. See “The Feeling’s Not Mutual” by CCPA’s David MacDonald (February 2015). 

4. For example, the life-cycle theory of personal finance suggests a simple pension-generation design that starts out accumulating retirement savings and converts most of these savings into life-long annuity payments as people age. Actual pension designs (e.g., with names like ‘shared risk’ and ‘target benefit’) continue to force plan members into ‘one-size-fits-all’ structures that ignore the different risk appetites of the young and the old, invoke arbitrary actuarial assumptions, and lack clear property rights.

5. An important complication here is the claw-back feature of the Guaranteed Income Supplement (GIS) for low income workers. Requiring low-income earners to save for retirement in a way that would reduce their future GIS payments is obviously counterproductive. We note below that the simplest way to deal with this problem is to introduce an opt-out feature into the ORPP and plain, clear language indicating that the plan is not designed for low-income workers. 

6. The White House has just indicated that President Obama’s speech to the AARP will say “the rules of the road do not ensure that financial advisers act in the best interest of their clients when they give retirement investment advice, and it’s hurting millions of working and middle class families ...” Where do Prime Minister Harper and Premier Wynne stand on addressing this issue?

7. See Bruce Little’s 2008 book ‘Fixing the Future’ for the full story. 

8. See my paper ‘Taking the Dutch Pension System to the Next Level: A View from the Outside’ for a more detailed exposition of this life-cycle-based approach to pension design. It can be accessed via the KPA Advisory Services website. At least in the Netherlands, the importance in plan design of distinguishing between long-term return compounding risk and short-term capital value risk is beginning to be appreciated.

9. Rapid progress is being made in the design and implementation of these kinds of communication protocols. NEST in the UK and QSuper in Australia are two of the global leaders. 

10. The government-sponsored NEST program in the UK has this opt-out design feature. It is experiencing a 92 per cent retention rate.

11. We agree with the Government’s sentiment that all ‘qualifying’ plans should, like the ORPP, have an ‘income for life’ back-end. Employers should have to explain its absence if the plan they offer doesn’t have one (this does not mean that the employer should necessarily be the longevity risk underwriter ... for example, it could be provided competitively by the insurance industry, using transparent longevity and investment return assumptions).

12. NEST CEO Tim Jones recently expressed this view to me: competition has made NEST a better, more customer-oriented pension services organization in the UK.

13. See Claude Lamoureux’s article ‘Effective Pension Governance: The Ontario Teachers’ Story,’ RIJPM, Fall 2008. 

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