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pension-plan

Canada Pension Plan

The Canada Pension Plan (CPP) is a contributory, earnings-related social insurance program. It forms one of the two major components of Canada's public retirement income system, the other component being Old Age Security (OAS). Other parts of Canada's retirement system are private pensions, either employer-sponsored or from tax-free individual savings (known in Canada as a Registered Retirement Savings Plan).

The CPP program mandates all employed Canadians who are 18 years of age and over to contribute a prescribed portion of their earnings income to a nationally administered pension plan. The plan is administered by Human Resources and Social Development Canada on behalf of employees in all provinces and territories except Québec, which operates an equivalent plan, the Quebec Pension Plan. Changes to the CPP require the approval of at least 2/3 of Canadian provinces representing at least 2/3 of the country's population. In addition, under section 94A of the Canadian Constitution, any province may establish a similar program at any time.

Lester Bowles Pearson was the Prime Minister at the time who implemented the CPP.

The CPP is funded on a "steady-state" basis, with its current contribution rate set so that it will remain constant for the next 75 years, by accumulating a reserve fund sufficient to stabilize the asset/expenditure and funding ratios over time. Such a system is a hybrid between a fully funded one and a "pay-as-you-go" plan. In other words, assets held in the CPP fund are by themselves insufficient to pay for all future benefits accrued to date but sufficient to prevent contributions from rising any further. While a sustainable path for this particular plan, it is atypical of other public or private sector pension plans. A study published in April 2007 by the CPP's chief actuary showed that this type of funding method is "robust and appropriate" given reasonable assumptions about future conditions. The chief actuary submits a report to Parliament every three years on the financial status of the plan.

History

Initial plans for a public contributory pension plan in Canada were drawn from 1957 to 1963, under the Conservative governments of Prime Minister John G. Diefenbaker, but the final details of the CPP were only settled under the Liberal governments of Lester B. Pearson, between 1963 and 1965. Negotiations with the government of Quebec were also important in shaping the program, because of the need to amend the Canadian Constitution (i) to include disability and survivor benefits in the federal plan, combined with (ii) Quebec's desire to establish its own scheme. After section 94A of the Constitution was amended in 1964 to settle both points, the CPP was launched at the start of 1966 (all of the preceding history is described in "Wrestling With the Poor Cousin: Canada Pension Plan Disability Policy and Practice, 1964 - 2001").

At its inception, the prescribed CPP contribution rate was 1.8% of an employee's gross income up to an annual maximum. Over time, the contribution rate was increased slowly. However, by the 1990s, it was concluded that the "pay-as-you-go" structure would lead to excessively high contribution rates within 20 years or so, due to Canada's changing demographics, increased life expectancy of Canadians, a changing economy, benefit improvements and increased usage of disability benefits (all as referenced in the Chief Actuary's study of April 2007, noted above). The same study reports that the reserve fund was expected to run out by 2015. This impending pension crisis sparked an extensive review by the federal and provincial governments in 1996. As a part of the major review process, the federal government actively conducted consultations with the Canadian public to solicit suggestions, recommendations, and proposals on how the CPP could be restructured to achieve sustainability once again. As a direct result of this public consultation process and internal review of the CPP, the following key changes were proposed and jointly approved by the Federal and provincial governments in 1997:

  • Total CPP contribution rates (employer/employee combined) were increased annually from 6% of pensionable earnings in 1997 to 9.9% by 2003.
  • Continuously seek out ways to reduce CPP administration and operating costs.
  • Move towards a hybrid structure to take advantage of investment earnings on accumulated assets. Instead of a "pay-as-you-go" structure, the CPP is expected to be 20% funded by 2014, such funding ratio to constantly increase thereafter towards 30% by 2075 (that is, the CPP Reserve Fund will equal 30% of the "liabilities" - or accrued pension obligations).
  • Creation of the CPP Investment Board (CPPIB).
  • Review the CPP and CPPIB every 3 years.

Contributions and Benefits

In 2007, the prescribed contribution rate is 4.95% of a salaried worker's gross employment income between $3,500 and $43,700, up to a maximum contribution of $1,989.90 The employer matches the employee contribution, effectively doubling the contributions of the employee. If a worker is self-employed, he/she must pay both halves of the contribution. The rate of 4.95% has been in effect since 2003.

Historical contribution rates and contributory earnings can be found in Table A of this document

When the contributor reaches the normal retirement age of 65 (a reduced pension is available from age 60), the CPP provides regular pension benefit payments to the contributor, calculated as 25% of the average contributory maximum over the last 5 years, adjusted downwards if someone contributed on less than the maximum at any time during their career. However, there are provisions that enable the lower-earnings years in a contributor's contributory period to be dropped out. CPP benefit payments are taxable as ordinary income. The CPP also provides disability pensions to eligible workers who become disabled in a severe and prolonged fashion, and survivor benefits to survivors of workers who die before begin receiving retirement benefits. If an application for disability pension is denied, an appeal can be made for reconsideration, and then to the Canada Pension Plan / Old Age Security Review Tribunals or Pension Appeals Boards (POA).

CPP Investment Board

Under the direction of then Finance Minister Paul Martin, the CPP Investment Board was created in 1997 as an organization independent of the government to monitor and invest the funds held by the CPP. In turn, the CPP Investment Board created the CPP Reserve Fund. The CPP Investment Board is a crown corporation created by an Act of Parliament. It reports quarterly on its performance, has a professional management team to oversee the operation of various aspects of the CPP reserve fund and also to plan changes in direction, and a board of directors that is accountable to but independent from the federal government.

Socially Responsible Investing

The growing issue of socially responsible investing has been raised for the CPPIB, with civil society groups like ACT for the Earthand InterParesexpressing concerns about the investment policies of the CPP Investment Board, alleging potential conflicts of interest or asking for the adoption of ethical investment policies. These groups have criticized the CPP's investments in arms manufacturers, tobacco companies, big oil, and companies that engage in criminal activities. The CPP Investment Board (CPPIB) has responded with a Policy on Responsible Investing ACT for the Earth countered this with its own report, Against Common Sense, which argues that the CPPIB uses its proxy shares in a wide array of companies "to vote against peace, ecology, and human rights at numerous corporate shareholder meetings," in direct violation of its own responsible investing policies.

Future and Direction

David Denison is the current Chief Executive Officer of the Canada Pension Plan Investment Board. An article in the May 18, 2006 Globe and Mail reported that the CPPIB plans to increase the fund's foreign investments. According to the 2007 Annual Report, about 45% of the fund's assets are now invested in securities domiciled outside Canada, largely in the United States and Western Europe. In addition, the CPPIB has been broadening the scope its investments to include emerging markets, although Mr. Denison would not pinpoint a specific country or area. “Canada as a single market cannot accommodate the future growth of our organization,” said Mr. Denison.

In recent years, the CPPIB has also changed direction in its investment philosophy. It evolved from investing exclusively in non-marketable government bonds to passive index-fund strategies and, more recently, to active investment strategies.

Growth and Strategy

The CPP reserve fund receives its funds from the CPP and invests them like a typical large fund manager would. The CPP reserve fund seeks to achieve at least the projected return (inflation-adjusted) needed to help sustain the CPP , a rate set at 4.1% by 2020 in the CPP actuary's report, grading down from 5.0% in 2005. As indicated in its Financial Highlights for the fiscal year ended March 31, 2007 (document consulted on Aug. 3, 2007), the CPP reserve fund averaged 13.6% return in the past 4 years, well in excess of Canadian inflation rates.

The CPP reserve fund is aiming to achieve the following growth targets (in assets):

  • $147 billion by 2010.
  • $200 billion by 2015.
  • $592 billion by 2030.
  • $1.55 trillion by 2050.

The strategies used to achieve these targets are listed on the CPPIB website, and include the following:

  1. Diversification. In 1997, the CPP fund was 100% invested in federal government bonds, but it has since diversified not only by asset class, but also internationally.
  2. Employing basic asset allocation theories. With diversification of investments as one of their objectives, the current asset mix is now as follows. :
    • Public Equity => 51.8%
    • Fixed Income => 25.6%
    • Private equity => 10.9%
    • Inflation Sensitive Assets => 11.7%
  3. Using equity firms to assist in achieving targets for each asset class. The CPP reserve fund allocates certain amounts to various pre-qualified equity firms to be managed and used towards reaching the growth targets. For example, the CPP Investment Board hires private equity firms to help it invest in private companies, fund managers to help it invest in public equities, bond managers to assist in investing in bonds (within Canada and foreign bonds), and so forth.

Performance

The total growth of the CPP Reserve Fund is derived from the CPP contributions of working Canadians, and the return on investment of the contributions. The portion of CPP Reserve Fund growth due to CPP contributions varies from year to year, but have shown a slight decrease in the past 3 years. The historical growth with the investment performance is tabulated as follows:

Date Net Asset Value (CAD)¹ Rate of Return (annual)²
Mar 2003 $55.6 Billion -1.1%
Mar 2004 $70.5 Billion +10.3%
Mar 2005 $81.3 Billion +8.5%
Mar 2006 $98 Billion +15.5%
Mar 2007 $116.6 Billion +12.9%
Mar 2008³ $122.7 Billion -0.29%

¹Assets are as at the period end date (March 31).

²Commencing in fiscal 2007, the rate of return reflects the performance of the CPP Fund which excludes the short-term cash required to pay current benefits.

³Increased fund value due to worker and employer CPP contributions not needed to pay current benefits. The negative investment return amounted to $303 million CAD.

Losses due to changes on Income Trust taxation

On October 31, 2006, Finance Minister Jim Flaherty new rules that will effectively end the tax benefits of the income trust structure for most trusts. The Canadian Association of Income Trust Investors research shows that the Canada Pension Plan has lost $300 million CAD in market value as a result of the surprise change in tax legislation.

However, according to the CPPIB website, no such losses were ever reported or even acknowledged. The above suggested estimates are unverified by either the Ministry of Finance or by Bank of Canada. The accuracy of the Canadian Association of Income Trust Investors report has never been verified by an independent auditor. However, from their report, it is not clear if the alleged losses refer to losses by CPP because they held Income Trusts in their portfolio or because the Toronto stock market index, the TSX, fell the next day.

Quebec Pension Plan (QPP)

Quebec is the only province in Canada that opted out of the CPP. The Quebec Pension Plan, or QPP, is the province of Quebec's own version of the Canada Pension Plan. Almost mirroring the CPP exactly, the QPP is a contributory earnings-related pension plan that pays benefits in the event of the earner becoming disabled, retiring, or dying. Both Quebec and the federal government tax benefits paid from the QPP.

References

External links

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