Editor’s Note: The following article provides a great overview of the issues surrounding public sector pensions. Critics say public sector pension plans are unaffordable and unfair and should be wound up. But would it really be cheaper and fairer to do so?
Canadians who dont have a pension often cast an envious eye at their friends and family who work in the public sector, maybe as nurses and hospital technicians, teachers, firefighters, police or municipal workers.
This is because 76 per cent of private sector workers dont have a pension of any kind. But 86 per cent of public sector employees do. Most public sector pensions are the best kind ; defined benefit plans paying a monthly amount for life. Many are adjusted for rising inflation.
If you were one of the have-nots, a diligent saver socking away all you could in a Registered Retirement Savings Plan, the 2008-09 stock market crash made you worth up to 40 per cent at the bottom. Markets have recovered ; the current plunge notwithstanding ; but even so, public sector pension envy has been on the rise. Safe. Secure. Indexed.
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A recent Toronto conference on pension reform sponsored by Canada’s Public Policy Forum, took a closer look at the divide. Critics say public sector plans are unaffordable and unfair, and should be wound up. But would it really be cheaper and fairer to do so?
Billionaire investor Warren Buffett said this spring that public pension plans threaten the financial health of U.S. cities and states. He said everyone has underappreciated the gigantic financial tapeworm created when the pension promises were made.
Former provincial Conservative party leader Tim Hudak brought the debate out of the shadows in the recent Ontario election. He pledged to grandfather the current defined benefit model for public servants and move to defined contribution plans which shift a lot of the risk onto employees.
Defined benefit plans guarantee that monthly payment and you can sleep easier because professionals manage the money and your company has to ante up if there’s not enough in the pot.
A defined contribution plan is one where employer and employee contribute, but the size of the pension pot varies with market conditions. When you retire its up to you to invest and manage the money. The risk is yours.
About 12 per cent of private sector workers have a defined benefit plan, a number that has been steadily declining. Companies don’t like these plans because investment returns are hard to predict and whatever happens to markets the risk is all theirs.
Robert Brown, a retired professor of actuarial science at the University of Waterloo, told the conference that pension envy aside, its a bad, bad idea to wind up these public sector plans. Brown co-wrote a paper with colleague Craig McInnes that looked at the cost of conversion.
Brown summarized the finding by saying it will cost us a lot of money to cap the plans. Going forward, retirees would end up with a smaller pension and at the end of the day taxpayers would foot the difference with income supplements.
It is a lose-lose, Brown said.
Here are some of Browns other conclusions:
- Private and public sector goals are different. Its in the best interests of companies to cut costs and focus on profits. But when they off-load costs, they dont care who picks them up. When the public sector does it, they offload the costs onto themselves, or another government.
- Large, well-run defined benefit plans are efficient. They keep fees low and reduce risk by spreading their costs over a large number of plan members. They have a long time horizon which smooths out market ups and downs. These things help a defined benefit plan produce up to 77 per cent more income than a defined contribution plan with equal contributions, Browns said.
- The risk of a public pension failing is far less likely than a private one.
- The only way a defined contribution plan can lower costs is by decreasing benefits. In Nebraska and West Virginia where state plans were converted, they’ve partially switched back.
- If public sector funds are capped and new ones set up, governments will have to run two funds in parallel for decades. If a legacy plan is underfunded the government is on the hook to cover the gap.
- The conversions would carry a big political risk for governments in the form of job action and legal challenges. They would be seen as breaking contracts negotiated in good faith.
In the end the message wasn’t so much that public sector pensions are too rich, but that workers in private sector have been abandoned. Their employers are leaving them to make retirement decisions they are often ill-equipped to make, in an increasingly complex and unpredictable world.