Annual Report of the Canada Pension Plan 2001-2002
As joint stewards of the CPP, the federal and provincial ministers of Finance review the Plan's financial state every three years and make recommendations as to whether benefits and/or contribution rates should be changed. They base their recommendations on a number of factors, including the results of an examination of the Plan by the Chief Actuary. The Chief Actuary is required under the legislation to produce an actuarial report on the CPP every three years (in the year before the legislated ministerial review of the Plan).
Changes to the legislation governing the general level of benefits, the rate of contributions or the investment policy can be made only through an act of Parliament. All such changes require the agreement of at least two thirds of the provinces representing at least two thirds of the population. The changes come into force only after two years' notice, unless all the provinces waive this requirement. Quebec participates in the decision-making formula, even though it has opted out of the CPP and administers its own plan. The Quebec Pension Plan must be implicated in changes to the CPP if the two plans are to remain parallel.
Finance ministers last reviewed the CPP in December 2002. They agreed to leave the schedule of contribution rates unchanged, as the Eighteenth Actuarial Report, prepared for the review, confirmed the financial sustainability of the Plan (taking into account the projected aging of Canada's population). Further information on the 2002 federal-provincial review and previous reviews of the Plan can be found at: www.cpp-rpc.gc.ca.
The Eighteenth Actuarial Report was tabled in Parliament by the Minister of Finance in December 2001. It provides an actuarial examination of the Plan as at December 31, 2000. The Report confirms that the 9.9 percent combined employer-employee contribution rate scheduled for 2003 and thereafter is expected to be sufficient to sustain the Plan over the long term. The Eighteenth Actuarial Report, along with previous actuarial reports, can be found at: www.osfi-bsif.gc.ca/osfi/index_e.aspx?DetailID=499.
A panel of independent actuaries reviewed the Eighteenth Actuarial Report. Their conclusions should give Canadians confidence. The panel concluded that the Report is based on economic and demographic assumptions that are reasonable in the aggregate (though somewhat on the conservative side). It also stated that the Report meets current professional standards of actuarial practice and uses data and methodologies that are appropriate and reasonable. In addition to its conclusions, the panel made a number of recommendations regarding the preparation of future actuarial reports. The panel's report and recommendations can be found at: www.osfi-bsif.gc.ca/osfi/index_e.aspx?DetailID=499.
The Eighteenth Actuarial Report is the second triennial actuarial report since the major federal-provincial reform agreement in 1997. Its confirmation of the financial sustainability of the Plan underlines the success of federal-provincial cooperation in this area.
Bill C-3, An Act to Amend the Canada Pension Plan and Canada Pension Plan Investment Board Act, was tabled by Parliament in September 2002 and received Royal Assent in April 2003. It proposes to transfer the bond portfolio and operating balance that are currently managed by the federal government to the CPP Investment Board. Consolidating all assets in one professionally managed organization will allow the CPP Investment Board to determine the best asset mix and investment strategy. The goal is to enhance rates of return and manage risks for plan members. The Chief Actuary in the Nineteenth Actuarial Report has estimated that the transfers could increase CPP assets by about $85 billion over 50 years. When a Bill that materially impacts the estimates contained in the most recent statutory actuarial report is introduced in Parliament (in this case, the Eighteenth Actuarial Report), the CPP legislation requires the Chief Actuary to produce an actuarial report. The Chief Actuary must use the same assumptions and methods as the statutory report but modify them to take into account the proposed legislative change.
A Fair Approach to Funding
When it was introduced, the CPP was designed as a pay-as-you-go plan, with a small reserve. This meant that the benefits for one generation would be paid largely from the contributions of later generations. This approach made sense under the economic, financial and demographic circumstances of the time. The period was characterized by a rapid growth in wages, labour-force participation and low rates of return on investments.
The federal and provincial governments decided to keep contributions at a reasonable level while beginning to pay full retirement benefits as early as the mid-1970s. This was important - many of the seniors who received benefits at that time had been unable to accumulate sufficient retirement savings.
However, demographic and economic developments and changes to benefits in the 30 years that followed resulted in significantly higher costs. Federal and provincial finance ministers began their statutory review of the finances of the CPP in 1996. Contribution rates, already legislated to rise to 10.1 percent by 2016, were expected to have to rise again - to 14.2 percent by 2030 - to continue to finance the program on a pay-as-you-go basis.
This would mean imposing a heavy financial burden on Canadians in the workforce 25 years down the road, which was deemed unacceptable by the federal and provincial governments. Therefore, in 1997, they agreed instead to change the funding approach of the Plan to a hybrid of pay-as-you-go and full funding (where each generation pays for its own benefits).
Steady-state financing
Under steady-state financing, the contribution rate is scheduled to increase incrementally (from 5.6 percent in 1996) to 9.9 percent in 2003 and to remain at this level thereafter (see Figure 1). Steady-state financing requires that contribution rates be set no lower than the lowest rate expected to ensure the long-term financial stability of the Plan without recourse to further rate increases. (The combined employer-employee contribution rate in 2002 was 9.4 percent, up from 8.6 percent in 2001.)
Steady-state financing will generate a level of contributions between 2001 and 2020 that exceeds the benefits paid out every year during this period. Funds not immediately required to pay benefits will be transferred to the CPP Investment Board for investment in financial markets. Plan assets will cover an increasing number of years of expenditures over this period (see Figure 1).
After 2020, as more and more baby boomers retire and benefits paid begin to exceed contributions, investment revenues from the CPP's accumulated assets will provide the funds necessary to make up the difference with contributions. Nonetheless, contributions will remain the main source of funding for benefits. Despite the increase in cash outflows from the Plan due to the retirement of the baby boom generation, Plan assets will continue to cover at least five years of benefits. On this basis, the Eighteenth Actuarial Report concludes that the pool of assets the Plan is expected to accumulate should make it possible to absorb almost any unforeseen economic or demographic fluctuations. These fluctuations would otherwise have to be reflected in an increase in the contribution rate above the scheduled 9.9 percent rate for 2003 and on (see Figure 1). Under the Nineteenth Actuarial Report, the Chief Actuary expects the CPP to accumulate an even larger pool of assets, putting the CPP in an even stronger financial position.
The Eighteenth Actuarial Report calculates the value of accrued pension benefits at $487 billion as of December 31, 2000, and Plan assets (valued at cost) at $43.7 billion. The future financial health of a plan funded along the lines of the Canada Pension Plan is better measured by the evolution of the projected growth rate of assets and liabilities than by accrued pension benefits. The reforms agreed to by federal and provincial governments in 1997 should ensure that CPP assets grow much more quickly than liabilities over the next 20 years and at least as rapidly thereafter. This will ensure a stable level of funding for the Plan over the long-term.
A partially funded CPP not only balances the two approaches to funding, but also complements the other components of Canada's retirement income system:
- the Old Age Security program, funded by federal government revenues, and
- private savings, including tax-assisted, fully funded employer-sponsored pension plans and registered retirement savings plans (RRSPs).
A diversified funding approach allows Canada's retirement income system to be less vulnerable to changes in economic and demographic conditions than are systems in countries that use a single funding approach.
FIGURE 1 - ACTUAL AND PROJECTED RATIO OF CPP ASSETS TO ANNUAL PLAN EXPENDITURES
