Exploring Pension Fund Issues Impacting the Maple 8

PETER HAYNES: Hello. It's Peter here. The podcast you're about to listen to is full of incredibly detailed information on Canada's pension funds from two lifelong industry observers. During the conversation, I asked some tough but increasingly relevant questions about pension liabilities, life expectancy, and the costs of managing pension funds, including Canada's Maple 8.
These are issues that society has been kicking down the road and have just recently seen greater socialization. As you'll hear from the dialogue, the views of the two speakers on these complex issues are not always aligned, and, in some instances, might be construed as a bit controversial.
It made for a very interesting conversation and led me for the first time in my hosting career to insert some comments to the tape material to close the loop on some of the more complex discussion points.
Finally, it is important to remind listeners that the opinions discussed are of the guests and may or may not represent the opinions of TD Cowen. Thanks for listening. And I hope you enjoy this discussion as much as I did.
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Welcome to TD Cowen's podcast series, Bid Out, market structure perspective from north of 49. My name is Peter Haynes. And today for episode 66, we're going to focus on Canada's pension funds, which are without question the envy of the world.
Joining me for this episode are two of Canada's leading pension experts, Malcolm Hamilton, who spent over 30 years as a consultant at Mercer, followed by time at the CD Howe Institute and Fraser Institute, and Bob Baldwin, an Ottawa-based consultant and lifelong pension observer who currently co-chairs the CD Howe Institute's Pension Policy Council. Malcolm and Bob, thanks for joining the show today.
MALCOLM HAMILTON: Good to be here.
BOB BALDWIN: Yeah, pleased to be here.
PAUL HAYNES: Malcolm, I really should say welcome back to the show as you were a guest on one of our first episodes with Bill Chinery maybe five years ago. So I'm going to start with a question for you. Last week, UK chancellor, Rachel Reeves, met with the CEOs of several of the Maple 8 funds in Toronto to learn about the funds and promote UK investments.
Chancellor Reeves is one of a steady stream of foreign pension executives and government officials that make the trek to Canada to meet the Maple 8, as these funds are known to be the envy of the pension fund universe. Malcolm, what makes these Canadian funds the envy of the world?
MALCOLM HAMILTON: Obviously, different people will have different opinions about what makes them the envy of the world. I want to clarify a couple things first, [? albeit. ?] The plans that are the envy of the world are the Maple 8. They are Canada pension funds in general. There are large public sector pension funds.
And they have a pretty solid worldwide reputation. Now, I was fortunate enough to have a front row seat during the period where I think that came about. Nobody in the 1980s was talking about Maple 8s. Nobody in the 1980s were talking about how well Canadian pension funds were managed.
In the early '90s, a number of the public sector plans-- the one I'm most familiar with is probably the largest of them, the Ontario Teachers' Pension Plan-- the money was basically spun out of the government. It was set up in trusts.
And the pension funds were reorganized more as arm's length activities for the government. This was not an undertaking of a government department. It wasn't the responsibility of the government department. They had their own fund, their own board of trustees, their own management teams. They could more or less decide for themselves what the mission was and what it was they needed to do.
And the Ontario Teachers' Plan at the time was particularly blessed. The chairman of the board was Gerald Bouey, the governor of the Bank of Canada, who was a very competent and very serious individual.
And the CEO, first one became Claude Lamoureux. And he was not from the government. He came from, I think it was, Metropolitan Life insurance in the US, although he was a Canadian actuary. And the investment guy was Bob Bertram. And eventually, they had an economist, Leo de Bever.
And from my perspective, I had a front row seat to watch those three guys reinvent what Canadian public sector plans should look like. And it wasn't just how the money should be invested. That was in many ways the smaller part in the early years.
The big thing was how the money-- other contributions should be determined, how large the pension fund should be, how the gains and losses that arise from good and bad returns, or early retirements versus late retirements, how those things should be divided between the employer, taxpayer, on one end and the public employees and unions on the other hand.
And they spent a lot of time on that. They worked very seriously on it. They ended up with something that worked quite well. A number of other pension funds stayed in touch with that, other provinces. And I think they influenced the way pensions evolved in Canada over the following decade.
Now, they had the great good fortune that the 1990s was a wonderful decade to be running the pension. Now, the stock market did well. Interest rates were incredibly high. Real interest rates were high. Nominal interest rates were high. Inflation rates were dropping.
Had we had the exact same team done the exact same thing starting in 1980, it would have looked really ugly by the time it got to the mid-'80s. So it was the right people doing the right things at the right time.
And then ever since that time, the other thing they've done, which quite distinguishes them from most pension plans around the world, is they've been aggressive self-promoters. They work very hard at branding the Maple 8 and the Canadian model and the way we do things in Canada.
And it's probably given foreign pension funds a bit of an exaggerated impression about how well what we do works. But we, at a minimum, we have serious independent pension funds. The decisions are made for good reasons by capable people.
We didn't insist that all the senior people be low paid, so they could hire very capable individuals out of the investment world. Now, the financial institutions, which would have been virtually impossible to do as a government entity, they gave these people the independence and the authority to do the jobs that needed to be done, to rethink the things that needed to be rethought. And they executed very well.
PAUL HAYNES: So, Malcolm, if an executive or a government official from the US came up to Canada and sat in a room with you and said, what are we doing wrong in the US, and how do we fix it, how would you answer that question?
MALCOLM HAMILTON: Well, in a word, it's tempting to say everything.
PAUL HAYNES: [LAUGHS]
MALCOLM HAMILTON: It really, it starts with the funding. Like, if nobody's putting enough money aside, it's very hard to make up for not having any money by investing well.
All the states are different. So it's always a problem to generalize when you're talking about how things are done in the US because there are probably as many approaches as there are pension funds.
But one of the things that is very different there is we have a board, and they'd be running a pension fund. And an actuarial valuation would be done, and an actuary would identify the contribution that needed to be made.
But having done all of that work, whether the contribution actually got made or not, or how much was actually contributed was not up to the board, was not up to the actuary, was not up to anybody affiliated with Pentagon, was up to the people running the government.
And if for fiscal reasons that was in an inconvenient year to put more money aside, they didn't put more money aside. And so they were constantly undercontributing. And so they end up underfunded. Part of that may be bad investment performance. I'm not competent to make the distinction. But a lot of it was they just didn't follow their own rules about how much money to set aside to fund a pension plan.
PAUL HAYNES: So, Bob, I'll move over to you and get your thoughts on some of the differentiating features associated with the Canada's pension funds.
BOB BALDWIN: I'll just mention two things. And I mean, Malcolm's covered a lot of territory. And in large measure, I agree with what Malcolm has had to say, so there's no need to repeat that. I think the single most important thing from my perspective is the arm's length nature of the governance of the Canadian Plans, that is arm's length from [? core ?] government.
And I think this is profoundly important. And I would second Malcolm's suggestion that the initial chair of the board and the initial CEO were profoundly important in establishing this model.
The one other thing I would mention is these plans are very large. And one of the things that I think is often underestimated assessing the advantages of size is the degree of internal analytical expertise that these plans have. I know every time I work with them, I'm just startled and impressed with how much analytical expertise is there.
The one other thing I would mention is that I think the big Canadian funds were to some degree first movers, especially in the acquisition of private assets and in their global diversification. And I think this has helped them through time.
But I'm also wondering whether the extent to which the Maple 8 becomes a model for others will increase investor competition in some of these fields where the Canadian Plans have been first movers. And life might not be as comfortable in those spaces in the future as it has been up to now. I'll leave it at that.
PAUL HAYNES: It's going to be interesting your point about-- in many ways, that's probably why Chancellor Reeves is here, is they're contemplating some changes to the UK pension structure. New competition for the Canadian pension funds in terms of assets is something that they're going to have to face. They face that in the private sector as well with the large private firms. But hopefully, they'll continue to be first movers, and maybe geographically that'll be the next place to pick the right countries to be investing in going forward as the world changes.
So, Bob, obviously, we've said some nice things about the Canadian pension funds, but sometimes things are too good to be true. And one of the recent developments in Canada that maybe isn't as positive is the potential for Alberta to leave the Canada Pension Plan, one of the social safety nets for retired Canadians.
You have written extensive on this topic, and in particular about the LifeWorks Actuarial Study that was commissioned by the Alberta government. And that concluded if Alberta were to leave the CPP, it was owed close to 50% of the current assets of the CPP, despite making just over 15% of the contributions. Can you explain this apparent disconnect?
BOB BALDWIN: The CPP legislation includes the right of any province to withdraw from the CPP. And as one of the conditions of the [? share ?] province withdrawing from the CPP is they have to accept the accrued liabilities that have emerged up to the date that they leave the CPP.
The quid pro quo for that is that the CPP legislation also includes a section which defines what has to be paid to a province that leaves the CPP. This is Section 113, which I may refer to before I'm through these remarks.
Unfortunately, Section 113 is really problematic because it is, in fact, very unclear. If you read the LifeWorks or TELUS Health report, whichever title you want to use, you run into a very interesting short passage in which the authors of the report say that if we take the CPP legislation literally, what is owed to Alberta is $747 billion, which is more than 100% of the CPP fund.
They say this is unreasonable. So they rejigged the formula that's in the act. And they say, well, on the basis of this revised version of the formula, what we're owed is $334 billion, which is 53% of the assets of the CPP.
So we can see before finishing the report that the most relevant section of the CPP legislation does not give rise to a single clear answer as to what should be paid to Alberta. And I might add that since the time that report was published, Professor Trevor Tombe, an economist at the University of Calgary, has come up with his own version of what should be paid to Alberta based on Section 113. And his conclusion is it's $150 billion, which is, it's still a lot of money, but it's 1/5 of what LifeWorks or TELUS Health said a literal interpretation of the act would give rise to.
The other thing that's very interesting about the TELUS Health report or LifeWorks report, whichever term you want to use, is its declaration that the $747 billion transfer, which it says follows literally from the act, is quote, "unreasonable." It's important because it tells me that any final settlement with Alberta, should Alberta choose to leave, will require the imposition of somebody's concept of reasonableness on the final amount that is paid to Alberta.
PAUL HAYNES: We'll be unpacking that in the next little while here. So, Malcolm, if Alberta is owed over 50% of the assets of the CPP, then other provinces that have made significant contributions could ask for the same, and before long there wouldn't be anything left of the CPP.
How is it possible that the Section 113 literal reading that Bob discussed could result in assets to one province that made 15% of the contributions being equal to the entire amount of the fund?
MALCOLM HAMILTON: Alberta has been dissatisfied with the CPP for a long time. This wasn't something that arose in 2020. I think it first arose in 1980, and that there was another flurry of discontent in 2000. And then there was the most recent episode circa 2020. So about every 20 years, this is a problem.
And what they observe every time is something that if you were running a province, you would probably be miffed by. That is they would say what percentage of the contributions are coming from Alberta? And the answer would be 15% according to Statistics Canada.
And then they'd say, what percentage of the benefits are being paid to people in Alberta? And the answer there would be 10% So they would look at that and look at that and look at that, and they'd look at it. And then people would say, well, maybe it'll change. And 20 years later, it didn't change. And 20 years after that, it didn't change.
And they're saying, this seems like a bad deal for Alberta to constantly make 15% of the contributions and to only get 10% of the benefits. Other provinces don't have that problem.
I mean, BC might have it to a limited extent, but there are some provinces that are getting a higher percentage of the benefits than they're paying of the contribution. So what is the justification for that, and what is the remedy?
And luckily for Alberta and unluckily for the Canada Pension Plan, this ability to drop out was put in right at the outset of the CPP. And it was put in because Quebec elected to opt out. Quebec was never part of the CPP. It has the QPP. The plans are essentially similar design, similar contribution up until relatively recently.
And so the original thinking was if Quebec is allowed to opt out at the outset, then we don't want to commit to being in the CPP, whether it's Ontario, Alberta, or anybody. We want to commit to being in perpetuity. We want to have the option to leave if it turns out that for reasons that we don't fully understand today that we decide that the plan's doing a bad job for us.
And so they put in a provision that did that. I suspect nobody ever thought it would be exercised. I didn't even know about it until recently, and I thought I knew a fair bit about the CPP.
But the thinking behind the provision doesn't work with the CPP. The thinking behind the provision is if you pull out, well, you have to set up your own pension plan. But we will restore it to where it would have been today had it always been separate. And what that means is you couldn't charge Alberta 15% of the contributions for 10% of the benefits, because when you transfer that to their plan, then retroactively for all the past years, they are getting a refund of an amount that they contributed.
And all these refunds, when you accumulate them at the pension fund rate of return over 60 years, you get a gargantuan amount, a small part of which is their current 15% share of the pension fund. The rest is refunding all of the older contributions they made for all the years.
So what we did was we set up the CPP to have a single contribution rate for all the provinces. We then set up a second provision that said, by the way, if you want to come out, you can yank your money out in 60 years. And if you've overcontributed, we'll give it all back to you with interest. And that just doesn't work.
That might have worked if you said we'll give you five years. And if by the end of the five years you're unhappy, we'll let you pull out then. That would have been easy to do. But you can't go 60 years with compound interest and do this. It just makes too big a mess of the plan.
So somebody has to decide, I think, on an ongoing basis. It makes sense to keep the plans together. This taking up, taking apart all the plans so we end up with end similar provincial plans with 10 reciprocal agreements and money flowing all over, that's really not going to work in the long run.
If we want to end up with each province paying its fair share based on its benefits, then the ongoing determination of the contribution rate has to be separate by province. And we have to have a plan where there's an Alberta contribution rate, the BC contribution rate, an Ontario contribution rate.
We could have done that from the outset. We didn't do it from the outset. Because we didn't do it from the outset, not only do we get the situation we're in today, but it's not at all clear to me that anyone can sort this out. Because the catch here is to sort it out, you have to decide how much benefits would have been charged to each provincial plan if each provincial plan had been separate like the QPP.
And that isn't an amount equal to the benefits paid to people living in the province. That's a determination of you have to sort of look at where the benefits were. And so if I look at myself, I spent a third of my life in Quebec and 2/3 in Ontario. And when I retire, I get all my benefit from the CPP. I'm pretty sure in the background, there is a transfer of funds from the QPP to the CPP to pay their third of the benefit I earned in that province.
But we have those numbers for the QPP because it was always separate. I'm pretty sure nobody's got those numbers for Alberta and BC, Ontario, and Prince Edward Island. And it's going to be very hard to go back 60 years and try to reconstruct them. So I'm not sure we're going to get an answer here that satisfies everybody.
I think ultimately, somebody's got to decide whether we want one contribution rate for all provinces other than Quebec or whether we want separate contribution rates. And if we want separate contribution rates, how separate and how those should be determined. And right now, the impression I get is everybody's just hoping that the problem never gets raised again. And maybe that'll work out. I don't know.
PAUL HAYNES: It is important to add some additional context to Malcolm's explanation on the transfer payments. Given the lack of data, it is impossible to adjust benefits for the very common occurrence when an individual moved to Alberta to work and contributed to CPP while in Alberta but moved back home to a home province, say Newfoundland, upon retirement and received benefits in that other province.
Think of workers at the [? oil sands, ?] for instance. The entire premise of Alberta's argument is that contributions outweigh benefits paid to date, and hence Alberta is owed an outsized chunk of the CPP. However, clearly the benefits paid to Alberta's workers are understated due to the portability of the pension benefits, and the lack of accounting for this issue is definitely a problem.
Apparently, the government may be able to piece this info together via tax filings, but it does not appear to be an easy task. Further complicating this discussion is the fact that CPP is known as a pay-as-you-go-fund.
It is not fully funded, and this lowers the transfers owing to Alberta. Further, despite the fact that demographics seem to always be in favor of Alberta, this is a point-in-time analysis and could change in the future altering the math for Albertans down the road.
Finally, on the topic of differing contribution rates for differing provinces, I will paraphrase my colleague, the honorable Frank McKenna, one of the signatories to the CPP when he was premier of New Brunswick.
Frank Made a passionate plea to Albertans in a recent op-ed in the National Post to remember that Canada is one country, and while not every benefit or cost gets allocated perfectly, it averages out and the end result is a pretty good place to live.
All right. So, Bob, Canadians probably don't know the name I'm about to mention, Assia Billig. I hope I pronounced that correctly. Assia is Canada's chief actuary. And she is actually responsible for figuring out a fair and equitable valuation of Alberta's share of CPP. How do you expect her to complete this analysis, and when do you expect that analysis to be complete?
BOB BALDWIN: First of all, let me say that I have enormous respect for the Office of the Chief Actuary. I feel like the office has been put in a rather awkward position in the sense that if you follow Malcolm's commentary all the way through, somebody at some point in time has to decide what is a reasonable amount to transfer to Alberta if Alberta leaves.
And that's not an actuarial question. It's a question of your sense of what are just deserts in this field bearing in mind that we've got a legislative provision that is, I think, everybody agrees is clearly unworkable. So first thing I want to say is that I feel like the Office of the Chief Actuary has been put in a very awkward position.
Secondly, I have no insider information on where this inquiry is likely to go. I don't know whether it's [INAUDIBLE] our best guess. But my guess is that they'll try to end up with a formula which does not do serious damage to the CPP that remains after Alberta leaves.
And exactly what that looks like is unclear. I think that any transfer to Alberta in excess of about $125 billion really starts to create problems for the ongoing operation of the CPP. So I'm expecting an attempt will be made to avoid a transfer in excess of that amount.
As you may know, the ongoing governance to the CPP is really a joint responsibility of federal and provincial finance ministers. They have regularly scheduled meetings every six months, usually in June and December.
I had expected a finance ministers' meeting in June which might opine on this issue. That did not happen. And frankly, at this moment in time, I'm unclear when we'll hear from the finance ministers on this. The next normal opportunity would be December, and unfortunately, that's as clear as I can be on this point at this point in time.
Let me add one thing, by the way. And Malcolm's discussion of Section 113 I thought was really good. But the one thing I wanted to mention is that the right of a province to withdraw from the CPP is a pretty clear reflection of Section 94A of our Constitution, which allows the federal government to pass legislation with respect to old age benefits but qualifies that right by saying that the federal legislation cannot supersede a provincial law in this area, and that's what's carried into the CPP.
PAUL HAYNES: So Malcolm, over the past year, Canadian government officials have been meeting with pension fund leaders to push these funds to invest more in Canada. And again, this is the Maple 8 leadership. This prompted several high-profile members of Canada's investment community to publicly plea for more Canadian investments by Canadian pension funds.
The pushback from the funds is there aren't enough assets in Canada to invest in. With rumblings that the federal budget in April would include new taxes on Canadian pensions that don't invest in Canada, Minister of Finance Chrystia Freeland instead announced that former Bank of Canada Governor Stephen Poloz would liaison with the Canadian pensions on behalf of the government to work together to grow investing in Canada.
Now, the devil's advocate will argue that pension funds are actually underpriced and that governments provide an implicit put in the event of a solvency issue, and therefore, these governments have the right to demand something in return.
The flip side is that a government meddling through the introduction of investment constraints will almost certainly result in less than ideal outcomes. And I know you guys touched on that a bit earlier. What is your take on the Poloz appointment, and should governments have any say in directing the assets of the funds?
MALCOLM HAMILTON: If the governments do have say-- so I'm not sure there's a lot to be gained by asking the question whether they should have say. They grant a tax exemption basically to the pension funds.
They can invest subject to whatever constraints are put on them any way they want. They can earn interest or rents, capital gains, dividends. They don't pay tax on any of it. That's all by virtue of the Income Tax Act.
The Income Tax Act is something that the federal government does. So I have a hard time understanding what the argument is that the government doesn't have the power to constrain the pension funds.
Now, the better question, I think, is whether it's good public policy to constrain the pension fund. So the first thing I'd like to observe, because I have a memory that goes back into the '70s and '80s, is before we had all of these public pension funds, there was a time when governments' pensions were paid by governments directly.
And some of them had a notional account that they put on the provinces or the federal government's books. Others didn't have that. They weren't funded. They weren't invested. They didn't have investment policies. They didn't have funding policies.
And all of the registered pension plans in Canada were basically private sector. And at that time, the rule on what those private sector pension funds could invest outside Canada was 10%. They had to be 90% in Canada, 10% outside Canada.
I don't remember any outcries from public sector unions about the injustice of that or anyone in any government. They just did it because they felt like doing it. And they left it there, notwithstanding complaints from the private sector from time to time. They left it 90% Canadian until the public sector plans started to have real pension funds that they wanted to invest outside Canada, not entirely outside Canada but partially outside Canada.
The Ontario Teachers' Plan I remember at one point was doing swap agreements so that they basically could say the money was inside Canada, but the investment exposure was outside Canada. And by doing that, they were able to inrun the 10% foreign property limit.
So at that time, the government reconsidered it. And all of a sudden, the public sector employees and unions and pension funds are interested in having little or no constraint. So the 10% limit went up to 30%, and then the 30% limit was abandoned.
And I can remember the estimate at the time was you could safely abandon the 30% limit because since all the liabilities were in Canadian dollars and since everybody had an interest in there being investment in Canada, that the pension funds would just naturally stick to probably 30% foreign content, 70% Canadian.
And it didn't, obviously, go that way. And with the passage of time, the public sector plans had more and more foreign content, less and less Canadian content. In theory, if you view yourself as a large international investor, and you want to be optimally diversified, then you would think your assets should be in proportion to the investment universe.
And since 2% or 3% of the investment universe is in Canada, a number of them are sort of pushing this to its natural conclusion. The problem with all of this, though, is I think it's largely unnecessary. It's not like you couldn't be 20% in Canada or 30% in Canada without having severe portfolio ramifications that were a threat to the viability of Canadian pension plans.
Personally, I think there's been a complete loss of perspective by the Maple 8 in particular. They just need to be less tone deaf. There's nothing wrong with having 20% or 30% of your assets in Canada. We've got lots of good companies here, lots of good business opportunities, lots of good credit risks.
And so I just think they've made this problem to themselves by going to an extreme that they didn't need to go to. I understand why in theory they might want to get there. But I think politically, it was very unwise to push this to the extent that they do.
And someone needs to remind them that half the money in those public sector plans come from governments. And these governments are supposed to represent the public interest, not the public employees' interest. And somebody's got to remind them that by my reckoning, 2/3 of all the investment risk that they take is borne by the public, and about one third is borne by the members.
And somebody should point out to them that if you look at the contribution rates to these plans, like I just picked three big plans and averaged them out 21%. And then I said, how much can their employees put in RRSPs on top of the 21%? Now it's 5%. So that brings them to 26%.
So all these public employees can shelter 26% of their earnings in public sector pension funds, while every self-employed or employed Canadian without a workplace pension plan is stuck at 18%. And every employee with an RRSP has to bear all of their investment risk, while these public employees could bear one-third of the investment risk. And consequently, the plans can take way more investment risk than can individual Canadians saving for their own retirement.
And when you put this all together, basically, they're saving about 40% more than other Canadians are allowed in tax shelters. They're being gifted an additional return of about 2% per annum by virtue of the funds being able to take risks, all of which are borne by the public. There aren't savings institutions more subsidized in Canada than these public sector pension funds for them.
So for them to sit there and say, well, we think we really only want to be 1% or 2% or 3%, that we might accidentally create jobs here. And that would be a terrible thing because all of our people have lifetime job security. I just think they've just lost the train here. They're not looking at this in perspective.
PAUL HAYNES: Well, one of the topics that I've spent a lot of time on-- I know I talked to Bob about this offline-- was there's this gravitational pull around global markets to the United States. And I must admit, Malcolm, to take the other side of your argument, we lost another company from the Canadian market. It seems like it's happening every week. We've now lost four companies from the S&P TSX Composite to takeovers in the last month.
And we are actually running out of Canadian companies, and there's no pipeline. It's not so much that Canadian companies are redomiciling to the US to take advantage of higher valuations. Europe is facing that issue.
But in Canada we just have no IPOs. We have no firm system for these pension funds to invest in other than banks and energy companies, which we know about. So I'm a little sensitive to the argument that the Canadian pensions could in theory be 20% Canada, given they're getting so big, and the Canadian market is shrinking. So it's a bit of a problem.
And hopefully, Stephen Poloz can find some solutions there, find some assets that the government can bend off and maybe do some things to help stimulate more IPOs in the Canadian market.
MALCOLM HAMILTON: Most of their equities are private equity. They're not public equity.
PAUL HAYNES: Yeah, look, it's funny, having followed the pensions as long as I have, I built this database. And I'm looking at some of the numbers right now just comparing ownership across public versus private across the different asset classes.
And it is absolutely true that most, if not all, the Canadian pensions are significantly exposed to private equity, and that's come at the expense of public equity exposure across those funds. Teachers', for instance, and this is public information, in 2023 ended the year with 10% of their assets in public equities and 24% of their assets in private equity. So you're absolutely correct that has been one of the trends. And in many ways that's impacting the investment in public equities, because a lot of those companies are staying private and getting their capital through the private markets rather than public markets.
MALCOLM HAMILTON: And I think-- though, I may have this wrong-- but you may remember when we had income trusts--
PAUL HAYNES: Very well.
MALCOLM HAMILTON: --the federal government decided it had to get rid of income trusts because, I think it was Bell Canada, thought that it would become an income trust. They didn't want all these RRSPs being able to load up with Bell Canada and get tax-free distributions because they were tax-sheltered money. Because then you'd have the corporate earnings flowing right through to individuals with no tax at all in the middle. They didn't like that.
But I'm pretty sure the public sector pension plans can still do that with their private equity. I'm pretty sure they can still thinly capitalize the company. They can have partners. They can arrange that they're getting most of their profits coming out as interest instead of dividends or after tax corporate profits.
And so again, that's another advantage that they enjoy here. I'm not saying that they should seriously harm their returns, but I think the standard here should not be what's the optimal allocation by country. It should be considering where we're from, who we represent, what support we rely on, both regulatory and tax-wise from the federal and provincial governments. What would be a respectful portion of our money to invest in Canada without harming the members? I think that they can do quite a bit more than they're doing.
PAUL HAYNES: And the difficulty with that is that it's almost like if you open up the cookie jar to the politicians, they're going to want to take all the cookies. And where do you draw the line? I understand what you're saying in theory. I worry about it in practice. And I must admit I like the fence that exists today.
So, Bob, one of the issues that we face here, when pension funds were invented, the expectation was that a pensioner would live just a couple of years into their retirement. Nowadays, pensioners are often living decades past their retirement.
And I know you hear this from both CPP and Teachers' executives about the number of their members that are over 100 years old now. It's unbelievable. Some teachers are living in retirement longer than they taught for too.
So there's a school of thought that the generation that does benefit from what we'll call the cheap pensions was the generation-- and I know I heard this from you, Malcolm-- that fought a war and went through a depression. So it wasn't really a fight that governments wanted to have at the time.
But meanwhile, pension fund experts recently have been watching closely the move by the Macron government in France to add two years to public worker retirement. I think they were moving from age 60 to 62. That was a mess. And we saw the pictures on TV of all the garbage in Paris because the garbage workers went on strike when that suggestion was made.
It was introduced. And as I say, it was a mess. And now it appears that that proposal may be dead with the recent France election results. So, Bob, what actually can be done to solve this very delicate problem of the extension of life expectancy and its impact on pension liabilities?
BOB BALDWIN: First of all, a lot has been done if you look broadly at OECD countries. And France is a bit unusual in the forceful resistance to increasing the age of eligibility for retirement pensions, because the age of eligibility has been increased in many countries within the OECD.
I have often wondered whether part of the problem in France is the structure of the Trade Union movement. And we could circle back to that if you're interested. But it is worth noting, too, that other countries have responded to aging, either by lowering the initial amount of pension benefits or by changing the indexing arrangements once benefits begin to be paid.
Coverage is a bit unusual actually, in the public pension sphere. I don't think I know of another country that moved to change the funding arrangements for public pensions as we did here in Canada. And while Malcolm is correct that the base CPP benefits are still largely pay-as-you-go, there is enough investment income anticipated to stabilize-- at least to stabilize CPP contributions.
At the same time, we're facing population aging, which is putting upward pressure certainly on all of our pay-as-you-go arrangements. We also are experiencing much more employment at later ages, especially in the 65 to 69-year-old age range.
And I mention that because certainly I would not rule out increases in the age of eligibility, especially for old-age security as we move forward. If we pay old-age security benefits at age 65, about 30% of them will go to people who are still employed. And I'm not sure that that makes a lot of sense in terms of other pressures to which population aging will give rise. So that's an initial response, Peter, to your question about what can be done about population aging.
PAUL HAYNES: Bob, on the flip side, a stat that is fairly astounding is fertility rates in Canada, which have trended down from 1.5 child per family, just I think 10, 15 years ago to 1.2 as of 2022. What is the significance to pension funds, particularly the CPP, of this trend to lower fertility rates?
BOB BALDWIN: In any pay-as-you-go arrangement, including old age security and base CPP benefits, the declining fertility rate puts upward pressure on the amount that you've got to put into the plan to keep it viable.
I should say you've noted there, I mean, the 2022 fertility rate was really quite startling. But in looking at fertility rate trends, I mean, they've been trending downward since about 2011.
I mentioned this in part because I think when you're managing a pension plan, one of the most difficult issues you face is that you see experience that departs from your assumption about the future. And you can't be sure initially whether this is a temporary departure from the mean, which will return to the mean, or whether, in fact, you're looking at the front end of a secular trend.
And I think based on what we've seen since around 2011, you have to think that, in fact, there is a secular trend that is well underway, and it's not clear what might reverse it as we look to the future.
PAUL HAYNES: So, Malcolm, the last time we discussed pensions on this podcast series, your good friend Bill Chinery came on. And we were discussing the unfunded tax cuts that were introduced by the UK government, Liz Truss, which caused a run on the gilt and resulted in a UK pension fund crisis.
Now that the UK government is considering some sort of a superfund model-- and I know Tony Blair has mused about this possibility-- for local corporations, it would mimic the Australian Canada model, most corporations worldwide have moved actually away from the defined benefit model in favor of DC. Do you think that this so-called superfund model that Tony Blair has been using about a so-called DB Superfund would be the right direction or the wrong direction for the UK?
MALCOLM HAMILTON: What is he proposing to use the Superfund for?
PAUL HAYNES: I thought the idea was that they would allow various corporations to vend together and pool together and use the expertise of one central organization in a similar fashion to some of the provinces that have the local pension funds all under one umbrella like BC or Alberta.
I think the concept was to provide that alternative to an individual company running their own defined benefit plan and getting the benefit of these, both the scale and the expertise of that central organization. Because the company is in the business of selling widgets, not in the business of managing their liabilities, pension fund liabilities. I think that was the theory. Is that a flawed suggestion, Malcolm?
MALCOLM HAMILTON: If that's a theory, it's badly flawed. People in the public sector think there is no risk. Their whole idea of dealing with risk is you take the risk, and in the long run, it's not there. They have no idea what the fund will earn next year, but they're not worried about that because they're almost certain that they know what the fund will earn in the next 20, 30, 40 years.
What they like about the superfund things is you create a big fund, you take a lot of risk with the investing of it, which is what we do with our public sector funds. The reward for risk-taking goes to the members of the plan. The risk goes to the public. And the public's told, don't worry. In the long run, everything will be fine.
I think this is remarkably irresponsible if that's what they're proposing. The question you have to ask is, what is the plan for the bearing of the risk? If the returns aren't what you expected in the long run, what happens?
Do people get smaller pensions, or in future generations pay more money, or the public picks it up but nobody tells them? They just can't understand why government gets more and more expensive but never delivers any more in the way of services.
I look at our public sector plans. They are solving all of their problems by more and more illiquid investments, more and more risky investments. How is it that the average teacher retiring at age 59 and living till 91 and working for 26 years, how do you make that work? You've got to be taking a ton of risk. You've got to be overfunded, which they are.
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PAUL HAYNES: I think it is important to point out that there are many ways that the UK could structure their proposal, and we don't have all the details. Clearly, Chancellor Reeves remains on a fact-finding mission. And apparently, her next stop may be in Australia.
According to press reports, the biggest challenge the UK will have in combining public plans is keeping the government at arm's length, a key attribute of the Canadian model. Perhaps we will ask Malcolm and Bob to come back a second time to dig into the UK's solution once there are more details.
So Bob, last word to you. And maybe Malcolm has led us down this path, but when you think about pension funds 10 years from now and I have both of you back on this podcast, what's your best guess about what topics will be top of mind for pension experts at that time?
BOB BALDWIN: Sorry to do this, Peter, but I feel obliged to say that I have a very different view on the risk issues in the public sector that Malcolm has been discussing. And I won't pursue that any further, but I think it's important that viewers and listeners know that that's not the only view of the issue that exists.
I think, Peter, we've got a current problem that I fear won't be solved in the next 10 years, and that is the low levels of pension plan participation in the private sector. There are variety of ways we may come at that, but I think that is likely to be with us even 10 years down the road.
I think that we'll also be dealing with another problem, which is the aging of the population and the deceleration in population growth. I think that, especially the deceleration in population growth which will carry with it deceleration and labor force growth, will put upward pressure on wages and compensation 10 years down the road, and we'll be figuring out how to deal with that.
That problem would be dramatically accentuated if we make substantial progress on the health front to add to life expectancy. And here I'm thinking particularly of cancer cures. If we come anywhere close to cancer cures, bearing in mind that cancer now accounts for a large portion of our deaths at old age, we've got an aging problem that will be even more rapid going forward.
Another thing that I think will be on our minds 10 years from now is somewhat of a shift in global economic growth from Europe and North America to Asia in particular. And I think the discussion we were having earlier about pension fund investments in Canada may be even more accentuated in that kind of environment.
Finally, and at the risk of sounding too pessimistic, we do have to keep our eye out for further pandemics. I was somewhat surprised by a publication from the Office of the Chief Actuary on the evolution of life expectancy in Canada.
And I hadn't anticipated one of the things they pointed out, which was, in fact, we've had eight pandemics, starting with the Spanish Flu back in 1918, 1919, through to the more recent COVID pandemic. And obviously, that can change our demographic situation quite quickly. So those are some of the things I think will be on our minds 10 years down the road, Peter.
PAUL HAYNES: Yes, COVID was very interesting from an academic perspective to think about certain shocks to cash flows for certain pension funds that were anticipating cash flows that all of a sudden stopped, just probably weren't in the models. And you've got commitments to investments and the like. And that was a major challenge, and I'm sure will be factored into future forecasting.
So I've learned a ton here today. And I knew I would when we're talking to people that have spent their entire lives focused on the Canadian and global pension space. So thank you very much, Malcolm and Bob, for joining us today.
BOB BALDWIN: Thank you, Peter.
MALCOLM HAMILTON: You're welcome.

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