People often ask whether Canadians are saving enough for retirement. But having enough money to live on through your senior years is about more than just saving. It involves making the right investment decisions, having investment discipline during the market’s ups and downs, and managing risk over the long term to ensure that you don’t outlive your money.Take the time to read this report by downloading it here.
With all these considerations, the question we should be asking is: what is the most efficient way for Canadians to save for retirement? Is it by saving on their own or by using a collective approach?
HOOPP commissioned Common Wealth to lead research to answer these questions, with support from Ryerson University’s National Institute on Ageing.
The research found that (click on image):
Learn more about how Canada-model pension plans are the most efficient way for Canadians to save for retirement.
Read the full research report, The Value of a Good Pension, by clicking here.
Below, you can read the Executive Summary:
Retirement is one of life’s biggest expenses. Yet while there has been vigorous debate about whether Canadians are saving enough for retirement, there has been much less discussion of how they are saving. Given stagnating income and strained household budgets, now is an important time to examine how best to achieve value for money in retirement savings. This study compares the efficiency of a variety of approaches to retirement, from a typical individual approach to a large-scale “Canada model” pension plan, as well as a variety of models in between.Again, take the time to read the full report here, it is excellent.
The value for money in a retirement arrangement can be measured by the efficiency with which today’s savings generates tomorrow’s retirement income. In other words, how much does a person need to save, over a lifetime, to meet their retirement goals? This is influenced by saving behaviour, investment returns, and the ability to manage the post-retirement or “decumulation” phase in an efficient manner.
A review of evidence from both academic and industry literature reveals that good pensions create value for money for Canadians through five key value drivers:The lifetime financial effect of combining these five value drivers can be dramatic. By participating in a top-performing pension plan—a plan with Canada-model characteristics, including independent fiduciary governance as well as scale, internal investment management, and risk pooling—a representative worker could achieve the same level of retirement security for a lifetime cost of nearly four times less than if they took a typical individual approach. This amounts to a lifetime savings of roughly $890,000.
- Saving
- Fees and costs
- Investment discipline
- Fiduciary governance
- Risk pooling
The largest savings comes from risk pooling ($397,000), fees and costs ($275,000), and investment discipline ($116,000). From a retirement “bang for buck” perspective, for each dollar contributed, the retirement income from a Canada-model pension is $5.32 versus $1.70 from a typical individual approach.
Although these numbers may seem high, they are arguably calculated on a conservative basis and are directionally consistent with findings from a recent study of the Australian superannuation system.
This efficiency advantage does not depend on where the contribution comes from, whether from the individual, their employer, or the government.
Pensions are often identified with cost. This research shows that a better way to characterize pensions, especially if they are well governed and managed, is as efficient vehicles to pay for something expensive: retirement. In an era of government fiscal restraint and tight household budgets, it is especially critical that policymakers continue to support existing high-quality pension
plans, of which Canada has some of the best regarded and most efficient in the world.
To take the opposite tack and move towards more individualized approaches to retirement would be to compromise value for money and efficiency. This would ultimately cost Canadians as savers, retirees, and taxpayers, and it would undermine a critical social and economic asset.
Policymakers should also encourage existing workplace retirement plan providers to adopt more of the characteristics of a good pension for their plans, including mandatory or automatic saving, lower costs, fiduciary governance, and risk pooling, especially during the post-retirement phase.
Unfortunately, outside the public sector, the past several decades have seen a trend away from pensions, resulting in a quiet but steady shift from collective to individualized approaches to retirement. Defined benefit pensions now cover only 10% of private sector workers—about a third of the coverage of the late 1970s—and overall workplace pension plan coverage has also declined. There is a growing number of uncovered workers who are disproportionately likely to be financially vulnerable Canadians, including lower-income people, women outside the public sector, young people, and new Canadians.
Economic and labour market trends, including automation, the rise of “nonstandard” work, and decreasing company longevity, suggest that, barring some intervention, this shift from collective to individualized retirement saving is likely to continue, if not accelerate. This will make retirement less efficient and thereby costlier for individuals, employers, and government.
In addition to continued support for good pensions, expanding access to pensions and other more collective retirement arrangements is a worthy goal for policymakers and other stakeholders that are concerned with the financial security of Canadians and their ability to make ends meet efficiently. Policymakers and other retirement system stakeholders, including employers, unions, associations, and private providers, could help more Canadians accessa pension or other collective retirement plan by extending the reach of existing plans or by creating new plans to serve uncovered workers,
including the growing portion of the workforce that is considered nonstandard.
A key focus of such efforts should be on the five value drivers identified in this report: saving, fees and costs, investment discipline, fiduciary governance, and risk pooling. Pursuing quality coverage expansion will be challenging, but unlike in other developed countries, Canada is in a strong position: we already have examples of well-regarded efficient pensions in the public sector, institutions whose principles and key features can be applied to build or improve collective retirement arrangements for other parts of the economy.
On Monday afternoon, I had a chance to talk to Jim Keohane, HOOPP's president and CEO, about this report and more things related to HOOPP specifically.
First, let me thank James Geuzebroek, HOOPP's Senior Manager, Public Relations & Corporate Communications, for bringing this report to my attention and setting up a call with Jim.
[Hint: Even though it's called Pension Pulse, it's a good idea to let me know when something of interest needs to be covered properly on my blog. These days, my attention is 150% on markets.]
Anyway, I told Jim this is a great report which covers a lot. Let me begin with this passage from the Executive Summary above:
The lifetime financial effect of combining these five value drivers can be dramatic. By participating in a top-performing pension plan—a plan with Canada-model characteristics, including independent fiduciary governance as well as scale, internal investment management, and risk pooling—a representative worker could achieve the same level of retirement security for a lifetime cost of nearly four times less than if they took a typical individual approach. This amounts to a lifetime savings of roughly $890,000.Interestingly, of the almost $900,000 in lifetime savings from combining the five value drivers, $400,000 comes from risk pooling, followed by $275,000 from fees.
The largest savings comes from risk pooling ($397,000), fees and costs ($275,000), and investment discipline ($116,000). From a retirement “bang for buck” perspective, for each dollar contributed, the retirement income from a Canada-model pension is $5.32 versus $1.70 from a typical individual approach.
This even caught me offguard because if you look at Exhibit 4 of the report, you see that Canadian mutual fund investors pay some of the highest fees in the world and Canada's pension plans offer lower cost to members than mutual funds (click on images):
Now, why is it that risk pooling, not fees, accounts for the bulk of the lifetime savings? Because, as Jim explained it to me, people don't know how long they're going to live and outliving your savings represents the biggest risk of an individual saver.
He gave me some examples from HOOPP where they have 350,000 members and when they retire at 65 years old, most go on to live until 87 but they have one member who is 106 and quite a few between 90 and 106.
In this case, pooling longevity risk adds considerable savings to the retirement plan.
But it's even more than that. As shown below in Exhibit 6, investment discipline also adds $116,000 to the almost $900,000 in lifetime saving (click on image):
Great, so why not just invest in a defined-contribution plan or some group savings plan run by some robo-advisor that invests in exchange-traded funds?
As I discussed in a recent comment on the pension dashboard, DC plans and robo-advisors can tackle fees and investment discipline but they cannot tackle longevity risk.
Specifically, as Jim told me, the decumulation phase is where defined-benefit plans really excel.
We discussed the risks in Canada's retirement system and he noted even though Canada has some of the best DB plans in the world, the coverage is awful.
By contrast, Australia has great coverage because they are mandated to save but it's a DC, not DB plan so they also run into problems because when people retire at 65 and accept a lump sum payment, they typically blow it and outlive their savings. "Australia has one of the highest rates of seniors poverty."
Jim welcomes initiatives by OPTrust and CAAT Pension Plan to offer a DB solution to more workers in Ontario but said HOOPP cannot do this without jeopardizing their members' best interests so they are not entertaining this idea.
But he agreed with me that expanding the Canada Pension Plan is a great idea but "it's not enough". At some point, policymakers need to carefully examine this report and come to the conclusion that we need to create more pensions like HOOPP and OTPP to address the retirement needs of people in the private sector.
The key for Jim is plan design to address funding risks. "If you have some sort of target benefit plan, you can address funding risks that may arise in the future."
But Jim also stressed: "The focus needs to stop being on DC versus DB as well-governed DB plans are clearly better for all stakeholders, including taxpayers but also for members and employers."
In fact, have a look at Exhibits 9 and 10 from the report (click on images):
These charts are quite sobering and suggest the way forward must involve building on the strengths and capabilities of Canada's well-governed defined-benefit plans. Period, end of story.
There has to be a political will to create one or several new well-governed DB plans to address the needs of many Canadians in the private sector with no defined-benefit plan.
It's also critical to understand that more DB plans lead to a better economy as seniors retire with secure benefits they can count on till the day they die, which means more tax revenues for governments and less spending on social assistance (click on images):
Interestingly, conservatives usually criticize the paternalism of "big CPP" and large Canadian public pensions but I told Jim I'm very conservative in my economic views and think it makes perfect sense from a conservative view to expand the CPP and DB plan coverage for all Canadians.
What else did we discuss? We discussed markets and HOOPP's returns for 2018. Jim told me apart from the Nasdaq, most exchanges around the world suffered big losses so he doesn't think returns of pensions will be good this year, especially since rates rose and hit stocks and bonds. "Maybe private markets will help some large pensions but it will be a low return year."
Still, higher rates translate into lower future liabilities for HOOPP so their funded status improved this year despite the hit to assets. "The duration of our liabilities is a lot larger than that of assets so higher rates are good for our funded status."
As far as equity markets, their model says they are now 5-6% undervalued relative to fair value whereas before the selloff they were 5-6% overvalued. He doesn't expect a huge selloff or rally going into year-end. He told me the old adage “Don’t fight the Fed” is probably worth bearing in mind now and it’s worth keeping an eye on the yield curve.
We also talked about HOOPP going forward. "HOOPP right now is where OTPP was ten years ago so we have discussed a long-term strategy to address the growth in assets."
Specifically, Jim still thinks core infrastructure assets are expensive but they are getting ready for any hit to that asset class to jump on opportunities. He noted that if you look at the City of London airport deal that OMERS, OTPP and CPPIB got involved in, "it looks more like a private equity deal than an infrastructure deal."
I told him over the weekend, I read draft paper from the Boston Consulting Group written by Andrew Claerhout, OTPP's former head of infrastructure and natural resources, and he was telling me how core infrastructure is very expensive now and to make returns of the past, you need to take "a private equity approach" in that asset class (ie. roll up your sleeves and really work the asset!!).
I also told him HOOPP is going to need to expand its relationships with external managers in public and private markets and capitalize on co-investment opportunities in privates to reduce fees. They might also open an offic ein London one day as Jim told me: "We are already flying there quite often so i might make sense to have boots on the ground."
Lastly, my readers should note Michael Wissell joined HOOPP from OTPP and is now the Senior VP Portfolio Construction and Risk. Michael is one sharp guy with great experience and Jim told me they're happy he joined their team.
Anyway, I thank Jim Keohane for yet another interesting conversation.
Below, for over 50 years, HOOPP has been helping members build a better financial future. Watch this clip, you'll appreciate the value of a good pension, especially if you're a member of HOOPP.
Also, from my recent comment on the danger of cutting DB plans, Jana Greer, AIG Retirement CEO, joins 'Squawk Box' to discuss how the selloff is causing retirement anxiety. Listen very carefully to what she says and think carefully about the wisdom of cutting DB plans. It's a disturbing trend, one that should concern all of us, especially policymakers.