The planned expansion of the Canada Pension Plan (CPP) should provide for the possibility that investment returns aren’t sufficient to fund higher benefits by putting measures in place to protect against the risk that younger workers will be required to fund any shortfall, argues a new report from Toronto-based think tank the C.D. Howe Institute.
Specifically, the report states that enhanced benefits will require a real return of at least 3.41% annually over the long run. Yet, in the current, low-growth, low-yield environment, meeting that return goal will require more investment risk.
“Given how much lower yields on high-quality assets currently are, and the likelihood of more modest returns in a future of lower-than-historical growth of real output, a 3.41% real rate of return is far from certain — and therefore the planned benefits at planned contribution rates are also far from certain,” the report says.
Moreover, the report notes that the mechanisms to deal with a shortfall in returns have not yet been established. So, in developing regulations to cover these scenarios, policymakers should avoid situations in which young workers have to pay higher contributions to fund benefits to retirees, the report argues.
“It is reasonable to worry that disappointments will lead to contribution hikes on future workers to pay for benefits that today’s workers did not, in retrospect, fully fund themselves,” the report says. “That possibility makes the current gap — a commitment to expand the CPP, but no explanation to Canadians of the risks, or how the expanded plan will adjust if things do not work out as planned — troubling.”
To limit potential contribution hikes, the report recommends an approach that ensures a high level of protection for a basic level of benefits, with more room to limit benefits above this basic level, if necessary.
“As a matter of transparency … all participants should understand these provisions — most importantly, that benefits above the basic level may drop if the plan’s cash flows are inadequate to cover them,” the report says.
“The starting place for this discussion needs to be understanding among the officials and among interested Canadians that, in an uncertain world, even the Canada Pension Plan makes no guarantees,” the report concludes. “Neither the base CPP nor CPP2 are, or will be ‘fully funded.’ They’e risky, and wise policymakers – [along with] farsighted Canadians – must deal with this fact.”
Read: Impact of pension changes
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