“…..an idea worth serious consideration.”
Jason Kenney Premier of Alberta
Calculations by the Fraser Institute and the CD Howe Institute show that a separate Alberta Pension Plan (APP) could provide the same base benefits as those of the Canada Pension Plan (CPP) at a contribution rate materially lower than the current CPP contribution rate. On top of that, a proportion of the $400 billion CPP reserve fund would be shifted to the APP to partially cover the accrued payment obligations the APP would be taking over from the CPP. On the face of it, to quote Alberta Premier Jason Kenney, this indeed sounds like an idea worth serious consideration…..
The goal of this paper is to put Albertans in a position to give the APP idea serious consideration from an information base that includes not just the pros of the APP idea, but also the cons. To that end, the paper addresses three questions:
- What underwriting risks would current and future APP members be undertaking by shifting from the CPP to an APP?
- What costs would Alberta taxpayers be incurring in setting up and managing an APP?
- What investment risks would current and future APP members be undertaking by shifting from the CPP to an APP?
Here are summaries of the paper’s answers to these three questions:
- By shifting to an APP, Albertans would be taking on material underwriting risks. To mitigate these risks it would be imprudent to lower the base APP contribution rate below the CPP’s current 9.9% of pay up to the maximum earnings.
- Establishing an APP would incur set-up and operating costs in the $100s of million dollars.
- Establishing an APP would also expose plan members to political involvement in deciding APP’s investment policy. Would its assets be managed ‘at arm’s length’, or would they be used to shore up a potentially declining oil and gas industry? The latter outcome would expose APP members to a double jeopardy possibility of falling APP contributions and asset values at the same.
Keith Ambachtsheer has been named ‘Top 30 Difference-Maker’ by P&I, the ‘Globe’s #1 Knowledge Broker in Institutional Investing’ and ‘Top 10 Influential Academic in Institutional Investing’ by aiCIO, in the ‘Top Pension 40’ by II, ‘Outstanding Industry Contributor’ by IPE, the Lilywhite Award recipient by EBRI, the ‘Professional Excellence’ and ‘James Vertin’ Awards recipient by CFA Institute, and the McArthur Industry Pioneer Award recipient by IMCA.
He is Adjunct Professor of Finance, Rotman School of Management, University of Toronto, and Director Emeritus of its International Centre for Pension Management. He is also Senior Fellow at The National Institute on Aging (NIA) at Ryerson University. He is a member of the WEF Council on the Future of Long-Term Investing, the Melbourne-Mercer Global Pension Index Advisory Council, the Georgetown University Center for Retirement Initiatives Scholars Council, and the Advisory Council of the Tobacco-Free Finance initiative. He is also the founder of KPA Advisory Services and cofounder of CEM Benchmarking Inc.
Issue #1: Underwriting Risks in an APP
The underwriting risks embedded in the base ‘pay-as-you-go’ CPP since its founding in 1965 have been borne by CPP members and their employers. Contribution rates (split 50- 50 employer-employee) were set at a high-enough level so that pension benefits could be paid. Triannual tests over time ensured that future contribution rates would continue to be high-enough to pay future benefits. These tests set off alarm bells in the 1990s as projections showed material contribution rate increases would be needed to pay benefits in the decades ahead. These findings prompted the federal and provincial governments of the day to decide that rather than watching CPP contribution rates continuously rise, it would be fairer to almost double the CPP contribution rate to its current 9.9% of payi, thus building up a CPP reserve fund to be managed by the CPP Investment Board (CPPIB). As a result of that build-up (about $400 billion today), the 9.9% of pay contribution rate for the base CPP has been deemed sustainable for almost 20 years now.ii
This history explains the cited Fraser and CD Howe studies suggesting a base APP could operate with a sustainable contribution rate below CPP’s 9.9% today.iii Why? Because the 3 million Alberta members of the CPP are materially younger than the other 17 million members. That means relatively more CPP contributors and relatively fewer retirees drawing CPP pensions in Alberta. Further, Alberta workers have been higher-paid. As a result, a base APP could be sustainable with a contribution rate in the 6-8% range (depending on the assumptions made), compared to the CPP’s 9.9%. Another way to look at this is that Albertans are making 16.5% of total CPP contributions and drawing 10.6% of CPP benefits, an annual net contribution gap of $2.9 billion. A contribution rate reduction in the 2-4 percentage point range in an APP would eliminate that gap.
However, this kind of static gap analysis cannot tell the whole story, as it does not address an important question about the future. Net migration of younger workers into Alberta’s oil and gas industry over the course of the last 25 years was an important contributor to Alberta’s demographic make-up today, and hence (combined with higher wages) to its current net CPP contributor status. Recent events (e.g., climate change-related policies in Canada and around the world, weakening oil and gas demand and prices, oil and gas transportation constraints, Alberta budget cuts) have conspired to reverse that worker inflow into an outflow, and increase Alberta’s unemployment rate at the same time.iv What if these recent reversals became a multi-decade trend? What implications would that have for the sustainability of an APP?
Appendix E of the 30th Actuarial Report of the Canada Pension Plan published in December 2019 provides a rough answer. It reports estimates of changes in base CPP contribution rate based on changes in long-term net migration into Canada. The central migration projection is +0.62%/yr. If actual experience was 0.05% lower (i.e., 0.57%), base CPP cost would rise by 0.08% of pay. Extrapolating, if actual net migration was 0%, base CPP cost would rise by about 1% of pay. Extrapolating still further, if net migration was -0.62%/yr., base CPP cost would rise by about 2% of pay. Placing these calculations in an Alberta context, a reversal of the historic interprovincial worker inflow into Alberta over the last 25 years to an equivalent outflow over the next 25 years could raise the base contribution rate of an APP by 2% of pay above the calculations made in the Fraser and C.D. Howe studies. A reduction in the current positive pay gap between Alberta workers and those in the rest of Canada would further narrow or eventually even eliminate the current $2.9 billion Alberta contribution gap reported in the studies.
These calculations show that the country-wide CPP contributor base offers important diversification benefits to Alberta CPP participants. The history of the Quebec Pension Plan (QPP) is a case in point. While at its 1966 inception the QPP had a younger membership than the CPP, this is no longer the case. As a result, while both plans started out with a 3.6% contribution rate, the base QPP contribution rate today is 10.8% of pay versus the CPP 9.9%. The migration sensitivity analysis in the 30th Actuarial Report of the CPP suggests an APP could eventually find itself in the same situation as the QPP. This suggests dropping the APP’s starting contribution rate 2-4 percentage points below the base CPP’s 9.9% rate would expose APP members to underwriting risk in the form of potential benefit reductions, higher contribution rates, or some combination of the two sometime in the decades ahead.
Issue #2: The Costs of Establishing and Managing an APP
Setting up an APP would be no trivial matter. A long list of issues would have to be resolved between the CPP and an APP. For example:
- Would APP benefits be identical to CPP benefits or differ?
- How would past service be resolved for Canadians with an Alberta work history but now working or retired elsewhere in Canada or abroad?
- What about Canadians with a work history elsewhere in Canada but now working or retired in Alberta?
- What about Canadians with a work history in Alberta and elsewhere in the same year?
- How would the resolution to these questions impact an APP’s share of the CPP’s $400 billion pool of financial reserves? Given that there is no obvious formula for calculating APP’s share, this would be likely be a difficult negotiation process.
- Once all these start-up question were addressed, what would the ongoing annual financial settlement process between the CPP and an APP look like?
It would take considerable time, energy, and money to resolve these types of technical questions. Once they were resolved, the actual APP support system would have to be built. It would have to be able to accurately collect contributions, create earnings records, calculate benefits, and pay benefits. What would it cost to set all this up? A 2016 document published by the Government of Ontario provides a possible answer. Due to the lack of progress in expanding the CPP, the Province decided in 2014 to proceed with its own Ontario Retirement Pension Plan (ORPP). Two years later, it stopped developing the plan with the 2016 agreement to expand the CPP. The closing report of the ORPP Administration Corporation placed the 2-year development cost of the ORPP at $70 million.
This $70 million was spent before the ORPP became operational, meaning its actual implementation risks were never tested. The Federal Government’s own Phoenix payroll project disaster shows those risks are considerable. Further, what might an APP spend annually if it did become operational? A possible answer lies in the 2018 annual report of the Alberta Pension Services Corporation (APS). It provides workplace-based pension benefit administration services for some 375 thousand public sector employees (including 100 thousand retirees) and 500 employers in Alberta. It reported an annual cost per plan member of $175. What would it cost APS to also administer a separate APP with some 3 million members? At its current average cost per member rate, the answer would be about $525 million per year. Economies of scale would likely reduce the annual per member cost below the current $175 per year. However, even at half the current average APS cost, an APP would still cost Albertans in excess of $260 million per year to administer.
Issue #3: Investment Risks in Managing an APP
Presumably, the Alberta Investment Management Corporation (AIMCO) would manage the assets of an APP. As AIMCO’s structure is based on the globally-admired Canada Model, it likely would make a competent job of it.v It already manages over $100 billion of assets related to such provincial asset pools as those of the provincial public sector workplace pension plans and of the Alberta Heritage Fund. Instead, a possible investment risk lies in the AIMCO legislation clause that reads: “…..the Government may issue directives that must be followed by the Corporation”. Where could this lead somewhere down the road?
Consider recent comments on the APP idea made by former Wild Rose Party Leader Danielle Smith: “I think that’s part of the reason why Albertans are looking to have their own investment fund. They know there is a divestment mood in all of the pension funds across Canada and internationally. If the CPP starts bailing out of energy resources, we don’t want to be in a position where our money is being used to support solar or wind or other experiments that the CPP might want to invest in….”. From a different perspective, the former Chair of the Alberta Teachers Pension Board, Greg Meeker agrees. Commenting on legislation which requires AIMCO to manage the assets of the teachers’ pension plan: “We’re really worried that [the government is] going to treat these huge pools of assets as monopoly money that they can play with to support some agenda that they haven’t articulated to the public but that might include making risky investments in what most people see as a sunset industry.” vi
Premier Kenney and his Finance Minister Travis Toews respond that such fears are unfounded. The assets will be prudently managed at ‘arm’s length’. Indeed, the AIMCO legislation requires it. Yet, it is worth recalling how Norway has handled the financial windfall from its fossil fuel industry over the last four decades. It diverted most of this windfall in a national endowment fund called the Government Pension Fund – Global. Today, the GPFG has an asset value of some C$1.3 trillion, belonging to a population of 5.3 million (i.e., about C$250,000 per Norwegian). In contrast the Alberta Heritage Fund value is about C$18 billion, belonging to a population of 4.4 million (i.e., about C$4,000 per Albertan).vii As further gestures to long term investment care and prudence, the GPFG does not invest inside Norway and more recently, has begun a process leading to the exclusion of fossil fuel investments world-wide. Why? Because it wants to avoid the double jeopardy of having its financial assets invested in the same country and industry that is also a major source of employment and government revenues in that country.
Why compare the financial behavior of a sovereign country to that of a province of a federation? Clearly, Alberta did not have the same decision options as Norway did over the course of the last 40 years. The reason is to point to the reality that creating an APP will require political decisions to be made regarding its investment policy. The previously cited quite different views of Danielle Smith and Greg Meeker recognize this reality. What would other political views be on how the assets of an APP should be managed? Creating an APP would require this question to be addressed and decisions made.
In weighing the pros and cons of a separate APP, Albertans need to look beyond the short- term financial ‘windfall’ of a lower base contribution rate than the CPP’s current 9.9% of pay. They should also consider the material risks and costs of creating and managing a separate APP, as well as the very real longer-term underwriting and investment policy risks they would be subjecting young and future Albertans to.
- The 9% of pay deduction is up to a maximum earnings ceiling which is adjusted annually (YMPE).
- The earnings from the reserve fund will be used to stabilize the base CPP contribution The federal and provincial governments agreed in 2016 to begin to phase in additional CPP benefits starting in 2019. Eventually, these additional benefits will cover an additional 8% of average earnings above the 25% of the base CPP, raising the contribution rate eventually to 11.9% of pay. At the same time, the maximum level of earnings covered by the benefit increase will be raised by 14%. As this increase is to be fully pre-funded, assets related to the additional CPP will accounted for and managed separately by the CPPIB.
- See Clemens, Emes, Veldhuis, “Albertans Make Disproportionate Contributions to National Programs: The Canada Pension Plan as a Case Study”, Fraser Institute, April 2019. Laurin, Omran, “Opting out of the Canada Pension Plan”, C.D. Howe Institute, November 2019, and Baldwin, “The Alberta Pension Plan is no Slam-Dunk”, C.D. Howe Institute, November
- The Fraser Institute study shows net inflows for the 1971-1982 period, net outflows for 1983-1988, net inflows for 1995-2012, and net outflows since mid- 2013. The data series ends in 2016. The unemployment rate of young Albertan males today is approaching 20%.
- I should declare a conflict here, as I was the co-author of a report that led to the creation of AIMCO in 2007.
- For more on this, see the article titled “Playing with Alberta’s public sector pension system”, McLean’s Magazine, December 5, 2019.
- In fairness, as a province of a federal state, Alberta does not have the same fiscal options as a sovereign country like Norway. However, it could, for example, have used a provincial sales tax to fund part of its operating expenditures in prior decades rather than revenues from its oil and gas sector. If it had done so, the Alberta Heritage Fund would be much larger than its current $18 billion.