Don’t attempt to fix public sector pension plans without fully understanding how pensions work or the ripple effects of the benefits they provide.
By Robert Brown, President, International Actuarial Association, and Craig McInnes, Journalist
Before medical science fully grasped the role of germs, the intervention of a doctor would often hasten death rather than provide a cure. With no understanding of what was wrong, the healers of the day couldn’t make it right. In their ignorance, they often violated what has become a guiding principle of modern medicine; “first, do no harm.”
The same risk applies today to critics who call for radical reforms of public sector pension plans. Like those ill-informed ancient healers, they claim they can fix something without fully understanding how pensions work or the ripple effects of the benefits they provide.
The critics argue that defined benefit plans are unfair to taxpayers today, that they threaten current government finances and pose an unconscionable burden for future generations. Some, including the Wildrose party in Alberta, the Conservatives in Ontario and the Fraser Institute think tank, have proposed replacing defined benefit plans with defined contribution plans as a cure.
They argue that defined benefit plans, which generate predictable retirement income, put taxpayers at risk, while with defined contribution plans the employees and their families carry the risk if investments fail to produce the expected level of benefits. That is deemed fair since they also get the benefits. Those arguments can seem pretty attractive at a time when fewer Canadians in the private sector can get adequate workplace pensions.
But are defined contribution plans really a cure that will benefit Canadians, now and in the future?
With the support of the Canada Public Pension Leadership Council, we analyzed other comparable North American jurisdictions where defined benefit plans were replaced with defined contribution plans based on individual savings accounts, or where such conversions had been considered.
Rather than a cure, we found the conversion to individual defined contribution savings accounts created new problems, without solving any of the old ones. Where pension plans were underfunded in the past, the unfunded liabilities were not reduced; in fact, they increased. Administration costs also rose and the amount of money available for benefits was less, often dramatically so. Retirees were less able to take care of themselves and depended more on public welfare programs. That means higher costs to taxpayers – the very outcome proponents said would not happen.
Using that experience, we created a model to predict what the effects would be in Canada if a typical $10-billion defined benefit pension plan was converted to defined contribution.
We were able to illustrate that large, public sector pension plans affect more stakeholders than just employers, plan members and their dependents. All Canadians have a stake in the continuing success of these large plans, which hold more than $900 billion in assets. Why? Because pension funds have a positive effect on the economy with their large pools of patient capital made available for major projects and public and private infrastructure.
We have a stake in the income that retirees bring into their communities. When seniors have saved enough during their working lives to look after themselves in retirement without the need for social programs, taxpayers benefit.
And since public sector pension plans are part of the pay packet provided by taxpayers, we have an interest in ensuring that the money we provide is used as efficiently as possible. Large-scale defined benefit plans are part of a highly efficient retirement savings method, in which the ability of the investments to grow is a more powerful tool for providing retirement income than is the need for plan members to pay contributions during their working lives.
What we found in our research and modeling was that 75 per cent of retirement benefits in a typical large defined benefit plan come from investments and just 25 per cent comes from employer and employee contributions.
Like those ill-informed doctors of yore, the evidence strongly suggests defined contribution plans create a cure that is worse than the ailment.
Dr. Robert Brown is a retired professor of actuarial science (University of Waterloo) and president of the International Actuarial Association, and Craig McInnes is a writer and journalist. Download their full report Shifting Public Sector defined benefit Plans to defined contribution – The Experience So Far and Implications for Canada.
Article provided by Troy Media, http://www.troymedia.com.
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