Guest Post: Time for a New Universal Pension Plan?

Almost nine out of 10 Canadian CEOs say pension funding is in trouble, according to a new survey released Monday.

Compensation experts Watson Wyatt said 88 per cent of Canadian chief executives surveyed now believe that defined benefit pension plans are underfunded, 42 per cent higher than the number who held the same feelings in 2008.

The global financial and equity market slump in 2008 and 2009 has hurt the returns for existing funds, forcing firms to pony up more cash to maintain their pension plans, whether of the defined contribution or defined benefit variety, Watson Wyatt said.

“The severity of financial threats, particularly the cost and volatility of maintaining DB plans, has increased substantially in the current financial climate,” said the consultancy in its annual survey of CEOs’ attitudes toward pensions.

In 2008, 62 per cent of executives — a relatively low level — thought Canadian pension plans were inadequately funded. Of those responses, 34 per cent of CEOs said the problem was long-lasting while another 28 per cent believed the funding woes were related to cyclical downturns in financial markets.

But in 2009, more than half of CEOs, 53 per cent, believed the pension crisis is long-term in nature and needs government to fix the rules surrounding these plans, while 35 per cent of respondents said the 2009 pension crisis was cyclical and likely would ease once equity markets rose to higher levels.

“These companies are being hit with huge cash requirements [because of the economic recession],” said Laura Samaroo, Watson Wyatt’s retirement practice leader, Western Canada.

New rules needed

Currently Ottawa, Ontario, Alberta and British Columbia are examining whether to change their existing pension rules, Samaroo said. (The federal government regulates pensions as does every province except Prince Edward Island).

Right now, some pension authorities are easing the existing requirements concerning how quickly companies have to eliminate any shortfalls in their plans.

But nearly 90 per cent of the executives said one possible solution is for governments to push back the point at which firms with underfunded plans need to get member approval to maintain a shortfall status.

Changing that deadline would give companies more time to make up for the shortfall through stock market returns rather than higher corporate contributions, experts said.

Of course, the longer the funding period, the more likely that the pension plan will face a larger financial shortfall due to a stock market crash within that time frame.

Samaroo said, however, establishing overly onerous requirements for funding pensions could threaten a firm’s solvency and lead corporations to get out of the retirement business entirely.

“There isn’t any mass exodus [in terms of companies winding up their pension plans]. But, the real concern is that companies not provide pension plans,” Samaroo said.

One-third of the 156 CEOs who replied to the questionnaire said they would make substantial cuts to their capital spending programs in order to cover their pension plan shortfalls.

Less spending on new equipment often places firms at a competitive disadvantage with companies that are updating their production, economists said.

Let’s go back to Susan Eng’s proposal for a universal pension plan. A new CARP poll finds members overwhelmingly support a new Universal Pension Plan:

CARP released a poll of 3,700 of its members and found “overwhelming support for a universal pension plan” for the roughly one in three Canadians without retirement savings. CARP is also calling for a Pension Summit that would include First Ministers and Finance Ministers. Pension reform can no longer be the “quiet preserve of pension experts,” Eng said, “Canadians are looking to all levels of government for bold leadership to ensure hat protection of their retirement security remain the top public policy priority.”

CARP cites a C.D. Howe Institute estimate that 3.5 million Canadian workers — or 25% of the workforce, mostly middle-income, working for smaller employers — are most likely to be on “an inadequate retirement savings track” and would thus benefit from access to a supplementary pension plan. C.D. Howe has suggested the creation of a new savings vehicle called the Canada Supplementary Pension Plan, or CSPP.

Features of a UPP

CARP says pension experts agree retirement income from all sources must replace between 60 and 70% of working income. Currently, the CPP provides at most 25% of Year’s Maximum Pensionable Earnings (YMPE): $46,300 in 2009. Thus, for those without employer-sponsored private pensions, the maximum CPP benefit this year is $10,905.

CARP suggests gradually phasing in a UPP so that coverage would eventually cover 70% of pre-retirement income to a maximum pensionable earning limit of $116,667 (which is the 2009 limit for Registered Pension Plans). Like the CPP, the UPP would be a mandatory enrollment plan. CARP is wary of any version that would let individuals “opt out.”

CARP has 330,000 members. In March, it made a joint submission on Private Pension Reform jointly with the Common Front for Retirement Security, which includes 21 organizations representing 2 million Canadians. CARP says there are 14.5 million Canadians 45 years of age or older, representing 42% of the total population. There are 4.6 millon Canadians over age 65, making up 13.3% of the population.

Canada’s savings shell game

Coincidentally, the Post’s lead editorial today (Tuesday) was entitled Canada’s savings shell game. It points out that workers who counted on the “pension promise” from long years at a single employer are in danger of being short-changed in the case of corporate bankruptcy.

The more money you can put into an employer-sponsored pension, the less you can save in an RRSP. This is the Pension Adjustment, a number that appears on your T-4 slip and which you enter when you’re preparing your annual tax return. The one point not made by the editorial writer is that there may be recourse to a PAR, or Pension Adjustment Reversal but the problem there is you still need the money to make a giant catch-up RRSP contribution.

Meanwhile, by overtaxing “safe” interest income, we are tempted to put money into riskier equities which are taxed less harshly — but can generate huge losses, as many have suffered in their non-registered portfolios the last year.

Before you dismiss the idea of a universal pension plan, consider what is happening right now. The Toronto Star reports that pension costs are weighing down autoworkers.

Soaring pension costs are also weighing down other companies. The FT reports that Lockheed Martin, the world’s largest defense contractor, reported first quarter profit down 8.8 per cent as rising pension costs offset higher sales of defense electronics and computer services.

While people worry about the cost of a new Universal Pension Plan, I submit to you that over the long-run the benefits of secure and stable retirement income outweigh the costs.

In fact, as I stated at Tuesday’s hearing, although I am against expanding the CPP (I prefer to have a few large DB plans that are capped at a certain size), I am all for a new Universal Pension Plan because i believe it will enhance Canada’s productivity over the long-run.

Policymakers tend to be myopic focusing on short-term costs, but as Ms. Eng stated the additional cost would not be exorbitant. Moreover, we have to come to grips that the current retirement system is an abysmal failure, leaving too many people to fall victim to the whims of the stock market.

Speaking of the stock market, my former colleagues at the National Bank of Canada looked into how long it takes for stocks to return previous peaks following a financial crises (click on chart above to enlarge). They found that financial crisis recessions hit harder and require longer recovery:

If you want to know how long you’ll have to endure the current stock market slump, consider the source of the downturn in the first place.

A chapter of the International Monetary Fund’s upcoming World Economic Outlook, which the organization prereleased last week, shows that over the past 50 years, recessions triggered by a financial crisis – as the current one was – are longer, deeper and slower to recover than recessions driven by other factors.

The average financial crisis recession lasted six quarters, then needed another six quarters to return to the previous peak of economic output.

The financial crisis recession is simply a nastier animal than the garden-variety economic slump.

The IMF’s findings suggest that when stock market investors want a guide to the current market downturn, it does them little good to look at average depth and recovery time for equities in all recessions. The focus needs to be on the financial crisis recessions in order to gain some clarity.

MEANER THAN AVERAGE BEAR

In a research note this week, National Bank Financial assistant market strategist Pierre Lapointe looked at the 15 recessions, in various parts of the world over the past 50 years, that the IMF identified as financial crisis driven.

He found that the average stock market decline was nearly 40 per cent – and those declines have dragged out over an average of 21 months.

The current downturn has already been deeper than the typical financial crisis (a 56-per-cent loss in global equities at the early March lows), though the bear market has so far lasted 17 months – still four months short of the average.

To some, that might imply that even for a financial crisis bear, the markets had become oversold, and that based on history, we may be within spitting distance of the end.

However, it’s important to keep in mind that this is no “average” financial crisis. It’s the most severe financial crisis to hit the global economy since the Great Depression.

As the IMF noted, the “Big Five” financial crises of the past 50 years – Finland (1990-93), Japan (1993), Norway (1988), Spain (1978-79) and Sweden (1990-93), which represent the previous worst banking crises in the past 50 years – triggered longer and deeper recessions than the average.

Mr. Lapointe’s data also show that the Big Five accounted for some of the worst stock market slumps in terms of depth, length and recovery. (Indeed, Japan is still waiting to return to its pre-crisis market highs.)

THE PATIENT NEEDS PATIENCE

Even the average financial crisis market slump has taken 25 months to recover all its losses. That suggests to Mr. Lapointe that investors shouldn’t get too excited about the 20-per-cent-plus rebound in equities in the past six weeks.

“If history is any guide, patience will be needed before we see equities at precrisis levels,” he said.

Patience indeed. If my forecast is correct, we are heading into a long bout of debt deflation in the developed world. Also, watch for another round of goods deflation coming out of China as their economy slows.

All this means that this is likely to be the longest recovery ever, possibly taking five or more years. I expect stocks to be volatile over this period and while some sectors may shine, the overall stock market indexes will trade sideways.

In the meantime, most people will not be able to rely on hefty gains in the stock market for their retirement income.

The time has come to introduce a new Universal Pension Plan. Hopefully, this time around, we’ll get it right.