Canada could create a large new pool of investible assets in the near future as a result of efforts to correct financial problems with the Canada Pension Plan.
To make the pay-as-you-go CPP more sound, the federal and provincial governments could agree to an acceleration of planned increases in contributions and trimmed benefits. (Similar treatment is planned for the Quebec Pension Plan; Quebecers don't participate in the CPP). The result could be a much larger pool of assets, which could feed the capital markets.
While nothing has been decided so far, concern about the current plan is building.
Public hearings on the CPP will begin this month, jointly sponsored by the federal and provincial governments; this is the year the federal and provincial finance ministers undertake their regular five-year review of CPP contribution levels; a consultation paper on the CPP was recently released by the federal and provincial governments; and just last year, Canada's chief actuary reported the CPP will be bankrupt in 2015 if the current schedule of rate increases and level of insured benefits is maintained.
Given this background, it seems likely Canadian officials will make some important changes to the 30-year-old mandatory plan.
To keep the CPP solvent in perpetuity, contribution rates in the future will have to hit 14.2% of salary in 2030, according to the chief actuary's report, a level many consider too expensive. In comparison, the rate now stands at 5.6% (a combined employer/employee contribution), and the rate is scheduled to rise to 10.1% in 2016.
Evidently, Canada wants to find a way to hold down contributions while saving the system. The federal and provincial finance ministers are expected late this year to make their recommendations on any change to Parliament.
The widely expected outcome is a plan to accelerate contribution increases and trim benefits. And within that scenario, the capital markets could play an important role. The government has pointed out accelerated contribution rates would create a sizable CPP reserve fund whose investment returns could help hold down contributions. In contrast, accumulated CPP funds today equal only about 2.5 years of benefit payments, or about C$40 billion (U.S. $28.8 billion).
But just how might larger accumulated CPP sums be invested?
"One option," said the federal/provincial governments' report, would entail a modification of the current policy that gives "provinces the option of borrowing a share of the contributions" for general purposes. For example, provinces could be allowed to "borrow (in) a range of maturities instead of just (the currently allowed) 20-year maturities" and would be charged an interest rate "equivalent to the rate .*.*. on their market borrowing."
If the CPP fund exceeded provincial borrowing needs, "the excess could be invested in the market." But "another option is to invest most or all future available funds in the market," the report said.
Exactly how much money is involved remains unclear because no changes have been approved. But one federal government official, who asked not to be named, said if CPP contribution rates are ramped up to 10% to 11% over the next six to nine years, it could create an asset pool of about C$150 billion within 10 years.
Whether such developments would benefit money managers remains to be seen. Even if a larger CPP reserve were created, the issue of "who would get (to manage) the money is farther down the road," said Malcolm Hamilton, principal of William M. Mercer Ltd. in Toronto. He imagines the money would "mostly be invested passively - although that's not been written yet." If so, such passive investment would lessen the opportunity for money managers. But even passively managed assets "would be good news for Canadian securities prices, because the money would mainly be invested" in Canada, he said.
The broader concept of fixing the CPP appears to have support.
"Some acceleration in contributions and some benefit reductions could be packaged to make a good solution," said Michael Beswick, senior vice president for pensions of the C$21 billion (U.S. $15 billion) Ontario Municipal Employees' Retirement System, Toronto. He also believes "investing the money in the markets, at arm's length from the government," is a "win-win" situation. Not only could it help keep down the long-term contribution rate, but also the arrangement would "increase the supply of capital, which we need in this country," he said.
Moreover, the Association of Canadian Pension Management, Toronto, probably will favor faster increases in contribution rates and a rationalization of pre-retirement CPP benefits "to keep this important program in place," said Gretchen Van Riesen, the association's chair.
But she and others would like CPP contribution rates held to single-digit levels. "A 10% to 11% contribution rate is too high for the level of benefits this plan should provide," said Ms. Van Riesen. An official with the Ottawa-based Canadian Chamber of Commerce has advocated limiting any contribution rate increases to the 8% to 10% range, a spokeswoman for the chamber said.
For its part, the C.D. Howe Institute recently advocated in a paper that the "crisis-prone Canada Pension Plan should be scaled back and ultimately wound up." The Toronto think-tank's paper said the CPP should be "replaced with an expanded private pension system."
But other experts say the government opposes any privatization of this social security-type system. They point out the CPP, which replaces 25% of a retiree's income up to a threshold around C$35,000 a year, is considered an important social program.
But just how much will the program be changed to keep it going? "Reading between the lines, it looks like the government would like to cut benefits and accelerate contribution increases," concludes David Adams, a lawyer in the Canadian Research and Information Center of Watson Wyatt Worldwide in Toronto. He could see benefit cuts of 7% to 10% and contribution rate increases accelerated to 11.3% in the next six to eight years.,aw0>
Mr. Adams thinks the government has a way to make accelerated increases in CPP rates more palatable. One possibility is the government would announce an accelerated contribution rate for the CPP at the same time it announces a cut in unemployment insurance premiums.