A prominent Canadian think tank warns that fat pension plans for federal government employees are not as well-funded as they declare themselves to be.
Last month, the federal government announced that the Public Service Pension Plan (PSPP) has an “excess surplus.” By the government’s accounting, the plan’s assets exceed its liabilities by 26.3%. Because this figure is more than the 25% limit permitted by the Income Tax Act, the government plans to transfer the alleged $2 billion excess to general revenues and reduce the federal deficit.
However, the C.D. Howe Institute disputed the numbers in a recent memo published by institute president William Robson and director of research Alex Laurin.
"The dismal reality, however, is that this surplus is an illusion. It results from the use of an artificially high number to discount the PSPP’s liabilities — shrinking them by about $80 billion," the authors warn.
"Rather than pretending the plan has an 'excess surplus' — or indeed any surplus at all — the government should reveal that Canadian taxpayers are on the hook for billions in underfunded pensions and set about reforming the plan to prevent the problem from getting worse."
The PSPP depends on expected returns from investments by a pension fund. The C.D. Howe says this "risky" practice has been abandoned by private-sector accounting standards, which instead require companies to calculate pension costs and liabilities by using yields from safe, long-term corporate bonds.
"That makes sense. Promising to pay a pension is like promising to repay a loan. The obligation is a fixed amount. It does not change based on how the creditor’s investments perform — or whether the creditor has investments in the first place. Pension payments should be valued like bonds, which implies a fair-market value: the price at which employees and retirees would be willing to sell their pension entitlement," the authors explain.
International public-sector accounting standards also align with this approach, stating that pension accounting should be based on “market yields on government bonds, high-quality corporate bonds, or another financial instrument.”
Although Canadian Public Sector Accounting Standards align with international standards in most respects, Canada’s Public Sector Accounting Board has stated that this approach would not serve Canadians’ best interests. The chief actuary for the PSPP has been free to choose a discount rate for benefits earned ever since the PSPP became partially funded in April 2000.
The authors say if the government applied a fair-market valuation to the PSPP, it would rely on real return bonds that currently yield 1.5%. Instead, the PSPP actuarial report assumes 4% yields. A fair-value calculation would flip the fund's reported $39-billion surplus into a $33-billion deficit. This means the PSPP is not 26.3% overfunded, but 14.5% underfunded.
"Sadly, however, no economically meaningful surplus — excess or otherwise — exists. Acting as if one does is misguided. What the government should do is dispel the illusion," Laurin and Robson write.
Government defined-benefit pension plans pay out an average of the best five years of pay (whether spiked through overtime or not) times 2% times years worked. This means a 35-year employee earning $100,000 at the end of their career will get an inflation-protected pension of $70,000 for life.
According to the PSPP's own special actuarial report, members would prefer lower employee contributions, richer benefits, or a pay increase. C.D. Howe's findings suggest a proper accounting would require a combination of higher employee contributions and lower benefits.
Better accounting would make that easier, Robson and Laurin insist: "That would set the stage for a discussion of how to transition federal employee pensions to a shared-risk, jointly governed arrangement, like those that have proved so successful elsewhere in Canada’s public sector."
