Misperceptions plague the public’s view of the Canada Pension Plan. Mark Machin, CEO of the Canada Pension Plan Investment Board (CPPIB) — the organization tasked with investing Canada Pension Plan contributions — recently hit the road in a cross-country effort to clear up the confusion. Unfortunately, Machin’s lack of clarity on key issues may have muddied the waters even more, giving the impression the Canada Pension Plan (CPP) is a much better deal for Canadians than it actually is.Now, before I begin reviewing this comment, it should be noted the authors of this op-ed work at the Fraser Institute, a right-wing think tank funded primarily by Canada's powerful financial services industry.
Machin told Canadians that the CPP is financially sustainable. But this wasn’t always the case. The CPP was overhauled in 1997; reforms included the creation of the CPPIB to invest pension contributions. That money, taken from working Canadians, is well in excess of the benefits paid to retirees in a given year.
As Machin himself admits, most Canadians don’t know much about the CPP’s investment arm. But its existence gives the impression that the money Canadians pay into the CPP will eventually fund their individual retirements, the way things work with private pension plans. But that’s not how it is. CPP premiums paid today are still largely used to pay benefits to already-retired Canadian workers (referred to as a “pay-as-you-go” plan). So, in reality, the CPPIB only invests a portion of our contributions. The rest is income redistributed to existing retirees currently receiving CPP benefits.
The CPPIB has seemingly done well in recent years. According to the last annual report, the five-year inflation adjusted rate of return earned by the CPPIB is 11.8 per cent. Does this mean the CPP is a great deal for Canadians? Simply put: no. The benefits Canadians receive from the CPP do not directly depend on the CPPIB’s investment performance.
For the CPP to remain sustainable, CPPIB investments must deliver inflation-adjusted rates of return of 3.9 per cent each year. Beating that target puts the CPP on a sound financial footing. But that does not directly translate into higher benefits for retirees. Yet, in his recent comments, Machin failed to differentiate between the CPPIB’s rate of return and the rate of return individual contributors receive.
In fact, there is simply a formula — based on how many years you work, your annual contributions, and the age you retire — that determines your benefit amounts when you retire. This formula has nothing to do with the CPPIB’s investment performance. So, then, what is the actual rate of return on CPP contributions for individual Canadians?
It’s not great. Canadians born after 1970 can expect to receive a rate of return from their CPP contributions of between 2.3 per cent and 2.5 per cent (depending on their specific year of birth). That’s pretty meagre. But the CPP is also a not-so-great deal for Canadians in other ways.
Unlike most pension plans, CPP benefits cannot be fully bequeathed upon death: spouses get only partial benefits if their partner passes away but only if they are not eligible for benefits on their own. Indeed, the program is designed so that the contributions made by Canadians who die early in life are used to subsidize those who live longer.
The CPP also lacks the other kinds of flexibility offered by privately managed retirement vehicles. Unlike RRSP contributions, CPP payments cannot be withdrawn early in an emergency or in case of hardship (financial or health-related), to fund a down payment on a home, or to help support the costs of education upgrading.
Machin is right that it’s important Canadians understand the CPP and how it works. But he should be careful not to add to the confusion.
I state this because it's always important to understand who is funding the research of any think tank and whether they have an axe to grind, leaning toward left-wing or right-wing policies.
The authors do a masterful job in misinforming the public. Let me first begin with some things I do agree with. First, it's true, the CPPIB’s rate of return is not the same as the rate of return individual contributors receive. The benefits individuals receive is an amount based on how many years they work, their annual contributions, and the age they retire. You can read all about this here.
Second, the authors are right, the benefits individuals receive from their Canada Pension Plan contributions are meager. This is why some of us have argued vociferously to enhance the CPP and increase the contributions so that Canadians can retire with dignity and security.
Third, they're right, unlike most pension plans, CPP benefits cannot be fully bequeathed upon death: spouses get only partial benefits if their partner passes away but only if they are not eligible for benefits on their own. This is something which needs to be rectified.
Fourth, they lament:
The CPP also lacks the other kinds of flexibility offered by privately managed retirement vehicles. Unlike RRSP contributions, CPP payments cannot be withdrawn early in an emergency or in case of hardship (financial or health-related), to fund a down payment on a home, or to help support the costs of education upgrading.This is where I almost spilled my coffee and threw up, quite literally.
Why? Because the honest truth is the CPP managed by the CPPIB is infinitely better than crummy RRSPs over the long run even if you cannot take the money out for emergency purposes.
I believe for a pension plan to work, it needs to be mandatory, you need to force people to save, and it needs to be made clear to them that under no circumstance can or should they take the money out.
I'm sympathetic to people who run into medical emergencies and we can argue whether there should be some opt-out mechanism of the CPP when someone faces a life-threatening emergency and needs access to money right away, but let's face it, most people squander their crummy RRSP on frivolous things, like putting a down payment on an overvalued house or condo.
I'm sorry, if you're relying on your RRSP to buy a house or condo, not your tax-free savings account (TFSA), then you have a problem managing your finances and you shouldn't be buying real estate, you should be renting and saving every penny.
More importantly, I cannot overemphasize how lucky Canadians are to have an organization like the Canada Pension Plan Investment Board managing their CPP contributions.
Let's quickly examine what advantages this offers:
- The CPP pools assets and pools longevity and investment risk. This means individuals won’t outlive their savings like they risk doing with their RRSP or be unable to retire if a financial crisis like 2008 strikes and it clobbers their portfolio.
- Also, CPPIB operates at arm's length from the government and is looking to maximize returns without taking undue risks. It can use its huge size to lower costs and hire smart people to manage assets internally across public and private markets all over the world as well as build solid relationships with world-class asset managers in public and private markets.
- What this means, in effect, is that CPPIB’s long-term strategy to invest in a globally diversified portfolio across public and private markets ensures higher risk-adjusted returns over a traditional 60/40 stock bond portfolio. The value-added is significant over a long period and so is the lower volatility.
- Importantly, the brutal truth on RRSPs and defined-contribution plans is they're not real pensions, they do not guarantee a secure pension payment for life because they are too beholden to the whims and fancies of public equity markets which are very volatile and will remain very volatile in a low rate, low return world.
Lastly, and equally important, I urge all my readers to carefully read the transcript of when CPPIB's CEO Mark Machin spoke at the Standing Committee on Finance in Ottawa in November 2016. The transcript is available here.
Below, I share with you his opening remarks:
Thank you for having me here today to speak with you and answer questions regarding the Canada Pension Plan Investment Board and how we are helping ensure that the CPP remains sustainable for future generations.I've said it before and I'll say it again, Canadians are lucky to have their CPP contributions managed by a world-class organization run by a world-class leader like Mark Machin.
With me are Michel Leduc, our senior managing director of public affairs and communications, and Ed Cass, our chief investment strategist.
I'm Mark Machin. I joined the CPPIB four and a half years ago as their first president for Asia and then became head of international work in 2013. Prior to that, I worked for Goldman Sachs for 20 years in Europe and Asia. While I'm a new resident of Canada, so far I've had the pleasure of travelling across the country meeting with finance ministers, the stewards of the CPP, and some of our contributors.
I was enormously honoured to be chosen by CPPIB's board of directors to lead such an important professional investment organization with a compelling public purpose. International organizations such as the OECD, the World Bank, the Harvard Business School, and The Economist have all praised the “Canadian model” of pension management due to its strong governance and internal investment management capabilities.
Our governance structure is a careful balance of independence and accountability, enabling professional management of the CPP fund while ensuring that we're accountable to the federal and provincial governments, and ultimately to the Canadian public. We know that contributions are compulsory, so we're motivated to work even harder to earn that trust.
We hold ourselves to an extensive disclosure policy, including quarterly reporting, annual reports, triennial reviews, and special examinations, and we announce all major investments and corporate developments.
It was just over 20 years ago that the Chief Actuary of Canada projected that the CPP would run out of money by 2015 if changes were not made to the management of the CPP. In 1997 the federal and provincial governments addressed this challenge head-on by increasing the contribution rate and creating CPPIB to manage the contributions not required to pay benefits. There was a clear imperative: to expose the fund to capital markets in order to achieve growth objectives.
Since then, CPPIB has been focused on getting the best investment returns possible. Our ten-year rate of return is 7.3%, and our five-year rate of return is 12%. More than half of the assets of the CPP fund today are now the result of investment returns, not contributions. The chief actuary noted in his report last month that over the last three years investment income was 248% higher than anticipated due to the strong investment performance of CPPIB.
Most importantly, the chief actuary reported that the CPP fund would be sustainable for the next 75 years, with an assumed 3.9% net real rate of return after inflation and all expenses. CPPIB's five-year net real rate of return as at September 30, 2016, is 10.5%.
At CPPIB we know we can't take these results for granted. It's a difficult investment climate around the world, and single years can produce very different results. In 2009, we had our worst year ever, losing over 18%, but in 2015, we had our best year ever, with a gain of over 18%. We know we can't focus on the yearly results. Our ability to see past these short-term pressures and pursue the best long-term strategy depends on strong, independent governance and the clarity of our mandate.
With the CPP's risk exposure, including wage growth, demographics, longevity, and economic risks, being highly weighted towards Canada, it's especially important that CPPIB's investments hedge against these risks.
To address these risks, CPPIB is diversifying the fund around the world and across asset classes. Currently, over 80% of the CPP fund's assets are in international jurisdictions and in a variety of asset classes, from private equity, infrastructure, and real estate to public markets.
While we're confident that this is the right strategy, we also know that competing with the largest investment firms around the world to secure the best assets comes with costs.
CPPIB, at approximately $300 billion in assets under management today, is a mid-sized organization competing with global giants. BlackRock, the largest asset manager in the world, has over $5 trillion in assets under management. Closer to home, Sun Life has almost $900 billion. Among global competition, we fall well down the list in size.
To fulfill our long-term investment goals, CPPIB took the decision 10 years ago to pursue an active management strategy that would both maximize returns and create a more resilient, diversified portfolio.
Pursuing an active global strategy was a decision taken very seriously, with considerable analysis. Success depends on sufficient resources to compete and manage risk effectively, and this is important context when looking at our costs. In order to compete, we need expertise and skill as a knowledge-based enterprise. There's no doubt that the winners will be those investment firms with the most talented investment teams and a global footprint to cultivate critical relationships with partners, governments, and others to secure deal flow and manage the risks over time in order to maximize returns and manage risks for our contributors and beneficiaries.
Before concluding, I'd like to address Bill C-26. CPPIB is currently analyzing the legislation to ensure that we are completely ready to implement the amendments that affect us.
With or without reform, the CPP fund is projected to grow significantly in the future, and we're well prepared to manage a larger fund. When we evaluate investment programs, new processes, and supporting technology, we always want to ensure that they can be scaled to take into account increased size. We are very confident that we'll be ready to manage the additional funds.
Bill C-26 requires separate and joint financial statements for both the base CPP and additional CPP. While we're working through the details, we will be able to meet this new requirement.
We believe that it's possible to manage the consolidated fund while having regard to the funding and the requirements of the base CPP and the additional CPP. We recognize the additional reliance upon investment income for the additional CPP due to its fully funded nature and therefore a need for a more conservative asset mix for the additional CPP. We will be working closely with the chief actuary, Finance Canada, and provincial governments to ensure that we are meeting the intent of the legislation.
To conclude, in order to successfully achieve our mandate for Canadians, our competitiveness is predicated on capabilities to buy assets that will create enduring value-building growth. It is a deep privilege to serve, and we believe we are on track. Public confidence is critical, and we must continue to work hard to earn that trust every day. We submit that Canadians have reason to be confident as the hard work continues.
The CPPIB or CPP Fund is doing its job ensuring the sustainability of the Canada Pension Plan over the next 75 to 100 years.
Can we improve the CPP? We sure can but let's begin by enhancing it and ensuring more Canadians will be able to retire with dignity and security in the future.
Whatever you do, stop reading these terribly biased articles from "experts" at the Fraser Institute. They're presenting things to think about but the evidence is clear, the CPP is a great deal for Canadians, it's unlike anything from anywhere all over the world.
Below, part of PwC's 20th CEO Survey, they spoke with Mark Machin, President and CEO of CPPIB (January 2017). Here he shares his perspectives on growth in an age of divergence, talent and trust in the digital age, and making globalization more inclusive.
I also embedded a clip from Finance Canada on why it's important to enhance the CPP. Like I said, Canadians have no idea how lucky we are to have our CPP contributions managed by CPPIB.