brucecohen wrote:From Benefits and Pension Monitor:
An advocacy piece, and as such, biased in its selection of facts and arguments. (Funded by a group representing present and future public pensioners.)
While the paper visits all sorts of arguments in favour of maintaining public DB plans, and not converting them to DC, at the heart of its reasoning are three claims:
(1) Governments can obtain better financial returns via a DB plan than individual investors via DC plans
(2) Government pensions have a social welfare aspect to them, preventing retired public services from resorting to GIS, etc.
(3) Governments can better bear risk than can individual investors
Governments are better investors than individuals
I'm ambivalent about this claim. It's true that many investors are terrible at finance. But I reject the assumption that the only way an individual investor can get a decent return is by hiring a financial adviser at 3% per annum fees. I also reject the conclusion that individual RRSPs are poor vehicles for building a retirement. (For example, I've done better in my LIRA than Bell Canada has done in its pension plan.)
I note that public sector pension plans are subject to political interference. Although federal pensions have done well in this regard in recent decades, if we go back to the 1970s, financing provincial government spending was a major objective of federal plans. As well, under Paul Martin, the government appropriated the surplus of the federal public servants' pension plan, to the tune of $26 billion if I recall correctly. Such expropriation is less likely under a DC plan, not least because it is harder to define a surplus under such a plan.
Nevertheless, suppose that the authors are right, and that the government can do a better investing job. In that case, why not create a government-administered fund, open to all Canadians on a voluntary basis, that would invest their savings for them? This would spread the benefits of centralized investing to all Canadians, not just those who are public sector employees. People would naturally flock to this plan. (Isn't Saskatchewan trying that model? How is that working?)
A subtheme is that a DB is desirable because it is a form of forced savings. But as discussed upthread, there is no reason why a DC shouldn't be a form of forced savings as well.
Government DB plans are a partial substitute for welfare
The idea here is that, if governments do not provide proper (read DB) pensions for employees, these will do such a poor job of saving and investing that some might end up collecting GIS or other forms of welfare.
I find the proposed link between pensions and welfare surprising. Although the two can have some connection, it seems at best tenuous. In any case, I have always believed that public sector pensions are best seen as an element in a compensation package, not a social safety net.
In any case, if one of the objectives of public pensions is to keep people off welfare, why should that be limited to public servants? Why should that not be extended to the entire Canadian population? If the problem is than individuals are lousy investors, set up a voluntary government investment body, to invest for them. If the problem is that they are spendthrifts, make it compulsory to save a certain proportion of one's income. If the problem is that people become disabled and cannot earn enough to save, improve disability benefits. And so on.
Using public sector pensions as a welfare program that helps those who are already advantaged just seems wrong.
Governments can better bear risks than individual investors
This is getting closer to an intellectually respectable argument. Even here, though, we need to consider some issues that the authors skip over.
First we need to distinguish the different types of risk. For example, market (or investment) risk comes in two flavours, systematic and idiosyncratic. I believe (along with the textbooks) that a well-diversified portfolio can pool away idiosyncratic risk. You don't need to be a government to be big enough to do so. All you have to do is buy units of an ETF such as VT. (In passing, I note that CALPERS has been quite disappointed by the performance of alternative investments; maybe missing out on these doesn't disadvantage individual investors.)
Diversification won't get rid of systematic risk. That's true for the individual investor. But it's also true for a government. Switching from a BC to a DC plan doesn't increase market risk, it merely shifts it from the employer to the employee.
Unfortunately, there is currently a huge problem with most public sector pension plans. As pointed out by Malcolm Hamilton in two publications for the C D Howe Institute earlier this year, governments bear the market risk, but the contributions charged to pensioners don't recognize this. Rather, they are based on an assumption that there is no market risk. (One way this manifests itself is to simultaneously use a government bond rate to discount future benefits, on the grounds that they are "safe", and a market rate of return for investments. Who is out of pocket if the market investments do badly?)
So if DB plans are to be retained, contributions have to be adjusted upward. The alternative is to keep the present contribution rates, but to shift market risk to pensioners, i.e. to convert to a DC pension.
There are other risks of course, the primary one being longevity risk. It is true that this can be a much bigger burden for individual investors than for governments. I agree with the authors that annuities are an imperfect substitute, given the present state of the annuity market in Canada. But it seems to me that this is a problem for all Canadians. The DB plan solution helps only members of the DB plans. Wouldn't it be better to work on solutions that would help all Canadians, e.g. government offering annuities in competition with insurance companies, or perhaps organizing tontines (which apparently are coming back).
So no, I didn't like the paper.
George