Chevreau: Pooled pensions make sense — in principle

Originally published in the Financial Post on December 20th, 2010. To go to the Financial Post website please click here

Finance Minister Jim Flaherty has surprised pension reformers by dashing hopes for an expanded CPP in favour of Pooled Registered Pension Plans. While modest expansions to the almost universal CPP may yet be in the cards, PRPPs are aimed squarely at the 3.5 million middle-income private-sector workers and self-employed who lack employer-provided pensions.

In principle, the idea of “pooling” pensions among multiple small employers makes sense. PRPPs are in essence group RRSPs or Defined Contribution RPPs but relieve employers of the administrative burden, says Fred Vettese, chief actuary at Morneau Sobeco. The burden shifts to a third-party administrator.

One reason only a third of private sector workers now have employer pensions is the complexity of set-up and administration. Classic Defined Benefit (DB) plans are notoriously complex because providers must deal with solvency issues, surpluses and onerous regulations. No surprise that small businesses and entrepreneurs often choose to provide no pension at all, leaving workers to make their own RRSP contributions or — just as likely — no contributions at all.

Smaller firms that take the plunge are confronted with high-cost solutions, similar to what RRSP investors face buying mutual funds. One benefit cited by Finance’s draft, Framework for Pooled Registered Pension Plans, is “enabling more people to benefit from the lower investment management costs that result from membership in a large, pooled pension plan.” If annual fees are lower by 1%, resulting pensions will be 20% higher, Vettese says. Thus, PRPPs “have the potential to change the pension landscape more dramatically than one might think.”

There are major differences. CPP is compulsory and provides a DB-style pension that gives workers a known future income. The PRPP is voluntary and Defined Contribution in nature, meaning market risks are borne by workers if stocks fall.

There’s room for both, says Mercer partner Malcolm Hamilton. A small gradual rise in CPP contribution rates over five years wouldn’t do much harm if imposed on workers rather than employers, he says: “If we want Canadians to save more for retirement we must accept that they will have less to spend.” But to the extent the PRPP encourages more workers to participate in low-cost retirement savings plans, it too is “worth trying,” he says.

There are “major challenges” either way, says Towers Watson senior consulting actuary Ian Markham. Both build on existing efficient frameworks. Ideally, PRPPs will be established through a single federal legislative framework. Markham worries about the higher CPP premiums employers or employees (or both) might face under an expanded CPP. He says there’s only so many extra deductions employers can load onto payrolls before they look to cut back on employee pay — including existing DB or DC pension arrangements.

One benefit cited by Finance is portability of benefits. Another is the “fiduciary” duty for pension administrators. In theory, that should provide peace of mind to employees that their interests are being put ahead of the firms managing the money.