Chapter 9

A Ten-Step Plan for Pension Reform

There's also a strong and growing sense of unfairness among workers who don't work in the public sector, two-thirds of whom don't have any kind of company pension plan. Many of those who do have company plans have seen them converted to defined-contribution (DC) plans, wherein the size of their pension depends on what the invested funds provide at retirement. Implementation of this pay-as-you-go type of plan is the only way to get government pension costs under control.

Gwyn Morgan, The Globe and Mail

As we have seen so far in this book, and as its title suggests, the system of pensions that has been created for Canada's public sector is no longer sustainable. It was developed with the idealistic goal that retired public sector workers in Canada should have a disposable income close to their final salaries.

Pensions were originally designed to protect workers from the possibility of living in poverty during retirement. Such protection is an admirable goal for society, and one that we support. The combination of the Old Age Security program, the Guaranteed Income Supplement, and the Canada Pension Plan, in addition to RRSPs, provides this for many Canadians, and these programs should certainly be tweaked to better provide for those seniors who are still struggling financially. Public sector unions, however, have negotiated pensions that lift their retired members far above the poverty line. Their plans have been heavily funded by Canadian taxpayers and provide a seamless level of income support for public sector employees, spanning their careers and continuing into their retirement until death. In fact, many retirees on public sector plans have a higher disposable income in retirement than they had on average during their working years. It is unfair for taxpayers to be on the hook for these liabilities.

Public sector pensions have traditionally been defined benefit plans. This is consistent across Canada and throughout the Western world. There has been a serious lack of discussion in Canada about public sector pension reform, but other governments have begun to address the issue. The UK, California, and Rhode Island have finished in-depth analyses to uncover systemic problems in public sector pensions and identify the best options to correct pension-related problems going forward.

The UK reforms are based on policies developed by Lord Hutton, the former Labour Party Business Secretary, with a very moderate and liberal political perspective. Many of the Hutton Report1 findings coincide with the Little Hoover Commission's2 report into public sector pensions in California. Finally, a report from the Treasurer of the State of Rhode Island,3 built upon the UK and California findings, may provide the most comprehensive solutions to public sector pension reform. The fight to make pensions sustainable and fully funded by employee contributions, rather than relying on constant additional cash injections from taxpayers, is essential, and a battle that taxpayers must win. Based on an analysis of these reports we present this road map for solving Canada's pension predicament.

A Ten-Step Plan for Public Sector Pension Reform

1. Change the retirement age.

The most immediate change that needs to be made is to realign the retirement age of the public sector with that of private sector Canadians. We recommend public sector pensions use the established CPP age (currently 65) as the basis for determining the retirement age for public sector workers. If early retirement (between 60 and 65) takes place, there should be a reduction in pension benefits that corresponds to the reductions in place for early retirement under the CPP system.4 This should also be applied to workers in so-called “public safety” careers, who are allowed to retire five years earlier than everyone else. If they are not physically capable of performing the tasks of a safety officer, they should be transferred to a less physically demanding job to complete their public service careers, or retire with a reduced pension.

A realignment of public sector worker retirement ages with social security norms was recommended in the Hutton Report. According to a 2008 StatsCan study, “Federal Public Service Retirements: Trends in the New Millennium,” Canada's public sector employees retire earlier than any other in the world. The study notes that while the average age of retirement within the Canadian labour force in general is close to 62, in the public sector, 58 has been the average age of retirement over the last decade. In 2005, the average age of retirement from the public sector in the European Union was 60.9, with Iceland (66.3) and Ireland (64.1) boasting the highest retirement ages. The next lowest retirement ages were France (58.8) and Slovenia (58.5). In the U.S., 27 major federal agencies of the United States averaged a retirement age of 58.7.

2. Eliminate the CPP Bridge Benefit and OPEBs.

This is a special arrangement that allows public sector retirees to collect full CPP benefits during early retirement prior to age 65. Public sector retirees should be subject to the same CPP regulations as all other contributors.

This should also apply to extending health care benefits to early retirees. Currently, many early retirees continue to receive the full benefit packages received by those still working, often at no cost. There has been virtually no examination of the liability of OPEBs in Canada. These benefits could potentially be as large as unfunded pension liability deficits.5

3. Base Pensions on Career Average Earnings.

Current public sector pensions boost payouts by allowing members to use their highest three or five years' income as the base for pension benefit calculations. Private sector DB pension plans use lifetime career average incomes. This change would make pensions more sustainable and reduce the risk of future shortfalls.

4. Eliminate Buyback Options.

Many pension plans allow members to make one-time contributions to the fund in lieu of actually working. This is in reality a guaranteed investment program, since the taxpayer guarantees the rate of return. Since the plans have insufficient money to pay the higher benefits, this is essentially a form of larceny that—again—gives public sector workers more money than they deserve. All working Canadians have access to the RRSP and the TFSA programs. If a public sector worker has additional funds to invest in his own retirement, these funds should be invested privately. Taxpayers are already on the hook for the pension earned by the worker; they should not also be subsidizing pensions for service time not worked.

5. Eliminate Double-Dipping.

Changing the retirement age would go a long way toward controlling double-dipping, but legislation ensuring that no public sector worker can be paid a pension and a public sector salary at the same time should be enacted. If a person is qualified to retire but chooses to continue working, her pension should be put on hold until she does retire. If she chooses a lower-paying job—perhaps through a sense of duty, or a desire to remain active and contribute her skills to the public good—a partial pension benefit could be given to raise her total income to the level of her previous job, but she should not make more in “retirement” than she did when she was working.

6. Eliminate Pension Spiking.

Overtime pay should not be included in pension calculations. Overtime is already compensated at higher rates than regular hours, so the benefit is given as the work is done—it should not be used as a credit toward higher lifetime pensions. In return, pension contributions would not be charged on overtime earnings.6

Taxpayers need to ensure that there are no other termination benefits such as sick-time payouts, vacation payouts, or termination allowances that go toward the calculation of final pension benefits.

7. Cap Pension Earnings.

As we have seen, the Income Tax Act specifically limits government pensions to $101,161 (in 2008) including CPP, based on an annual income of $144,516.00,7 adjusted annually. The Supplementary or Supplemental Executive or Employee Retirement Plans (SERP),8,9 created by and for public sector employees who earn more than this to circumvent this legislation, eliminated the pension ceiling for public sector employees. This was highly unethical considering that the beneficiaries almost certainly knew that their contributions would not come close to funding the benefit payments they would receive. SERP is one of the best examples of the most powerful public sector employees abusing their power. Why should taxpayers subsidize already overpaid civil servants? Higher-income earners can fund their own RRSP or TFSA for higher pension benefits.

The State of Illinois, facing the same fiscal calamity from public sector pensions, introduced House Bill 14610 in 2011. It places limits on the pensions that senior bureaucrats and managers receive. The bill would apply a $106,800 maximum-salary basis for calculating the pensions of its workers. Canada's SERPs should be cancelled immediately, and the Income Tax Act enforced for all government pensions.

The Illinois law applies to new pensioners, but existing pensions could be clawed back through progressive taxation. It would be possible, for instance, to create a reasonable ceiling, say the average income of a single Canadian—currently about $41,000 per year—and have publicly-funded pension income above that amount taxed at a much higher level. As an example, let's suggest that the first $25,000 after the annual ceiling would be taxed at 50 per cent, the next $25,000 above that at 75 per cent, and any pensionable income above $91,000 per year would be taxed at 90 per cent. This recovered pension income should be put directly into the Canada Pension Plan or redistributed through the OAS and GIS programs, which could then be raised for those at the bottom income levels.

8. Standardize Accrual Rates.

All public sector employees are important. The practice of boosting accrual rates to allow some to retire earlier than others is inherently unfair to those who must work longer before retiring. We might, on the surface, feel that a police officer is more important than a garbage dump worker, but if you were to spend time in either job you would quickly realize that being a police officer might be preferable to spending eight hours at a smelly dump every day. Multiply the daily unpleasantness of working at a dump by 35 years and it becomes reasonable to suggest that the dump worker should be allowed to retire earlier than the officer. Either way, society cannot operate properly without both. Officers already receive higher pay with its related benefits and pensions. All public sector pensions should be based on the same accrual rate. We suggest this rate should be 1.25 per cent, which for a 40-year career would result in a pension that replaces 50 per cent of income, or if a slightly higher rate is sustainable, at 1.5 per cent.

9. Change Future Pensions to DC or Hybrid Plans.

It will be difficult to go from a DB plan to a full DC plan in one step. We have seen around the world that any adjustment to pensions generates monumental battles between government workers and any politicians who have accepted the challenge of protecting the taxpayer. Wisconsin public sector protests and those in the UK, Greece, and France saw millions of government workers shut down services and stage angry protests. It might be more politically acceptable to phase in the transition by first creating a “hybrid” plan that combines features of DB and DC pensions. Originating in the Little Hoover report from California, the DB portion of a hybrid pension plan provides the base for retirement and the DC plan is “stacked” on top. This seems to be the most viable option for pension reform today. In July of 2011 the City of Atlanta in Georgia implemented this plan for its city workers' pensions.11

A hybrid plan would create a fair distribution of risk between the employee and taxpayers. Currently in the public sector the general accrual rate is 2 per cent. Our recommendation is to change this to a rate of 1 per cent for the defined benefit portion of the pension and 1 per cent for the defined contribution portion. The employer would be responsible for the DB portion and employee contributions would go into the DC portion.

As an example, employees with a $30,000 annual pension would have $15,000 coming from the DB portion and $15,000 from the DC portion of the pension. If the investment assumptions made by the plan managers are correct there would be no change to the pension benefits. If there are funding shortfalls, they would be the responsibility of current employees and not the responsibility of future taxpayers.

Currently government managers who negotiate DB plans have a clear conflict of interest because they ultimately receive the same benefits they promise to government employees. A DC plan would provide transparency of the compensation promises made and the funding situation, along with any financial consequences for taxpayers.

At the point the hybrid plan is introduced all employees, new and existing, would start accumulating under the new hybrid plan. Changes would occur on a go-forward basis so that all current employees currently enrolled in DB plans would have accumulated credits from the old plan “vested.” This means that existing contracts would be honoured up until the current date but that new contributions from taxpayers and employees would go into the new system. For example, if an employee has worked 20 years under the existing DB plan they would be entitled to 40 per cent (20 years × 2% accrual rate) of the wage estimated for pension benefits. This would be their vested rights. From this point on all pensions would accrue under the hybrid system. All new pensions vesting would happen under the new plan.

10. Create a Comprehensive Public Report.

Politicians are reluctant to talk about public sector pensions and are deathly afraid of them arising as a political issue. They have so far thwarted any attempt to make these pensions an election issue. Perhaps, as Dan Kelly of the Canadian Federation of Independent Business says: “No wonder politicians won't deal with gold-plated public service pensions. Taxpayers pay $5.50 for every $1 from MPs in their platinum plan.”12

It is a travesty that, leading up to pension reforms at the end of 2010, all levels of government had commissioned special task forces, expert commissions, and special reports to examine retirement security in private sector Canada. While these commissions and reports all examined retirement planning from a broad perspective, they did not even check the heartbeat of the 800-pound gorilla sitting in the corner, public sector pensions. When you consider how much of our country's wealth is now under the control of these pension funds, it is stunning to consider that no government has been willing to investigate their management, goals, and sustainability. Only a groundswell of public anger will cause a review. Look at the assets of some of the largest of these plans:

Table 9.1: Largest pension plans in Canada (based on most recent annual report information)13

Members Assets ($ billion)
Ontario Teachers' Pension Plan (OTPP) 295,000 107.5
Federal—Public Sector Pension Investment Board (PSP Investments) 561,000 58
Ontario Municipal Employees Retirement System (OMERS) 409,000 53
Quebec Government and Public Employees Retirement Plan 45,010 41.3
Healthcare of Ontario Pension Plan (HOOPP) 257,712 35
B.C. Municipal Pension Fund 267,000 27
Alberta—Local Authorities Pension Plan (LAPP) 206,000 17.6
Ontario Public Service Pension Plan (PSPP) 77,924 17
B.C. Teachers' Pension Plan 77,000 16
Total 2,195,646a 332
CPP Investment Board (CPP) 17,000,000 148.2
a. Includes active and retired members

The first place to start the reform of our pension system is with a federally commissioned investigation to uncover the details about public sector pensions in Canada. A good place to start would be to use the terms of reference set out for the Hutton Report:14

Not only are pensions confusing to elected officials, but they can be extremely confusing to average Canadians who have never had any exposure to them. It is important for all Canadians to hold politicians and unions accountable. There must be a basic understanding of pension-related concepts, and we have a created a checklist for all Canadians to use—including politicians, employers, and taxpayers—to evaluate the various pensions in place at each level of government. Although most pensions are similar in many ways, there are differences within each one, depending on how successful a given union has been in negotiating concessions.

Checklist for Pension Accountability

By asking your area politicians these questions you can bring the unfairness of public sector pensions to the forefront of their agendas. If your elected representatives can't answer these questions, you will know that they don't understand the problem or are trying to cover it up. Make your position clear and ask them to investigate those pensions under their jurisdiction—municipal, provincial, and federal. Send your local representatives a copy of this book with a covering letter. Through massive country-wide effort, we can bring this 800-pound gorilla into the open and begin the reforms necessary to make pensions sustainable and fair.

Naturally we would expect public sector unions to be actively supporting existing plans and fighting against changes, however, they need to consider the risk presented by the status quo. There is a very high likelihood that delays in making the changes necessary to ensure a sustainable pension system will have a greater negative effect on retirees in the future than any short-term unpleasantness such changes might cause. New employees will be in the system for another 35 years. Pensions will have melted down long before that point if taxpayers decide they are no longer willing to fund existing DB pension promises.

Consider the Saskatchewan Teachers Superannuation (pension) Plan. As of June 30, 2010, the unfunded liability in the Teachers' Plan is estimated—by their own managers—to be $4.006 billion.15 At that date there were 1,499 active teachers contributing and 11,280 people receiving pension benefits from the Commission. The fund has only $999 million in assets.16 To balance this fund the working teachers would have to contribute $2.6 million each. Hope they can attract the “best and the brightest” to take care of this without taxpayer support. (Don't hold your breath.) Based on the fact that the fund is currently paying pension benefits of $309 million per year, the fund will be bankrupt by 2014. After this time the shortfalls will be the sole responsibility of taxpayers. This will then be known as a “pay as you go” plan.

This colossal failure of plan management has occured despite extremely conservative goals of a 3.3 per cent yearly return, which they exceeded, having achieved 5.2 per cent over the past 10 years, so it has been clear for decades that the contribution rates by employees were not remotely sufficient to fund the pension guarantees negotiated by their union and agreed to by the local education boards and the Provincial Legislature. This same taxpayer ripoff has occurred with virtually every public sector pension fund in every jurisdiction in Canada. With their own retirements imperilled and the future debt of the gold-plated pensions of the protected class being heaped upon their children and grandchildren, it will be only a matter of time before taxpayers stage their own protests.