Canada's politicians and business leaders need to reform the pension system or the country could be staring into the “abyss” as a wave of workers retire, the country’s third-largest pension fund manager said.
“The worst case scenario is that we just keep digging ourselves into a bigger hole and when we hit that final crisis the pain will be significantly greater because you’ve got a shorter time frame to do it,” James Leech, chief executive officer of Ontario Teachers’ Pension Plan, said yesterday in Toronto.
Leech, 66, co-authored “The Third Rail: Confronting our Pension Failures”, in which he highlights problems facing the country: Canadians aren’t saving enough for retirement, they’re living longer, and generating lower investment returns.
Leech cited Nortel Networks Corp. and the city of Detroit as examples of what can go wrong when a crisis hits and pensions aren’t prepared.
Nortel, once North America’s largest telephone-equipment maker, filed for bankruptcy in January 2009, leaving an underfunded pension plan. Detroit filed the biggest U.S. municipal bankruptcy with about $18 billion in debt, and said it didn’t have enough to pay its retirees, bondholders, and employees.
“The guarantee’s only as good as the solvency of the guarantor, and in some cases that can be threatened,” Leech said.
Third RailMartin Regg Cohn of the Toronto Star also reports, Our pension peril is the third rail of politics:
The ratio of elderly to working-age citizens will probably rise 16 percent over the next two decades, Canada’s finance ministry said in a 2012 report.
Even without a financial downturn or company default, pension issues should be addressed now before it’s too late, Leech said. The government needs to work with companies and pensions to stem the decline of defined benefit plans such as the Ontario Teachers’ fund; enhance the Canada Pension Plan, and make it mandatory for the self-employed to invest for retirement, he said.
“Pensions are the third rail, the electrified rail on the subway system,” said Leech, who joined the fund in 2001 and became CEO in December 2007. “You touch it, you get killed. It’s so much easier for all leaders -- business, labor, political to say ’I’m going to let another generation worry about that and I’m just going to kick the can down the way.’”
Leech faces his own retirement soon, leaving the C$129.5 billion ($123 billion) Toronto-based fund on Jan. 1. Ron Mock, currently senior vice president of fixed income and alternative investments, will succeed him.
Ontario Teachers’ earned 13 percent on investments in 2012, according to its annual report. That beat the 9.4 percent median return of Canadian pension funds, according to a Jan. 29 report by Royal Bank of Canada’s RBC Investor Services unit.
Ontario Teachers’ fund had 97 percent of assets needed to meet liabilities as of Jan. 1, 2013. It’s been facing funding shortfalls since 2003 as future pension costs increase faster than plan assets due to low interest rates and increasing life expectancy, according to the annual report.
The Third Rail, a new book on our pension peril, takes its title from the electrical rail that powers subways: Touch it, and you’re electrocuted.I too hope our political leaders who received a copy of The Third Rail will read it carefully ahead of their meeting on Friday. Jim Leech sent me an advanced copy earlier this week and I devoured it.
That’s why most politicians keep their distance from pensions: They’re terrified of being zapped.
Undaunted, Finance Minister Charles Sousa points cheerily to an advance copy sitting in his sixth-floor office. He’s reading and heeding it, but disregarding the danger.
Sousa, it seems, isn’t afraid of being singed. On Friday, Ontario’s treasurer will convene his provincial counterparts in Toronto to sell them on long overdue reforms to the Canada Pension Plan, setting the stage for a premiers’ summit next month and a December showdown with federal Finance Minister Jim Flaherty.
Advance copies have gone out to most of the politicians around the table. The wise ones will read the Third Rail — and get a grip on it.
Co-authored by Jim Leech, one of Canada’s renowned pension wizards, the book is essential reading for decision-makers. And an indispensable primer for voters — the people who ultimately call the shots, and who will pay the price if the pension peril is put off for another day.
As head of the Ontario Teachers’ Pension Plan, Leech has street cred: His massive, $130-billion fund has achieved consistently high returns (13 per cent in 2012), at low risk, for an aging cohort of teachers (300,000 members).
When Leech talks, politicians listen. When he writes a book, it’s worth buying.
Written in accessible language (co-authored by Report On Business reporter Jacquie McNish), it outlines the demographic and fiscal pressures that pension founders didn’t foresee, and that fund managers closed their eyes to.
Retirees are living far longer than ever envisioned, and fewer workers are entering the labour force to backstop any pension losses (inter-generational diversification). Many teachers now spend more years collecting pensions than they do paying for them. The math no longer adds up, if it ever did.
Record high investment returns have petered out, replaced by low interest rates that are wreaking havoc. Employers have been forced to top up their pension funds at a time when cash is scarce, prompting most private firms to phase out traditional retirement plans for new employees.
“Pension plans were never designed to withstand these threats,” the book argues.
In the postwar boom, nearly half of all Canadian workers belonged to pension plans. Now, only 39 per cent get workplace pensions. In the private sector, a mere 12 per cent of employees belong to so-called “defined benefit” pensions that promise to pay a fixed amount upon retirement.
“Our business, labour and political leaders are preoccupied with laying blame or denying the enormity of the looming crisis,” the book says. “Politicians, loath to go near the third rail, reassure us our pension fears are overstated.”
Against that depressing backdrop of overstretched workplace pensions, the Canada Pension Plan is the underpowered pillar of our retirement system. Founded in 1966, the CPP now pays out an unrealistic maximum of $12,000 a year.
Leech warns that the CPP “will be of marginal assistance to middle-income earners.” He supports a proposal that would see someone earning $50,000 a year increase his CPP contributions from $2,300 to $2,930 annually — retirement payouts to $17,500 a year. A worker earning $100,000 a year would contribute even more to get an enhanced pension of $30,000 a year.
“Our problem is not a shortage of ideas but rather a lack of courage and political will,” Leech writes. “To date, the federal government has ignored any proposal to expand CPP.
In an interview, Leech expressed skepticism about an Ontario Pension Plan (OPP) that the province is considering to supplement the CPP if talks fail.
“It would be more expensive, because you have to start building the infrastructure to manage that fund,” he said. “It’s so much easier, it makes so much more sense to go the CPP route.”
Did he give that advice to Sousa when he last met Ontario’s treasurer? “My answer to him was that it (an OPP) was feasible, but clearly a second choice.”
As for Flaherty, with whom he talks regularly, Leech can’t explain the federal government’s timidity. But he is optimistic that the provincial finance ministers, who are closer to the ground, will lose their fear of the third rail after reading his book.
“I hope some of them will buy it and read it before Friday.”
There’s still time.
Yesterday afternoon, I had a chance to speak with Jim to discuss the book and his thoughts on what needs to be done to improve our retirement system (I thank Deborah Allen, Director, Communications and Media Relations at Teachers for setting up this conference call).
I started by praising Jim and his co-author, Jacquie McNish, for writing a book that reads more like a novel. I was afraid it was going to be another dreadfully boring book on pensions. Far from it, the book is short, concise and very well written. It focuses on three case studies -- New Brunswick, Rhode Island and the Netherlands -- before offering solutions to bolster Canada's pension system.
What I like about the book is that each chapter gives you a brief historical background and then discusses the pension challenges each place faced and the key players who had the courage to confront those challenges and bring about much needed reforms. The book is grossly engaging. There were parts where I was so engrossed, I just couldn't believe what I was reading on how perilously close New Brunswick and Rhode Island were to pension Armageddon.
Jim told me he wanted to make sure the book was accessible to the lay person and made it a point not to write a boring book on pensions. "I'm giving a copy of this book to my kids for Christmas and they are my toughest critics." He added: "There is only one chart in the book" (on page 150).
I began by asking him why he wrote the book. He told me he was increasingly frustrated with the debate on pensions. "The focus needs to be on solving retirement security because Canadians aren't saving enough. I kept talking about it and one day Deborah Allen came to my office and asked me 'why don't you write a book?', so I did."
We then talked about solutions to the looming crisis. The key for Jim is to implement New Brunswick's shared risk pension model which was enshrined in legislation in July 2012 and draws from the Netherland's pension system. "This way, employees, employers and pensioners all have a say on pensions and they share the risk of their pension plan." Indeed, New Brunswick has become a pension trailblazer and risk sharing must be part of the solution going forward.
We then talked about enhancing the Canada Pension Plan. He supports a proposal that would see someone earning $50,000 a year increase his CPP contributions from $2,300 to $2,930 annually — retirement payouts to $17,500 a year. A worker earning $100,000 a year would contribute even more to get an enhanced pension of $30,000 a year.
Interestingly, for higher income brackets, he sees a role for a defined-contribution type plan which pools money and lowers fees. This is where I sort of disagreed with him. I told him that defined-benefit plans are way better than defined-contribution plans and didn't understand why CPP enhancement should be limited to a certain income bracket, even if these are the people most vulnerable to pension poverty.
He explained to me that the cost of phasing in an increase in CPP contributions for people earning more than $100,000 would be very high and it would probably not make sense to include higher income brackets. I found that argument weak and told him I know a lot of doctors, lawyers and other high income professionals who would gladly pay more in CPP contributions to bolster their retirement security.
But we both agreed that Ontario shouldn't go it alone on a supplementary pension and that the benefits of defined-benefit pensions are grossly underestimated and under appreciated. Teachers and other leading Canadian pension plans sponsored a recent study on the benefits of DB plans, showing how they reduce the annual payout of GIS by approximately $2-3 billion a year and contribute $14 - $16 billion annually to government coffers across Canada through income, sales and property taxes.
Jim told me that OAS and GIS will triple in the next 15 years. "These subsidies cost a dollar for every dollar people receive whereas pension contribution cost employees and employers 15 cents each, with the bulk of the assets being made up by investment gains."
Interestingly, Jim also discussed the size of CPPIB, saying that it would make sense to have the money managed by a few large public funds than one single entity. Mark Wiseman would disagree with him but I also think it makes sense to cap these large funds at a certain level similarly to what they do in Sweden. Why? Because no matter how good their governance is, economies of scale will kick in and impact their returns.
We can discuss the appropriate cutoff point but in an ideal world, we wouldn't have an OTPP, HOOPP, OMERS, or CPPIB, just large public funds managing pension assets of all Canadians. And in my ideal world, companies wouldn't be in the pension business at all. Let them pay their share of CPP contributions but the money would be managed by well-governed public pension funds that operate at arms-length from the government.
I asked Jim what were some of the more memorable things he remembers from writing this book. He told me when he landed in Rhode Island and was met by husky customs officer with a gun who stared him down and asked him why he was visiting. He told her he was there to meet the state Treasurer. Jim told me she said: "You're here to meet Gina? She's the greatest." (I got a much deeper appreciation for Gina Raimondo reading this book, something you won't get reading the smut Matt Taibbi and Ted Seidle put out in their rants. Read this excerpt from the book published in the Globe and Mail, How the Rhode Island treasurer slayed her state pension dragon).
He also remembers walking into the state capitol building in Rhode Island and thinking how it was once a hustling place. "It"s a beautiful building but you can tell the effects of the fiscal crisis really had a negative impact. The building isn't as busy or well kept."
And that is another point that comes across this book. Pension deficits matter because when the shit hits the fan, and taxpayers can't contribute anymore, you will see drastic cuts in public services and then eventually cuts in benefits. At times, I found myself in complete disbelief reading some passages of this book, thinking to myself the pension shenanigans in New Brunswick and especially in Rhode Island make Greece look good (and trust me, that is very bad!).
Finally, I asked Jim what is his main concern going forward. He told me "inertia" and "politicians kicking the can down the road because they are petrified of the third rail." I asked him what about all those people who think we don't have a pension crisis and that rising interest rates and rising asset values will solve our pension crisis?
Here is where Jim Leech didn't mince his words. "They are all dreaming. That might be the case if people weren't living longer and investment gains were just as good as they were in the past but that certainly isn't the case now. I was in Chicago a few weeks ago and asked a group of senior investment managers how many of them really think they can attain an 8% rate of return on investments after fees on a sustained period. Not one of them raised their hand. Had to go all the way down to 6% before one person raised their hand."
He added: "These things are path dependent, meaning if funds experience losses at the beginning, it will be that much more difficult going forward to cover their deficit." I completely agree and think many people are underestimating the scale of the problem and the reforms that are needed to sustain the long-term viability of these pension plans.
Importantly, rising interest rates and asset values will help but not solve the looming pension crisis. And if for any reason, we get a Japan-style protracted period of low rates and low investment gains, watch out, things will get much much worse and some pension plans already at risk will find themselves insolvent, forcing politicians to make some very difficult decisions.
The main message of this book is that RRSPs aren't cutting it and while pensions are definitely worth saving, there is no free lunch. All stakeholders have to concede something if they want to maintain the long-term viability of pension plans. I highly recommend you take the time to read The Third Rail and try to understand why this pension crisis isn't going away anytime soon and why we need to implement reforms now to bolster our retirement system.
Below, Jim Leech, chief executive officer of Ontario Teachers' Pension Plan and co-author of "The Third Rail: Confronting Our Pension Failures," speaks about the book, the reluctance of government, business and labor leaders to deal with overhauling the pension system, and reasons why the Canadian government needs to work with companies and pensions to stem the decline of defined benefit plans.
You can also listen to this radio interview on the CBC's The Current where Anna Maria Tremonti talks to Jim Leech and his co-author, Jacquie McNish on their book. Great interview, well worth listening to. Also read Jacquie McNish's article in the globe and mail, The problem with pensions: symptoms and cures and Keith Ambachtsheer's review of the book here.
Jim Leech will soon retire from Ontario Teachers' Pension Plan and will become the next chancellor of Queen’s University. I thank him for taking the time to speak with me and Deborah Allen for setting up the interview. Remember, read the book, it's very well written and you will gain a deeper appreciation for why pensions matter and why we need to confront our pension failures now before it's too late.