Once all the costs are counted, the Canada Pension Plan isn't a model of efficiency
In the recent debate over an expanded Canada Pension Plan (CPP), its low cost was offered as one of the main benefits for larger government-managed pensions. The Ontario government, introducing its own version of the CPP, argues that lower costs helped to justify public pension plans. Not surprisingly, the Canada Pension Plan Investment Board (CPPIB), which manages the CPP's investments, burnishes this image of high efficiency and low cost. Every year it publishes its operating expense ratio, narrowly defined as operating expenses relative to assets under management. Last year, these operating expenses totalled $490-million or 0.28% of its average assets. Sounds like quite a bargain.
However, the operating expenses cited by the CPPIB cover only a select subset of the total costs involved in running the CPP, according to a new study we co-authored for the Fraser Institute. These total costs include those related to the CPP's design and routine operations like collecting contributions and paying benefits that are done on its behalf by the federal government. Some of these functions are analogous to costs incurred by a private annuity fund, notably verifying eligibility and issuing cheques.
The total cost of the CPP should also include all its external management fees and the transaction costs of executing its investment strategy. There seems no apparent reason to exclude these costs, especially external management fees which have increased to $959-million last year, except the "customary practice" in the words of the CPPIB of reporting "investment returns net of fees paid." These costs multiplied after the Board convinced governments starting in 2006 to allow it to pursue a more aggressive investment strategy beyond the traditional stocks and bonds to assets such as infrastructure and real estate.
Contracting out investment strategy consultations may be justifiable but excluding these rising costs from its reported expense ratio is not. After all, designing and executing its investment strategy is the very reason the CPPIB exists.The CPPIB's first and only loyalty should be to taxpayers, not the "customary practice" of the pension industry.
Currently, one needs to consult the Public Accounts and annual reports from both the CPPIB and CPP to get a complete picture of costs and investment returns. It is also worth noting that these costs do not include the compliance costs imposed on employers and self-employed individuals for calculating and remitting their CPP payments. Accounting for all the costs of the CPP is an important exercise, because every dollar spent is one less dollar available for beneficiaries. As well, it helps answer the question of whether government-run pension plans are significantly more efficient than private plans.
Unlike the benign picture of a minuscule expense ratio portrayed by the CPPIB, a fuller accounting of all the costs associated with the CPP paints a different picture. These "all-in" costs are at least four times higher than the narrowly-defined operating expenses ratio touted by the CPPIB. Most of the difference is higher external management fees, which have risen from $25-million to $782-million in just six years. Overall, the investment strategy of the CPP now costs twice as much as all its operating expenses.
In addition, the cost for the federal government's collection of all contributions and paying of benefits rose to $586-million last year, also more than its narrowlydefined operating expenses. As a result, the total cost of running the CPP has grown from $0.6-billion to $2.0-billion, or from 0.54% of assets to 1.15%, over the last seven years.
The CPP is Canada's largest pension fund. As such, it is in a unique position to set and not just follow industry standards for transparency in reporting all its expenses. As well, a full accounting of all its costs, including those incurred by the Government of Canada,is necessary. The reporting of all costs should be explicitly made by the CPP in its annual reports and by the CPPIB in theirs.
As part of the overhaul of the CPP in 1997, governments agreed to continuously seek ways to reduce the plan's administrative and operating costs. Given this fundamental directive, it is surprising that the total costs of the CPP are not presented more clearly by both the Government of Canada and the Plan's Investment Board. Canadians should be informed of the total cost of administering the CPP's operations and the total costs involved in its investment strategy. Otherwise, the expressed intent to relentlessly search for lower costs will appear to be just another politically-motivated bromide disappearing into the ether of a self-serving bureaucracy.
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