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Building the Foundation for New Retirement Systems Symposium Washington DC, 28-29 September 2006

Building the Foundation for New Retirement Systems Symposium Washington DC, 28-29 September 2006. The Canadian Retirement Income System – a Society Perspective. Presentation. Society’s role in providing retirement income What does society want in its retirement system?

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Building the Foundation for New Retirement Systems Symposium Washington DC, 28-29 September 2006

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  1. Building the Foundation for New Retirement Systems Symposium Washington DC, 28-29 September 2006 The Canadian Retirement Income System – a Society Perspective

  2. Presentation • Society’s role in providing retirement income • What does society want in its retirement system? • What does society need in its retirement system? • What type of system achieves these wants/needs? • How could society benefit from this system? • Risks faced by retirement systems • Which risks should be retained / hedged? • Greatest challenges facing retirement systems

  3. Society’s Role in Providing Retirement Income • Reasonable expectations • Provide a minimum level of social adequacy for all • Redistribution of income through the retirement system • Educate on the need to plan and save for retirement • Unreasonable expectations • Fully responsible for providing a sizeable retirement income to all individuals

  4. What Does Society Want? • Affordable and sustainable system • Intergenerational equity • Maintain standard of living after retirement • Workers to remain in the labour force longer • Flexibility in work-to-retirement transition

  5. Aging of the Canadian Population Population 65 and over (in millions) (% of population) 12 25% Increase of 150% From 2005 to 2050 10 20% 8 15% 6 10% 4 5% 2 0 0% 1966 1976 1986 1996 2000 2010 2020 2030 2040 2050 Number % of population Increase of 250% for 80+

  6. Future Labour Shortage, likely or not? For every 6 who leave, 10 enter Ratio of 60-64 over 20-24 2003 More people leaving than entering after 2015 150% 125% 100% 75% 50% 25% 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 Canada United States Source for US: United Nations Projections, 2003

  7. What Does Society Need? • A retirement system built on the principles of: • Intergenerational equity • Solidarity: society protects all individuals and collectively ensures a basic level of assistance/standard of living for low-income retirees • Responsibility: retirement income security is a shared responsibility between the government, society, employers and individuals • Incentives to remain in the labour force

  8. Canadian Retirement Income Security Programs Objective VOLUNTARY 3. Employer pension plans and private savings (RPP / RRSP) Increase retirement savings through tax incentive 2. CPP / QPP M A N D A T O R Y 123 Replace 25% of pre-retirement earnings up to avg. of last 5 yrs of YMPE (avg 2002-2006: $40,540) 1. Old Age Security/ Guaranteed Income Supplement Provide minimum income at retirement for seniors

  9. Canadian Retirement Income Security The Canadian retirement system could be viewed as about 40% to 45% funded. 123 Canadian retirement system with mixed funding approaches is well recognized in the world for its capacity to adapt rapidly to changing conditions. - Full funding (RPP/RRSP) - Partial funding (CPP/QPP) - Pay-as-you-go funding (OAS/GIS)

  10. An Efficient Retirement System Achieves These Wants and Needs by… • Diversification of sources of retirement income • Diversification of funding approaches • Reasonable economic cost of public pensions (% of GDP) • Reduction of poverty among seniors • Reduction of income inequalities • Maintenance of standard of living at retirement

  11. How Can Society Benefit From This System? • Decreased poverty • Intergenerational equity • Increased use of the third tier leading to lower costs in the lower tiers • However, approximately 60% of Canadian workers are not covered by a RPP and contributions to RRSPs are far below the maximum allowed • The mandatory portion of the retirement system could possibly replace some of the employer component. For instance, the Canada Pension Plan could be expanded. • Minimize economic cost to society (tax burden)

  12. Risks Affecting Retirement Income Security • Low participation in third tier • Financial Illiteracy • Funding Risk: Accumulated assets are insufficient to meet pension obligations • Investment risk:Investment returns less than expected • Market risk: Market failure • Inflation risk: Savings not adequately protected from inflation • Retirement risk: Earlier than expected retirement from employer failure/restructuring/downsizing, health issues, etc. • Longevity risk: Outliving one’s retirement assets • Operational / System risk: Inadequate / failed internal processes, people

  13. Risk Retention and Hedging • First Tier: OAS/GIS • Paid out of general revenues of Government of Canada • Main risks: • Insufficient cost of living adjustments • Longevity risk • Low participation in the higher tiers • Low economic growth  significant increase in cost as % of GDP • Most of the risk is retained; partial hedging of costs through inflation indexation instead of full GDP indexation

  14. How do we position for the aging of the Canadian population? 3.5% 3.5% 3.0% 3.0% 2.5% 2.5% 2.0% 2.0% 1.5% 1.5% 1.0% 1.0% 0.5% 0.5% $28 billion in 2004; $37 billion in 2010; $110 billion in 2030 Between 2010 and 2030, the ratio of expenditures to GDP increases from 2.4% to 3.2%, driven largely by the retirement of the baby boomers. 0.0% 0.0% 1990 2000 2010 2020 2030 2040 2050 2060 2070 Evolution of Old Age Security Expenditures in % of GDP 2004

  15. Risk Retention and Hedging • Second Tier: CPP/QPP • Partial funding through employee/employer contributions • Steady-state financing goal: stabilize and minimize the contribution rate • Steady-state contribution rate: lowest rate that can be charged that is sufficient to sustain the Plan without further increase • A funding level of 20-25% is sufficient to meet that condition for the CPP • All risks faced by the CPP are partially hedged through steady-state financing • Investment and market risks are also hedged through investment diversification

  16. CPP Steady-State Funding (Ratio) 8.0 7.0 9.9% Legislated contribution rate 9.8% Steady-state rate 6.0 5.0 4.0 In 2020, CPP/QPP assets are projected to be equal to 17% of the GDP. 3.0 2.0 1.0 0.0 2005 2015 2025 2035 2045 2055 2065 2075 Asset/Expenditure Ratio

  17. CPP Steady-State Funding • If the legislated contribution rate is lower than thesteady-state rate AND if finance ministers cannotreach agreement on a solution, then default provisions apply: • Contribution rate increased by ½ of excess over three years, subject to maximum increase of 0.2% per year • Benefits frozen until next review (3 years) • At end of three years, next review performed to determine financial status of Plan.

  18. Risk Retention and Hedging • Third Tier: RPP / RRSP • Funded by employee/employer contributions and personal savings

  19. Greatest Challenges Facing Retirement Systems • Low coverage, especially in the third tier • Individuals’ lack of knowledge and involvement in retirement planning • Employer-sponsored plan funding risk • Trend of risk responsibility being shifted from the employer to the employee (decrease in DB plans, increase in DC plans) • Aging of the population

  20. Building the Foundation for New Retirement Systems Symposium Washington DC, 28-29 September 2006 Thank you The Canadian Retirement Income System – a Society Perspective

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