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How CPP is weathering the market storm
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The Toronto Star-
With stock markets around the world taking a bath this year, your RRSP has probably shrunk dramatically. Thanks to some foresight by former prime minister Paul Martin and some rare cooperation by provincial premiers during the mid-1990s, you’ll at least have a solid Canada Pension Plan to fall back on.
The CPP was founded in 1966 as a way to give all working Canadians some financial security in retirement. Over the years, the plan’s obligations have grown, leading to worries over whether there will be enough in it to pay out as baby boomers retire.
In 1997, then finance minister Martin and provincial premiers did something about it, boosting premiums and allowing the excess to be invested in the stock market by the newly created CPP Investment Board. Last year, the CPP Fund managed by the CPP IB grew by 16 per cent to $153 billion. In the last six months, in contrast, the TSX S&P Composite Index has fallen almost 15 per cent. According to the Chief Actuary of Canada, that means there will be enough money in the fund to pay out CPP benefits for at least the next 75 years.
The cash in the fund comes from premiums deducted from your pay cheque, and income from investments made by the investment board.
Without that investment income, we’d all have to be digging a lot deeper to pay for our grandparents’ and parents’ pensions (the average retiree gets $512 a month from the CPP, but it can go as high as $960; Old Age Security and Guaranteed Income Supplements, paid out of general government revenues, can add another $900). And that’s just what Martin was hoping to avoid when, as federal finance minister, he pushed for reforms to the Canada Pension Plan in 1997.
“We had a bit of a magic moment here,” he said of the reforms, which were implemented following a rare degree of cooperation between the provincial governments. “To be quite honest, the provinces rose to the occasion.”
“My generation was going to be getting a good pension plan, and it was going to be paid for by my children and their generation.”
That’s because until that time, the CPP was what’s known as “pay as you go,” meaning benefits for existing retirees were paid for almost exclusively out of the premiums being taken off the paycheques of active workers. (Any small excess in premiums was invested in low-return government bonds). With more pensioners being supported by fewer active workers, it was a formula for rapidly rising premiums, shrinking benefits and inter-generational resentment.
“Young people felt that there was no savings or pension plan that would be available to them,” said Martin. “There would have been a public outcry against a plan that was essentially a chimera. . . Public pressure would have forced radical change that wouldn’t necessarily have been good.”
What Martin proposed, and what eight out of 10 provinces accepted, was an increase in premiums to 9.9 per cent of a person’s income, and a small cut in benefits. The resulting excess in premiums was allowed to be invested in the stock market, with the goal of boosting the CPP’s money to the point where it didn’t need to rely as much on current premiums to pay out benefits.
By and large, the strategy has worked, says professor James MacKinnon, head of the economics department at Queen’s University.
“What they did at that time greatly strengthened the CPP. . . The higher contribution rates and more market-oriented investments were a substantial move away from pay as you go,” said MacKinnon. “I don’t see any reason to use the world insolvency and the CPP in the same sentence.”
Having a 75-year investment horizon is a built-in advantage over other investors, says Don Raymond, the CPP IB’s chief investment strategist. For one thing, it allows them to ignore quarterly blips in a company’s performance, even though their long-term business is still solid.
“We tend to think in quarter centuries, not quarters,” said Raymond, a former investment strategist at Goldman Sachs.
The CPP IB has invested your money in everything from Canadian corporate titans like Royal Bank and international giants like Anheuser-Busch/InBev, all the way down to an airport in Auckland, New Zealand, and a holding company that owns hotels and casinos in Macau.
Just over half of the money controlled by the CPP IB is in equities (both public and private), while almost a third is in fixed income (including some government bonds it has owned since the 1997 reforms). The remainder is in a mix of real estate and infrastructure holdings.
And it would be logistically next to impossible, never mind politically suicidal, for any federal government to get its hands on money in the fund in the event of debt woes like those in Greece. For any government to try and get at the money, the Pension Benefits Standards Act would need to be changed, something that requires the approval of at least two thirds of the provinces and territories, representing two thirds of the Canadian population.
While some critics at the time suggested it was reckless to have a national pension plan subject to the vagaries of the stock market, Martin still insists that the decision was the right one.
“Look at the alternatives. The status quo had brought the CPP almost to its knees. The second alternative was to individually invest in pension plans, and that would be even more vulnerable to the market,” Martin said.
Besides, says the former prime minister, the proof is in the pudding. The pudding, in this case, being a report from the Chief Actuary of Canada projecting that the CPP Fund will have enough money to pay out pensions until at least 2086.
“It’s actuarially sound for the next 75 years, which is as far out as they go,” said Martin.
Still, warns MacKinnon, there are no guarantees.
“They don’t know what their rate of return (is that) they’re going to get on their investments, and they don’t know for sure what they’re going to have to pay out . . . You can never say with 100 per cent certainty that any pension plan is fully funded.”
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