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Canada pension myths; The CPP is hardly risk free or low cost

Appeared in the Financial Post
Release Date: April 5, 2011
Proponents of expanding the Canada Pension Plan (CPP) have spread inaccuracies and myths about the risks and costs associated with it. These misrepresentations are now being spread by political parties in the runup to the federal election in newly announced plans on retirement security.

The Liberals' plan includes an undefined "gradual" increase in premiums and benefits, as well as a Secure Retirement Option in which Canadian workers can opt to save an additional 5% to 10% of their pay in a retirement fund "backed" by the CPP. They claim the CPP provides enormous advantages to both employers and employees because it avoids the risk, complexity, and hidden management fees that too often drain retirement savings from plans that are administered by the private financial sector.

The Liberal plan does not explain why it describes private-sector plans as complex, but if it means that Canadians have a broad range of choice in the investment products they can select to meet their individual needs at different stages of their life, it is difficult to see why this is bad. The New Democrat Party goes even further and has announced plans to double the CPP, in addition to making it possible for Canadians to top up their public pensions with personal savings.

The reality is that the CPP is not risk free or as low cost, as advocates of expansion pretend. The Canada Pension Plan Act, governing the CPP, includes an automatic mechanism to adjust benefits and contributions to bring the plan back on track if at any point it is no longer considered sustainable in meeting its obligations. Every three years, federal and provincial finance ministers must review the financial state of the CPP and provide recommendations to the ministers as to whether benefits or contribution rates or both should be changed. Hence, there is risk. There is no guarantee that the CPP will deliver what is expected.

The Liberals argue that their Secure Retirement Option will benefit the millions of Canadians who "can't afford the risk of the stock market or RRSPs." This is simply not true. Close to 40% of the CPP's current assets are in public equities that trade on stock markets; over a quarter of its assets are in alternative asset classes considered riskier than equities, including private equity, real estate and infrastructure. Hence, the Secure Retirement Option is an option is for those who want more of the exact same risk associated with their mandatory CPP pension unless the CPP creates a separate portfolio, in which case who knows what the portfolio will consist of.

Advocates of CPP expansion describe the fund as low cost. For example, the Canadian Labour Congress notes on its website that the Canada Pension Plan Investment Board has a "low" fee of 0.5% in comparison to other investment options. However, the CPP Investment Board is strictly the investment manager for the CPP so its costs do not include all the administrative costs of the CPP such as the costs involved in collect-ing premiums and paying benefits. Those costs are charged to the CPP from various government departments such as Human Resources Development Canada and the Canada Revenue Agency.

Figures on the CPP's full costs can be found in the public accounts and show that CPP costs are in line with what the Canadian Labour Congress calls "lower cost investments." The Canadian Labour Congress webpage does not describe what this term means. But presumably it refers to investment options such as exchange traded funds or low cost mutual funds purchased through channels that do not include financial advice, as opposed to mutual funds that include a charge for providing professional financial advice.

The cost performance of these "lower-cost investments" is pretty impressive, since they face expenses the CPP does not, such as regulation and taxes. Moreover, the CPP Investment Board's costs are growing fast. In 2005, administrative expenses and external management fees as a percentage of total average assets came to 11 basis points. By 2010, the figure reached 56 basis points, a five-fold increase.

The CPP is currently doing exactly what it should: providing income for basic needs in retirement. Other pillars, such as tax-sheltered plans, are in place and have helped Canada create one of the best systems in the world for ensuring Canadians meet their financial objectives, including having adequate savings for retirement. The CPP Investment Board expects to be managing $700-billion in assets by 2038, a sum that will be challenging enough to manage without unnecessarily adding to it.