The ORPP in the Limelight
Three recent announcements have placed the Ontario initiative to create a province-wide employment-based pension plan (the Ontario Retirement Pension Plan) in the limelight. The first was the federal Conservative Government’s very public July 16 announcement that it would not provide any federal assistance to Ontario’s efforts to create the ORPP. The second was the August 11 announcement by the Ontario Government, providing more detail on how it envisions the evolution of ORPP’s design, how it would be implemented on a phase-in basis starting in 2017, and what constitutes a ‘comparable’ plan that would exempt an employer from having to participate in the ORPP. The third announcement, reported on September 3, was a confirmation by both the federal NDP and Liberal parties that if either was elected to form a government, they would call a first ministers meeting to discuss CPP/QPP enhancement.
At the same time, the ORPP initiative continues to generate considerable attention from think-tanks and the media. For example, I counted seven ORPP-related opinion pieces in the print media just in the last few weeks. Also, I seem to have become CBC radio’s unofficial ORPP guide for its listeners, being interviewed recently on three morning news shows on the topic. With this ‘guide’ experience and the prodigious flow of complex ORPP opinion pieces in mind, this seems a good time to write an ‘understanding the ORPP debate’ piece for non-experts. That is the goal of this paper.
The Evolving ORPP Initiative
The idea of the ORPP was first set out in the 2014 Ontario Budget. It was to provide an additional pension of 15% of earned income on top of the OAS/CPP pensions for some 3.5 million Ontario workers without a workplace pension plan. So for example, an earned annual income of $70K over a 40-year period would produce about a $10K/yr ORPP pension on top of the OAS and CPP pensions. The cost of this additional benefit was estimated to be 3.8% of earned income, to be split 50-50 between employer and employee. The target start-date for the Plan was January 1, 2017.
The Government justified the ORPP initiative by arguing that without it, many of these 3.5 million workers would face material drops in their standard of living when they stopped working. This would be bad for them, bad for the economy, and bad for government finances as tax revenues fell and income support payments rose. Four important ORPP elements were left to be resolved at a later date:
- The exact nature of the ORPP pension benefit (e.g., would it be a guaranteed defined benefit or some form of contingent target benefit?).
- The definition of a ‘comparable’ plan that would exempt employers from ORPP participation.
- The earned income range that would be subject to ORPP deductions (the upper-end was to be $90K, but the lower-end was left open for discussion).
- How to best make the ORPP available to the self-employed.
The Ontario announcement this past August 11 fills in some of these blanks. For example:
- It appears that the ORPP is going to be a Target Benefit Plan with contingent inflation protection (e.g., the provision of inflation protection will be “consistent with Plan sustainability”). However, the announcement was silent on the critical matter of how an ORPP contribution will be converted into a future benefit, and how future generations of ORPP participants will be assured that they will not become unwitting underwriters of possible future ORPP funding
- It also appears the Government is leaning towards setting the lower-end of the earned income range to be the same as it is for the CPP: $3.5K. In other words, all earned income between $3.5K and $90K would be subject to ORPP
- Due to pressure from the employer community, Defined Contribution (DC) Plans can now be deemed ‘comparable’ plans. However, they must have at least an 8% contribution rate (compared to the ORPP’s 3.8% contribution rate), and meet a number of additional requirements. The comparability of various forms of hybrid options would be dealt with on a case-by-case basis.
Opinions on the July 16 and August 11 Announcements
Only one of the seven media commentaries dealt specifically with the July 16 non-cooperation announcement by the federal Conservative Government. In an August 10 Globe & Mail article, Osgoode Law School Dean Lorne Sossin chides both the federal and provincial governments for their very public spat about the ORPP. Principles of federalism such as equal treatment of all provinces and lowering costs to taxpayers require the federal Conservative Government to cooperate with Ontario in establishing the ORPP. At the same time, based on those principles, the Ontario Liberal Government should stick to demanding cooperation rather than trading personal attacks with the federal Conservative Government politicians involved.
The other six commentaries were critical, in one way or another, of the design of the ORPP itself.i Rather than deal with them one at the time, I summarize the five key criticisms embedded in one or more of the commentaries:
- The ORPP is unnecessary, or least, should be more targeted: there is no evidence that most middle-income workers without workplace pension plans retiring today are experiencing major drops in their standards of living. At the same time, forcing low-income workers to save for retirement now reduces their standard of living now, as well as their eligibility for the Guaranteed Income Supplement (GIS) in their retirement years. At the other end of the income scale, high-income workers can sort out their retirement finance challenges on their own.
- Future Ontario taxpayers should not be placed on the hook for ORPP shortfall guarantees: the implication is that the ORPP should not be a guaranteed inflation-indexed defined benefit plan.
- ORPP contributions are a job-killing payroll tax: the Canadian Federation of Independent Business has surveyed its members, and many say that if they were forced to contribute 1.9% of pay into the ORPP, they would have to lay off workers. This is also the position of the federal Conservative Government.
- The ORPP will shift private savings to public savings, not increase savings: this is a bad thing because savers will lose choice, and governments may misspend public savings.
- There is a risk that the ORPP will be complex and expensive to administer: this will be especially the case without federal government cooperation, and without the ORPP eventually morphing into a Canada-wide plan on a larger scale.
How legitimate are these five criticisms? I offer my view on each, as well as on the indications by the federal Liberal and NDP parties that they would actively pursue CPP/QPP expansion if elected.
Is the ORPP Necessary?
The idea of a well-designed, well-managed workplace pension plan for workers without one is an attractive proposition. That is true for Ontario, and true for all of Canada. There are two reasons for this.
Inertia is one reason. Many of us regret not having done things years ago that we should have. In that context, people retiring today have been lucky. Many have been members of a workplace pension plan and hence have not had to worry about saving for retirement. Even if they were not, most started working at a young age, and have benefitted greatly from the generally strong post-WWII financial and real estate markets. Future generations of retiring workers are unlikely to have the same financial luck. Membership in workplace pension plans has been declining. Workforce entry is occurring at a later age, and future returns in financial and real estate markets are uncertain at best. All this leads to the logical conclusion that today’s and tomorrow’s workers would benefit materially from participating in a well-designed, well-managed workplace pension plan.
Cost-effectiveness is the other reason for creating such a plan. Much of the retirement savings of the millions of Canadians without workplace pension plans today is invested in retail mutual funds that charge average fees of 2%/yr. This compares with average annual costs of 0.5%/yr. for workplace pension plans. Using the rule of thumb that every one percentage point increase in costs reduces the ultimate pension by 20%, the implication is that the unavailability to millions of Canadians of a well-designed, well-managed workplace pension reduces their potential pension by some 30%.
I conclude that the idea of an ORPP is indeed justified. However, there are some serious devils in the details of designing and creating it.
Devil #1: Targeting the ORPP
One such detail is how to best target the ORPP. There are two proposed targeting instruments: 1. The definition of the earned income range subject to ORPP contributions, and 2. The definition of a ‘comparable’ plan which exempts an employer from having to participate in the ORPP.
Targeting Instrument #1
I have no problem with setting the upper end of the earned income range at $90K, but would prefer the lower end set at $25K. This would avoid the problem of ORPP contributions reducing the standard of living of low income workers now and reducing their access to the GIS benefit tomorrow. The problem for the Ontario Government is that not collecting contributions on income between $3.5K and $25K would mean requiring a contribution rate higher than 3.8% of pay on income between $25K and $90K in order to achieve the target ORPP pension. Their hope is that this problem will be solved by redefining low income support programs and GIS eligibility at the federal level. Whether this is a reasonable prospect depends on the federal election outcome in October.
Targeting Instrument #2
The opening up of the ‘comparable’ plan definition creates an important window for healthy private sector competition for ORPP business. I have long been an advocate of attaching ‘income for life’ back-ends to traditional DC plans (this is now happening in Australia). In my view, there is no reason why a well-managed, low-cost target benefit plan with income for life, and with a 3.8% contribution rate, offered by an insurance company, would not be deemed a ‘comparable’ plan.
There are two other important targeting opportunities for the ORPP initiative. Neither has been directly mentioned by either the Ontario Government or by the writers of the six cited media ORPP commentaries.
These potential targeting opportunities are: 1. Middle-income workers without a workplace pension plan who, for whatever reason, do not want to participate in the ORPP. 2. Millions of workers who have been saving for retirement through the high-fee retail mutual fund sector without realizing the negative consequences for their future pension prospects. These two opportunities lead to two more targeting possibilities:
Potential Targeting Instrument #3
The UK version of the ORPP (called NEST) offers workers an ‘opt-out’ clause. That is, after being automatically enrolled in NEST, they have a window during which they can dis-enroll themselves. Based on three years of experience, only 8% of enrolled workers have exercised this opt-out option. In the interest of respecting the value of individual choice, the ORPP should also offer this option.
Potential Targeting Instrument #4
The ‘public good’ potential of opening up the ORPP to work- ers saving for retirement through the high-fee retail mutual fund sector is material. For example, at the national level some $400B of RRSP/RIFF/TSFA assets are invested this way, attracting some $8B/yr. in fees at a 2%/yr. average fee level. If that fee level was reduced to 0.5%/yr., aggregate fees fall to $2B/yr. As a result, workers would retain an additional $6B/yr. in their retirement accounts. This public service opportunity surely deserves a serious policy response!
Devil #2: Placing Future Generations at Risk
The potential for placing future generations at risk is a real problem still not receiving the attention it deserves. Simply put, we cannot pass a law today requiring future generations to underwrite the risk that whatever investment return assumption on ORPP contributions we make today will not be achieved. In financial terms, that would be equivalent to requiring future generations to underwrite an insurance policy for us without receiving any compensation, or any say in the matter. I return to this still-neglected theme on the next page.
Devil #3: The ‘Job-Killing Payroll Tax’ Issue
People making this claim should be required to take (or retake) Economics 101. They would be reminded that total compensation is the sum of current compensation plus deferred compensation. The ORPP proposes to raise deferred compensation by 1.9% of pay (i.e., the employer’s part of the ORPP premium), phased in over a 3-year period during which EI premiums are projected to decline. In this context, there are a myriad of ways in which employers can absorb the 1.9% of pay deferred compensation increase without increasing total compensation. A simple example would be where the employer provides only inflation updates to total compensation. In a 2%/yr. inflation world, a 1.9% of pay ORPP premium phased in over a 3-year period could be easily absorbed without increasing total compensation in real terms.
Apart from this logic, there is a simple way to test the empirical validity of the ‘job-killing payroll tax’ claim. Between 1996 and 2003, employer CPP contributions rose from 2.8% of pay to almost 5.5% of pay, an increase close to twice the size of the proposed 1.9% ORPP premium. Was there a major rise in the un- employment rate over the 1996-2003 period? No. The unemployment rate actually fell from 9.6% to 7.6%.
Devils #4 and #5: The Risks of Poor ORPP Investing and Administration Practices
These risks exist in any new endeavour. What should give Ontarians comfort is the fact that Canadian pension institutions are considered role models for the rest of the world.ii They have come by this reputation
honestly by creating large-scale, arms-length organizations governed by boards which are both expert and publicly-minded. Research using the CEM Benchmarking Inc. long-term databases confirm Canadian pension institutions are top long-term performers in the delivery of both investment and pension administration services. The Ontario Government has made it clear that it intends to create the ORPP organization based on the success elements of ‘The Canadian Model’. This requires only considering the return and risk prospects of investments in setting and implementing the ORPP’s investment policy. Political considerations are not allowed.iii
The CPP/QPP Enhancement Conundrum
Given Canada’s good track record on maintaining CPP/QPP sustainability, it seems logical to propose CPP/QPP enhancement as the solution to Canada’s workplace pension coverage problem. Canadians trust these programs and think (at least in broad terms) they understand them. While the trust is warranted, the economics of the CPP/QPP are far more complicated than most people realize. My March 23 Globe & Mail article How Not to Ramp Up the CPP explained why.iv
The essence of the explanation is that the CPP/QPP deliberately paid out more in pensions to early beneficiaries than their true economic cost. This disequilibrium was stabilized through the mid-1990s reforms by doubling CPP/QPP contribution rates. This stabilization requires that even today, part of CPP/QPP contributions continue to go towards making up the contribution shortfalls of the pre-1990s decades. To ensure that no inter-generational wealth transfers of this kind would take place in the future, the CPP/QPP reforms of the 1990s included the condition that any future CPP/QPP benefit enhancements would be fully costed and prefunded.
It is this condition that I called ‘ORPP Devil #2’ above: placing future generations at risk. The key determinant of today’s cost of a promise to pay a pension, say, 20 years from now is the 20-year investment return between then and now. Set the return high, and the cost will be low. Set the return low, and the cost will be high. For example, to pay $100 in today’s dollars 20 years from now costs $46 today if the money earns 4%/yr., but a much higher $82 if it only earns 1%/yr. These two 20-year return possibilities are not random numbers. The 1% real return can actually be secured by investing in long-term Real Return Bonds. The 4% real return is a plausible expected return on a diversified portfolio of public and private equities. However, there is a 50% chance the actual return earned will be lower, in which case the $46 contribution today will not be enough.
So how will the CPP/QPP enhancement enthusiasts cost that $100 benefit 20 years from now? If it is costed at anything less than $82, who will underwrite the risk that it won’t be enough? Surely not the next generation of CPP/QPP contributors? Clearly, low-cost risk mitigation strategies will have to be a key dimension of any future CPP/QPP enhancement. The ORPP designers face exactly the same challenge today. Addressing it for the ORPP now will save having to address it for CPP/QPP enhancement tomorrow. The job will have already been done.v
I hope that the logic and facts set out in this paper do indeed offer a guide for non-experts who want to develop their own informed view on an ORPP initiative that might well morph into a CPP/QPP enhance- ment initiative down the road.
My own view is that the ORPP initiative is a timely one, representing the kind of public policy most Canadians expect from their governments. Having said that, three challenges remain to be addressed for the ORPP to achieve its potential:
- It needs to be better targeted,
- It needs to be clearer about how contributions today become benefits tomorrow, and
- It needs to explicitly foster private sector competition to ensure it meets customer expectations in a cost-effective manner.
Keith Ambachtsheer is Director Emeritus of the International Centre for Pension Management at the Rotman School of Management, University of Toronto. Through KPA Advisory Services, he advises governments, pension plan sponsors, and the boards and managements of pension organizations around the world on pension design, governance, and investing. He is a member of the Ontario Government’s Technical Advisory Group on Retirement Income Security.
- The six commentaries are 1. Lamman and Herzog, National Post-July 23, 2. Coyne, National Post-August 12, 3. Mintz, National Post-August 12, 4. Cross, National Post- August 12, 5. Lamman and Kirchman, Globe & Mail-August 13, and 6. Milligan, Globe & Mail-August 13.
- See for example, the article “Maple Revolutionaries” in the March 3, 2012 issue of The Economist.
- The Ontario Government has appointed David Dodge, Gail Cook-Bennett, and Claude Lamoureux as members of the ORPP Board Nominating Committee. They are respec- tively former Governor of the Bank of Canada, former Board Chair of the CPPIB, and former CEO of Ontario Teachers’.
- Google “How not to ramp up the CPP” to access the article.
- Happily, new innovations in pension design are making it possible to offer both high return compounding opportunities to young workers and payment safety opportunities to retirees. More on this in a future KPA Policy Paper.
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