Retirement Policy Issues in Canada

Retirement Policy Issues in Canada
Michael G. Abbott, Charles M. Beach, Robin W. Boadway and James G. MacKinnon (eds.), 2009 (Paper ISBN: 1-55339-161-6 $49.95) (Cloth ISBN: 1-55339-162-3 $90.00)

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  Table of Contents


Preface . . . ix
. . . 1

Chapter I: Policy Concerns
The US Fiscal Gap and its Troubling Implications
Laurence J. Kotlikoff
. . . 25
Pensions Are a Risky Business: Issues in Pension Regulation
David Dodge
. . . 37
Summary of Discussion . . . 44

Chapter II: Background Issues and the Pension Environment
Retirement in Canada: Some Trends ... Some Issues
Cliff Halliwell
. . . 49
Income Security and Stability During Retirement in Canada
Sebastien LaRochelle-Côté, John Myles, and Garnett Picot
. . . 65
The Distribution of Seniors' Income in Canada
Michael R. Veall
. . . 97
Pension Reform in Canada: Getting from Denial to Acceptance
William B.P. Robson
. . . 113
Summary of Discussion
. . . 123
Chapter III: Policy Levers and the Retirement Process
Incentives for Early Retirement in Canada's Defined-Benefit Public and Private Pension Plans: An Analysis with a Dynamic Life-Cycle CGE Model
Maxime Fougère, Simon Harvey, Yu Lan, André Léonard and Bruno Rainville
. . . 129
Personal Accounts, Changing Defaults, and Retirement Saving in the United Kingdom: Are there Lessons for Canadian Pension Policy?
Richard Disney, Carl Emmerson and Gemma Tetlow
. . . 167
Summary of Discussion
. . . 197
Chapter IV: Panel on Replacement Rates and Design Features of Workplace Pension Plans
Retirement Income Replacement Rates: Responding to Changing Attitudes and Needs
Peter Drake and Colin Randall
. . . 201
Design Features, Strengths, and Limitations of Defined-Benefit Plans
Stephen Bonnar
. . . 217
Defined-Contribution Plans in Canada and Possible Design Improvements
Dave McLellan
. . . 221
Recent Legal Decisions and Regulatory Changes and their Implications for Design Structure of Pension Plans
Marcel Théroux
. . . 227
Summary of Discussion
. . . 231
Chapter V: The Retirement Process and Macroeconomic Implications
The Emergence of Phased Retirement: Economic Implications and Policy Concerns
Robert L. Clark
. . . 237
Some Macroeconomic Effects of Population Aging on Productivity Growth and Living Standards
William Scarth
. . . 253
Remain, Retrain or Retire: Options for Older Workers Following Job Loss
Christine Neill and Tammy Schirle
. . . 277
Summary of Discussion
. . . 309
Chapter VI: Panel on Risk and Pension Investment Strategies
Longevity Risk and How to Manage It Effectively
Malcolm Hamilton
. . . 315
Pension Plan Investment Strategies by Major Pension Plans in Canada
Sterling Gunn
. . . 321
Managing Investment Risks Over the Long-Term
Graham Pugh
. . . 325
Summary of Discussion
. . . 330
Chapter VII: Pension Rules and Retirement
Working While Receiving a Pension: Will Double Dipping Change the Elderly Labour Market?
Kevin Milligan and Tammy Schirle
. . . 337
Mandatory Retirement and Incentives in University Defined-Benefit Pension Plans
John Burbidge and Katherine Cuff
. . . 353
CPP Sustainability: A Stochastic Liability Model Analysis
Rick Egelton and Steven James
. . . 375
Summary of Discussion
. . . 405
Chapter VIII: Manadatory Retirement and the Changing Prospects of Retirement
Mandatory Retirement: Myths, Myths and More Damn Myths
Rafael Gomez and Morely Gunderson
. . . 409
The Retirement Prospects of Immigrants: Will it Require a New Social Contract?
Derek Hum and Wayne Simpson
. . . 429
Mandatory Retirement Rules and the Earnings of University Professors in Canada
Casey Warman and Christopher Worswick
. . . 451
Summary of Discussion
. . . 471

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Economic Context of Retirement

Retirement is a concern of an increasing number of Canadians and the growing focus of attention of federal and provincial governments in Canada. Recent media reports have highlighted public concern on "The Pension Crisis" (Contenta, 2009) and "Retiring into the Unknown" as part of "The New Middle Class Reality" (Campbell, 2009). The beginnings of a tidal wave of on-coming retirements are already upon us, as more than 8 million baby boomers will be leaving the labour force over the next 15 years or so. This will have implications for the economic well-being of these on-coming retirees and the income-replacement rates they can expect, productivity rates and output levels for the Canadian economy, labour market opportunities across the whole age range of workers, revenue and expenditure patterns and hence demands on government budgets at both federal and provincial levels, and the rethinking of Canada's entire pension system. The last decade has also seen a remarkable change in the entire process of retirement. What was once a ratchet-like, and often mandatory, shift from full-time work to full-time retirement at some specific age such as 62 or 65, has now often become a period of transition or phased-in retirement, involving part-time work and perhaps self-employment activity. This reflects a greater range of choice, often within a family context (Clark et al., 2004; Wise, 2004; Lumsdaine and Mitchell, 1999).

The recent severe and sudden recession and meltdown of global financial markets raise obvious questions about the current incomes of those already retired and the future financial well-being of workers who had planned to retire shortly. To many workers, "Freedom 55" is now looking more like Freedom 75. Many long-run employees covered by workplace pensions in the private sector are having to take major pension reductions and indeed are seriously concerned about whether their pension benefits will even exist when they retire. The proportion of workers indeed covered by workplace pensions has plummeted. Canada's social safety net for the elderly is also looking increasingly under stress and in need of a major review. Indeed, governments have recently set up expert panels to report on older workers (federal) and the pension system (Ontario), and have already begun making changes to Canada Pension Plan (CPP) rules to better address the current economic environment. A flurry of proposals by several provincial governments, think tanks and pension experts will likely lead to the most substantial restructuring of the Canadian pension system seen since the establishment the Canada and Quebec Pension Plans in the 1960s (Ambachtsheer, 2007; Béland, 2009; Cooper, 2008; Munnell and Sass, 2008).

The objectives of this volume are threefold. First, it brings together different perspectives in the retirement area from a range of disciplines to raise public awareness of the issues and problems that are fast approaching and that currently risk being ignored while policy attention focuses on concerns of the immediate economic downturn and its fiscal demands. Second, the various papers in this volume seek to bring current research knowledge — both in Canada and elsewhere — to bear on these issues and to help educate and inform the needed policy debate on these issues. Third, the studies presented here offer options and proposals that will help address these issues to the benefit of Canadians as a whole and of retirees — current and future — in particular. Accordingly, this volume includes contributions from both public sector analysts and policy practitioners, academic and think-tank researchers, and private-sector specialists on retirement and pension issues.

Just what is meant by retirement is actually not clear at all. The basic intuitive notion of retirement is the withdrawal of older workers from the labour market. But this withdrawal may be full or partial, permanent or temporary. It is often associated with receipt of a pension or social security benefits. In many cases, it is not a complete withdrawal but rather a major reduction in hours worked, a move to a less demanding job, a move to some form of self-employment, or some combination of the above. Increasingly, this is the more complex phenomenon that we are seeing, so that retirement needs to be understood in a more comprehensive and nuanced way (Madrian, Mitchell, and Soldo, 2007).

Retirement Income Framework in Canada

Retirement and the standard of living of retirees occur within a complex framework of private and public savings and benefit schemes. Saving for one's retirement is a prerequisite to maintaining acceptable standards of living in retirement. This may be done solely out of self-interest. But many workers, especially in the public sector, may also participate in a workplace pension scheme as part of the conditions of their employment. These schemes are encouraged by government through tax sheltering, as are private retirement savings. Governments generally also implement mandatory contributory public pension schemes that force workers to save at least some minimal amount of their earnings for their own retirement, and furthermore they provide transfer payments to the less well-off retired population financed out of general tax revenues. This multidimensional approach to retirement income has been aptly referred to as the three pillars of saving for retirement: public transfers to the needy elderly, compulsory public pensions, and tax-assisted private savings.

In Canada, the first, non-contributory, pillar consists of Old Age Security (OAS) and the Guaranteed Income Supplement (GIS), which are geared-to-income transfers to all persons over 65. The second, compulsory contributory, pillar is the CPP (and its analogue in Quebec, the Quebec Pension Plan). All earnings are subject to a payroll tax, which then goes to a fund that finances future retirement benefits as well as providing other forms of social protection such as disability insurance and spousal benefits. While in many Organisation for Economic Co-operation and Development (OECD) countries public pensions are pay-as-you-go, the CPP is largely funded, and the fund is managed by an independent body called the Canada Pension Plan Investment Board. The third pillar includes tax-sheltered savings by employees in workplace Registered Pension Plans, by workers in Registered Retirement Savings Plans (RRSP) for the self-employed and those not covered by a workplace pension, and, as of the 2008 federal budget, Tax Free Savings Accounts. The latter differ from both types of registered plans in that they do not give an income deduction for contributions, but simply allow future capital income to be tax exempt, and thus are more favourable savings instruments for persons whose incomes are expected to rise over the life cycle and into retirement. Taken together, these three pillars constitute the main means of retirement income support for the vast majority of Canadians.

Why should firms and governments get so heavily involved in facilitating savings for retirement? In the case of firms, pensions are a form of deferred compensation that benefits both the firm and the employee. Firms are better able to retain employees in whom they have invested skills and training, at least to the extent that pension rights are not fully portable. Employees benefit by having their savings managed by knowledgeable pension fund managers who are able to obtain better returns at lower fees than individual workers can typically obtain on their own. The self-employed must manage their own retirement savings, but they typically obtain the same tax advantages as workers with registered workplace pensions.

The rationales for government intervention are somewhat more diverse. In the case of the first pillar, the motive is primarily redistributive. Income-tested transfer payments to the retired are a backstop form of social protection to ensure that all retired persons have a minimal level of income with which to sustain themselves.

The second pillar involves forcing income-earners collectively to save for their own retirement, reflecting the apparent fact that most people systematically save too little for their own retirement from the point of view of reasonable life-cycle predictions. Some reasons have been emphasized in the recent behavioural economics literature (see, e.g., Diamond and Vartiainen, 2007). People may discount the future excessively because of a sort of time inconsistency in their preferences that has been experimentally verified. The consequence is over-consumption that resembles myopia. Besides this seemingly irrational savings behaviour, they also suffer from what economists call bounded rationality: they do not have the knowledge or training to understand how much saving they should do in order to provide for their future. In both cases, people may welcome being forced to save in a form that is not up to them to decide. They may even under-save deliberately, fully anticipating that the government will come to their aid if they are left with too little in retirement, an expectation that is borne out by the first pension pillar. Finally, long-term capital markets may be imperfect owing to problems of adverse selection. To counter this, a compulsory public pension is itself a form of annuity. Some lifetime risks may be individually uninsurable, particularly those associated with disability, family circumstances, job displacement or inflation. Taken together, these arguments have persuaded most OECD countries to enact compulsory public pensions, whether funded or not, as part of their retirement income policies.

The third pension pillar involves tax assistance for private saving, including that done via workplace pensions. Tax-assisted private pensions can be seen as a complement to public pensions. The more people are induced to save for themselves, the less reliant they will be on public support in retirement. However, there are tax policy reasons for providing tax assistance to savings as well. Sheltering retirement savings from tax in effect converts the tax from one that is based on income as it is earned to one based on consumption that is spread over the life cycle. In so doing, it effectively eliminates differential taxation of future versus present consumption that is a characteristic of the income tax system. Indeed, taken together with the non-taxation of the imputed returns on owner-occupied housing, the so-called income tax system is actually much closer to a consumption-based tax system. Finally, sheltering retirement savings serves to smooth tax liabilities over the life cycle, which reduces the distortions resulting from a progressive tax structure.

Major Themes Underlying Retirement Policy

While many issues are touched upon in the studies in this volume and in the broad debate on retirement policy in Canada, several major themes can be highlighted. The first major theme concerns how retirement patterns in Canada have been changing over the last 20 years or so, and what factors are contributing to these changes. The median age of retirement in Canada had steadily declined for a generation to around 58 by the mid-1990s, but, since 1997, it has reversed directions and has risen to over 61 years of age. This is quite a remarkable turnaround, one shared with several other countries such as the United States and the United Kingdom, around the same time. There has also been a change from the traditional ratchet pattern of retirement, with an abrupt shift from full-time work to full-time retirement at some specified (often mandated) age, towards a phased period of transition into retirement involving part-time work or self-employment activity. Retirement is also becoming a joint endogenous decision, often involving dual-earner coordination, rather than an event largely determined by the employment of male household heads.

Why these changes have occurred may reflect several factors. People are healthier and living longer on average, so there is a need to provide for a longer retirement period by working longer in order to build up more of a retirement fund. A gradual shift from employment in manufacturing and goods production to a service dominated economy opens greater opportunities for older workers. More educated workers tend to retire later, and each successive cohort of workers attains higher levels of education. The inflow of women and immigrants into the Canadian workforce brings in workers who want to work longer in order to build up their own pension entitlements or pension accounts before retiring. Declining interest rates since the 1980s mean that a given retirement nest egg provides a lower annuity, and working longer helps build up this nest egg. Until recently, the Canadian economy had been experiencing over a decade and a half of uninterrupted growth, rising employment, and declining unemployment rates. And there is nothing like a tightening labour market to open up job opportunities for minority and non-prime-age workers. So there have clearly been several factors at work (Schirle, 2008).

A second theme concerns the implications of later retirement and an aging workforce for the macroeconomy and for government fiscal balance. Later retirement means more workers in the economy and hence higher output and higher income per capita. But an aging workforce associated with the advancing wave of baby boomers is likely to have the effect of (perhaps only slightly) slowing down the rate of year-to-year productivity growth. Delaying the average age of retirement is a way of countering the latter on-going demographic effect. Since individuals' incomes are typically higher while working than when retired, delaying the age of retirement helps keep government revenues higher and delays payouts of government transfer expenditures to low-income retirees, so it is also beneficial for the public sector balances (Robson, 2009).

A third theme concerns the effect of job displacements among older workers on retirement outcomes. How do older workers adjust when major industrial restructuring occurs, particularly if plant closings take place in smaller communities where few alternative employment options are available? This is especially important in light of the current severe recession in North America and elsewhere, where major long-run industries such as automobiles, forestry, and natural resources have shed large numbers of jobs, many of which had been held by older workers. A slow recovery from the recession and a rising Canadian dollar may mean that many of these and other manufacturing jobs are not likely to reappear, at least in the near future. In general, a weak labour market and rising unemployment rates make it particularly difficult for older workers to find re-employment. And if new jobs are found, they are typically at a substantially lower wage than before displacement, perhaps more so for older workers than for younger ones. Both these reasons may well cause discouraged job seekers to drop out of the labour market and take earlier retirement than they had planned.

Fourth, to what extent do pension income levels and pension availability affect retirement outcomes? Economic theory predicts that non-wage income options reduce work effort and time spent in the labour market. The major run-up of financial markets in the 1980s and 1990s was indeed associated with generally declining age of retirement. But the rising uncertainty of private pension payouts as major firms go bankrupt or pension underfunding occurs, and the recent loss of over $200 billion of household wealth in Canada associated with the 2008 meltdown of financial markets are likely to result in older workers staying in the labour market longer because they can no longer afford to retire. How major and long-lasting these uncertainty and wealth effects will be is unknown and will clearly need to be the subject of future research. At the very least, there is a need for a timely review of pension regulation and pension availability in Canada.

Fifth, there needs to be better understanding of the retirement incentives built into Canada's private and public pension schemes, and how these might be changed in order to open up opportunities and reduce barriers for workers who wish to continue working longer. Current restrictions in CPP, for example, require a worker to retire from a job before being able to access CPP benefits, whereas a more flexible option could allow one to continue working on the job past the CPP eligibility age, and to continue paying into the plan while also perhaps drawing partial benefits. Many US studies in recent years have established a strong relationship between the economic incentives of retirement policies and the age at which individuals choose to retire from the labour force, and more investigation along these lines needs to be done for Canada. The last 20 years have seen a decline in the incidence of workplace pensions in the private sector and a dramatic shift in the structuring of private-sector pensions away from defined-benefit plans and towards defined-contribution plans. But what are the consequences for retirement of this growing shift of retirement-income risk away from employers and onto workers themselves? And how adequate is the current public/private pension system in Canada in light of the recent recession and financial meltdown of retirement nest eggs? Is there, indeed, a crisis in workplace pensions in Canada resulting from this combination of events (Crossley and Spencer, 2008; Milligan and Schirle, 2008)?

Finally, there needs to be better understanding of the adequacy of and the retirement incentives built into Canada's old-age security, Employment Insurance (EI), and income tax systems. Compared to the United States, surprisingly little research has been done on the effects of these programs on retirement decisions. Considerably more needs to be known just about the broad economic circumstances of older Canadians and whether there is a growing gap between rich and poor in the older generation. Does Canada need a mandatory tax-sheltered savings program to help workers build up (or in many cases rebuild) their retirement nest egg savings? How significant are the retirement effects of the high implicit tax rates in the current GIS system as they relate to other sources of income? And should RRSP cash-out rules be made more flexible to accommodate workers who wish to continue working longer (Gruber and Wise, 2007; Ambachtsheer, 2008; Gustman and Steinmeier, 2008)?

Overview of the Contributing Papers The first two contributions of this volume identify some major policy concerns relating to retirement: demographics, public health care of the elderly, and pensions. Laurence Kotlikoff addresses the widespread demographic change and its fiscal implications for government treasuries. By 2050, for example, the proportion of the Canadian population age 65 and over will have more than doubled, from 13% to about 27%, with an even larger relative increase in those age 85 or more. The decline in fertility rates the last 60 years is the major source of the aging population, but on-going longevity increases also contribute. Since 1970, the annual growth in public health-care expenditures per elderly recipient exceeded that in gross domestic product (GDP) per capita. The resulting challenge for public health-care spending will be a large problem in the future for Canada, and in the United States will be a crisis. To fix things, Kotlikoff recommends replacing personal income, corporate income and payroll taxes by a single federal sales tax with a rebate to all households, and replacing public (and employer-based for the United States) health-care systems by a voucher to buy health insurance, where the voucher would be individually risk-adjusted and the government spending on vouchers could be a fixed proportion of GDP.

David Dodge's paper raises some challenges to improving the viability of private employer-sponsored pension plans. He argues that such plans are the most effective means to ensure adequate retirement incomes. But finding the right incentives to facilitate an effective plan is critically important. Dodge reviews the key risks faced by workers and employers and the role of incentives to see that these risks can be effectively managed. He argues the importance of being part of a larger pension group so that risks, governance, and transactions costs can be more widely spread. This allows plan members to gain efficient management of funds at wholesale, rather than retail, costs, enables them to purchase a retirement annuity at widely shared group rates, and ensures that the retirement income of individual members does not depend on market conditions at time of retirement. He reviews some of the benefits of defined-benefit pension plans, and poses the challenge of how to preserve the advantages of a defined-benefit pension plan, but make it possible to distribute risk more appropriately and hence enhance the viability of the plans.

The next set of papers set out some of the background information on retirement patterns in Canada, income security of retirees, and key issues in pension reform. Cliff Halliwell examines how retirement may be defined and uses a compound criterion: older workers who have left a job and haven't started another within three years. He cites a study that estimates that two-thirds of job openings over the next decade will result from retirements from the workplace. Halliwell then looks at recent trends in retirement in Canada, and attributes the recent turnaround and rise in participation rates of older workers to: the greater strength of job markets opening up employment opportunities over the period and the cohort effect of aging baby-boomer women who are simply continuing their strong labour market attachment. For older workers who do not continue working full-time, he finds a strong preference for part-time work and flexible work arrangements. Finally, he notes that life expectancies of both men and women are continuing to rise, leading to longer retirement periods than a generation ago. This means that pensions need to last longer, and hence workers need to seek greater wealth at their time of retirement and a higher rate of saving or a higher rate of return during their working years. Low savings rates over the last decade and declining average returns on household wealth thus pose a huge challenge for workers' increasing longevity.

Sébastien LaRochelle-Côté, John Myles, and Garnett Picot compare pre- and post-retirement incomes in order to examine: how well Canada's retirement income system maintains pre-retirement income standards (i.e., security of retirement income), and the stability of income in retirement years. They make use of Statistics Canada's Longitudinal Administrative Database (or LAD file) of income tax records to calculate income replacement rates for seniors who had significant labour market attachment. For specific cohorts of workers, the authors follow their income streams for 20 years, from ages 55 to 75, to see how income replacement rates unfold over this period. Their measure of income is adult-equivalent-adjusted family income. They find three main results. First, income replacement rates in Canada provide a relatively high degree of income security in retirement — they average around 100% for low-income individuals, close to 80% for middle-income recipients (and overall), and about 70% for high-income workers. Second, there is considerable variation in replacement rates across individuals. For middle-income recipients, the principal factors distinguishing between those with low versus high replacement rates were the maintenance of employment earnings by age 70 and the presence of private pensions and RRSP income by age 75. Third, year-to-year instability of incomes is greater among low-income earners than among middle- and high-income earners (because of unstable employment earnings). But income instability declines with age — more so for low-income earners because of the stabilizing effect of the public retirement income system — such that the gap in income stability between low- and high-income recipients disappears by age 75 as workers age into retirement.

Michael Veall in his contribution looks at inequality in the distribution of seniors' income in Canada since 1992. Using income data also from the LAD file, he measures inequality in seniors' receipts of market income, total income (including transfers), and after-tax income — all adjusted for family size. He finds that income inequality among seniors (age 66 and over), as compared to all ages as a whole, is slightly larger for after-tax income, moderately larger for total income, and vastly larger for market income, where those who continue working have much higher incomes than those who do not. Inequality for all three forms of income increased over the 1992–2005 period covered by the study, with the biggest jump between 1995 and 2000. At the lower end of the seniors' income distribution, immigrants appear disproportionately along with females and unattached individuals.

William Robson's paper focuses on the broad issue of misperceptions about the nature of defined-benefit pension plans and the contribution of regulation and tax provisions in fostering their use. He argues that the design of classic defined-benefit pensions have falsely presumed that equity could reliably earn several percentage points above high-quality debt, a presumption that was fostered in the era of rapid North American growth of the 1950s and 1960s. Moreover, it largely ignored agency problems that were endemic to defined-benefit plans. In the new reality, since the 1980s, of reduced growth and adverse demographic changes, the expectations that were prevalent during the Golden Age of defined-benefit plans are no longer reasonable. Robson argues that policies must foster a more balanced approach to pensions, and especially encourage greater use of money purchase plans such as RRSPs. These plans can be designed in a way that addresses the real difficulties that households have in saving enough, in investing wisely and efficiently, and in annuitizing wisely. And policies could be devised that foster such plans through wider pooling of occupational plans and use of default investment and annuitization options.

The next two papers in the volume discuss several policy levers that affect retirement decisions through defined-benefit pension plans in Canada and through personal savings accounts in the United Kingdom. The first paper by Maxime Fougère, Simon Harvey, Yu Lan, André Léonard, and Bruno Rainville reviews the incentive effects incorporated in Canada's current system of public and private defined-benefit (DB) pension plans. The work disincentive effects in a DB plan can be decomposed, according to the literature, into a wealth effect and an accrual or substitution effect. The former reflects the increase in total pension wealth. The latter arises from the difference in pension wealth between retiring at a given age and one year later. Since DB pension benefits depend on age of retirement, DB plans give rise to both a wealth effect and an accrual effect on retirement choice. Defined-contribution (DC) plans, however, depend on the history of contributions and the investment returns on past contributions, and hence have only a wealth effect.

Fougère et al. review the work disincentive effects incorporated in Canada's public pension system consisting of the Canada/Quebec Pension Plan (C/QPP), which is an earnings-based DB pension plan, and the Old Age Security/Guaranteed Income Suppplement (OAS/GIS) programs, which are income support programs. They find that the C/QPP and GIS programs interact to create strong disincentives to work for individuals between 65 and 70 years of age.

The authors also use a dynamic computable general equilibrium model to analyze private DB pension plans as well as Canada's public pension system for workers grouped by education into low-skilled, medium-skilled, and high-skilled. They find that inclusion of private DB plans along with the public pension system substantially strengthens work disincentives, especially after age 61, and for high-skilled and medium-skilled workers. They calculate that eliminating the early retirement incentives in Canada's private DB pension plans would produce labour supply effects for older workers that are several times larger than would the removal of the early retirement incentives in the public pension system.

Richard Disney, Carl Emmerson, and Gemma Tetlow review recent major reforms to the UK pension system with an eye for whether there are any lessons for Canada. The two key reform features they focus on are the introduction of Personal Accounts for retirement saving for workers who are not eligible for employer-provided pension plans, and the incorporation of "default options" in workers' pension choices. The authors begin by examining the concept of income adequacy in retirement and the explanations in the literature for why individuals, on average, do not seem to save "enough" for their retirement. Arguments in favour of compulsory savings are not convincing, they feel. However, evidence from behavioural economics finds that, in the presence of complex choices and imperfect information, inertia or a default option is disproportionately chosen by participants. This suggests an alternative policy approach to compulsory savings. The UK pension reforms of 2007 and 2008 make major use of this default option approach. For employees being offered an employer-sponsored pension plan of a sufficient standard, membership in the plan becomes the default option. For employees who are not members of such an employer-sponsored plan, the legislation sets up new Personal Accounts for retirement saving in which eligible workers will be automatically enrolled, and in which both employers and employees contribute to a total of 8% of earnings. The Personal Accounts will offer a choice of fund types with one of the options designated the default choice. The authors then provide some discussion of who are likely to be most affected by these reforms and the possible effects of the reforms for total level of retirement saving, their macroeconomic impacts, and possible welfare implications.

The next four contributions come from a panel session on income replacement rates and major design features of the two main forms of workplace pension plans — defined-benefit and defined-contribution plans. Peter Drake and Colin Randall consider development of benchmark retirement income replacement rates for Canada. Conventional wisdom in financial circles has cited 60–70% of average pre-retirement earnings as required to live comfortably in retirement. But a number of structural, demographic and attitudinal changes have occurred over the last 20 years with respect to retirement and work patterns of older workers. The Fidelity research group considers whether this is still an appropriate replacement rate in light of these changes. Financial surveys for Fidelity suggest that many higher-income respondents indeed maintained their pre-retirement spending levels; the incidence of doing so, though, declined with pre-retirement income levels. Assuming that retirees are able to maintain their pre-retirement spending levels and that retirement occurs at age 65, the analysts estimate that Canadians will need a replacement rate between 75% and 85% of their pre-retirement income. The specific rates rise slightly with pre-retirement income levels above $50,000 and are higher for individuals than for couples.

Stephen Bonnar discusses the strengths and weaknesses of traditional, single-employer, defined-benefit plans. He compares the principal features of public-sector DB plans, which typically provide workers with strong incentives to retire after their age plus years of service sum to 85 or 90, with those of private-sector DB plans. The latter are considerably less generous. They typically provide lower pensions, are not indexed to inflation (but generally do offer limited protection against inflation), and provide smaller incentives for early retirement. A significant number of unionized employers offer a different type of defined-benefit plan, in which pensions are not directly related to earnings. The legal status of surpluses and deficits in DB plans, though, is not entirely clear. It seems that employers may be liable for all deficits but have limited ability to claim any surpluses from the plan. Lack of legal clarity about who really takes the risk for funding plan deficits makes it difficult for Canada to have an effective, ongoing DB pension system.

David McLellan discusses defined-contribution (DC) pension plans. He first deals with group RRSPs. These have one major advantage over retail RRSPs: they typically involve much lower fees. However, they also have one major disadvantage: it is impossible for employers to prevent employees from withdrawing the contributions that the former have made on their behalf. Conventional DC plans do not suffer from this disadvantage, but they have other ones. In particular, former employees typically remain in the plan when they leave for another employer, so that over time the lion's share of the plan members may no longer be employees. There may be significant costs and ongoing liabilities related to these former, but not yet retired, employees. McLellan points out that there is really no DC pension legislation in Canada, just DB pension legislation turned sideways. The Guidelines for Capital Accumulation Plans, or CAP guidelines, proposed by the Joint Forum of Financial Market Regulators in 2004 provide a good start for such legislation. However, the CAP guidelines stop short in certain important ways, which McLellan discusses. He concludes that there is a place for defined-contribution plans, especially among employers who do not currently offer any sort of plan, and there needs to be DC-specific legislation to help make this happen.

Marcel Théroux discusses recent legal decisions and regulatory changes and their implications for the design of pension plans. He points out that a very high percentage of public-sector workers belong to pension plans, but a much lower percentage of private-sector workers do. In common-law provinces, pension statutes differentiate very poorly between defined-benefit and defined-contribution plans. As a result, it is unclear whether defined-benefit plans should be treated primarily as a contract between a company and its workers or primarily as a trust. Some recent legal decisions have said that they should be treated primarily as trusts. By doing so, the courts have, in effect, passed unforeseen legislation that applies retroactively to pension plans which have been in existence for many years, and this has created a certain amount of chaos.

The next three contributions look at the process of retirement and the macroeconomic implications of population aging on the economy. Robert Clark examines the arguments and experience concerning phased retirement whereby a growing number of older workers are now choosing to work part-time for a few years as a prelude to full retirement. From the employer's point of view, offering a part-time work option is a way of retaining valuable human capital over the period of transition to younger replacements. The evidence in the United States is that the incidence of phased retirement varies substantially across industries and occupations, and is relatively more common in higher education and professional and technical jobs and public administration. From an employee's view, the option of part-time work as a transitional phase between full-time work and full retirement offers an opportunity to continue working longer in order to further build up pension credits and accumulated savings and achieve a higher standard of living when entering retirement. Canadian evidence finds that just under a third of recent retirees have indicated they would have continued working if they had the option of part-time work. The incidence of phased retirement is more common among white-collar workers, highly educated workers and higher-income workers. From the government's perspective, providing incentives for older workers to continue working can help relieve pressure on public retirement programs and continue bringing in earnings-based tax revenue. Thus removing impediments to continued employment of older workers makes a lot of fiscal sense.

Clark then reviews the experience of a phased-retirement plan at the campuses of the University of North Carolina that was adopted in 1998. It was found that the introduction of phased retirement brought about an approximate 10% reduction in the full retirement rate of faculty and a 20% increase in the odds that an older faculty member would enter either full or phased retirement. About one in every five retirements involved phased retirement. The program turned out to be cost neutral to the university, and allowed the university to better plan for future hiring.

The paper by William Scarth analyzes some macroeconomic effects of population aging on overall productivity growth rates and living standards. He begins his review of effects within the framework of traditional neoclassical economic growth theory with exogenous rates of technological change and population growth. He identifies several channels whereby the demographic change of population aging can affect a country's living standards or per capita consumption: (i) increase in the old-age dependency ratio of non-working adults, (ii) increase in rate of saving for retirement, (iii) decrease in overall population growth rate, and (iv) increase in taxes in order to finance health and pension costs of the elderly. In the framework of this traditional growth theory model, he argues that the higher old-age dependency and tax rates effects are likely to dominate the higher saving and lower population growth rate effects, so that his best estimate on balance of the expected population aging is to lower average living standards by a one-time but ongoing amount of about 7%.

Scarth then extends the framework of analysis to incorporate three forms of the more recent endogenous growth theory: growth in knowledge or human capital, endogenous research and development which affects the rate of technological change, and the presence of non-renewable natural resources. Unfortunately, these different models lead to different predicted outcomes for the effect of population aging on living standards. His main conclusion is that population aging does represent a serious challenge, but one where "the hit to living standards may just be manageable".

The paper by Christine Neill and Tammy Schirle looks at the labour market responses of older workers who are laid off or displaced. What distinguishes older from younger workers in their responses is the retirement option. Current evidence for Canada suggests that the incidence of permanent layoff is slightly lower for older than for younger men, but essentially the same for older and younger women. However, older workers experience substantially longer spells of unemployment than do younger workers. Displaced workers in all age groups 25–69 experience large earnings losses in the year of displacement and in the two years following displacement; however, Neill and Schirle find no evidence that the post-displacement earnings losses of older male workers are any larger than those incurred by their younger counterparts.

Neill and Schirle also find that the incidence of participation or enrolment in a formal education program decreases strongly with age. Older workers do not appear to consider education and training to be worthwhile investments. Such evidence implies that policies with a large education or training component are unlikely to be successful in reintegrating older displaced workers into the employed labour force. On the other hand, policies whose main objective is to mitigate the financial hardship arising from the displacement of older workers have generally tended to reduce the labour force participation and employment rates of older displaced workers. One option that might avoid the work disincentive effects of past income support programs is a wage subsidy program that would pay displaced workers who are employed a percentage of the difference between their pre- and post-displacement wage rates. Such a scheme could potentially encourage labour force participation on the part of older displaced workers, while at the same time partially offset the earnings losses associated with displacement.

The next set of papers come from a panel discussion on risk and pension plan investment strategies. Malcolm Hamilton, in his presentation, discusses longevity risk. He points out that, for ongoing plans, longevity risk is greatly dominated by investment risk, but the opposite can be true when plans are to be wound up and their assets used to purchase annuities. If a plan is to be wound up, there is a risk that the mortality rate of its participants may be lower than average. This is a serious risk for universities, for example, where plan members tend to be long-lived. The other major risk is the unknown rate of future mortality improvement. The cost of winding up a pension plan is particularly sensitive to rates of mortality improvement at advanced ages, which are precisely the ages for which existing improvement scales are least reliable. Hamilton then discusses how longevity risk affects individuals. It is not really a problem for low-income seniors, because most of their income comes from government programs, and governments implicitly underwrite this risk. Nor is it a problem for affluent seniors, because they are unlikely to need all their money, and their heirs end up bearing the risk. For middle-income seniors, however, it is a big problem, which most manage by living frugally rather than by buying annuities. Finally, Hamilton discusses how longevity risk affects governments. For governments, the obvious solution to increasing longevity is to postpone the age of retirement. But this ignores the important distinction between life expectancy and healthy life expectancy. If life expectancy is rising much faster than healthy life expectancy, then people are going to spend a larger fraction of their adult lives as retirees.

Sterling Gunn, in his presentation, discusses the investment strategy of the Canada Pension Plan Investment Board, or CPPIB. In recent years, the CPPIB has chosen to become an active asset manager. In addition to holding a reference portfolio of equities and bonds, which is managed passively, it invests in relatively illiquid asset classes, such as real estate, infrastructure, and other long-term commitments. Because of the certainty of the plan's future contributions and the long-term nature of its obligations, the CPPIB is able to make long-term investments that many other investors cannot. If these investments can sustainably add value over a long period of time, the steady-state contribution rate for the plan can be reduced. The Board takes a top-down approach to asset management, always asking how its marginal investment decisions contribute to the risk and return of the total portfolio. It is seeking to build a culture of accountability built around integrity, high performance, and partnership.

Graham Pugh, in his presentation, first gives some background information about the Ontario Municipal Employees Retirement System (OMERS), and then discusses its target asset mix and how that mix is related to the objectives of the plan. The current target is to have 42.5% in illiquid assets. To determine and update its target asset mix, OMERS performs extensive asset mix studies that involve stochastic projections of investment, actuarial, and demographic assumptions. It also takes account of management's views as to where the greatest returns are likely to arise over the next decade. Pugh also discusses regulatory issues. Many rules for defined-benefit plans date back to 1985 and no longer serve a useful purpose. Canada's rules are out of step with those of other jurisdictions, including the United States, the United Kingdom, and Australia. He argues that eliminating regulatory restrictions will result in more investment opportunities and greater pension security.

The next three contributions look at various aspects of pension rules and retirement. Kevin Milligan and Tammy Schirle consider the possible consequences of recent changes in the tax treatment of Registered Pension Plans (RPPs) that, for the first time, allow taxpayers to accrue further tax benefits after retirement. They suggest that this reflects public acceptance that continuing to work while drawing pension benefits, or "double dipping", is quite reasonable. This view is consistent with the economist's view of pensions as deferred compensation, where there is no reason for the deferment to end only when full retirement occurs. Labour market shortages in recent years owing to demographic change and strong economic growth have contributed to this change in attitude. Milligan and Schirle attempt to infer the order of magnitude of the effect of this policy change by looking at three sorts of data. First, they look at long-run trends in elderly employment and pension coverage, and find that recently there has been a modest increase in work among those near retirement age, but also a decline in defined-benefit pension coverage. Second, they document that the proportion of workers who are receiving a pension is very low. Finally, they find from survey data that most retired persons prefer that status to working, and those who would like to work would prefer to do so part-time. They conclude that the empirical relevance of double dipping appears to be marginal, and the changes in the tax treatment of RPPs are unlikely to have much effect.

John Burbidge and Katherine Cuff explore some consequences of another legislative change affecting pensions: the ending of mandatory retirement in several provinces. Their concern is the impact on retirement, particularly how many older workers will opt to continue working past age 65. As they document, the trend later in the twentieth century was for early retirement to increase, especially among more educated workers. However, since 2000, there is indication that the trend is reversing. The participation rate of older workers is increasing both between 60 and 64 and 65 and over. Moreover, the trend is more pronounced in those provinces that already abolished mandatory retirement. The consequence of ending mandatory retirement for the participation rate of older workers is of obvious importance given coming demographic changes. To study this, they develop a life-cycle model of household consumption and retirement in order to simulate the effect of ending mandatory retirement using a particular group of workers — faculty at two Ontario universities with similar defined-benefit pension plans (McMaster and Waterloo). They find that those with lower earnings trajectories will tend to work beyond 65. To estimate how much the option to continue working benefits this type of worker, they calculate that pension benefits would have to increase by something like 20% to induce them to retire at age 65. These results suggest that abolishing mandatory retirement could have a noticeable effect on labour markets.

Rick Egelton and Steven James examine the sustainability of CPP and the stochastic liability model on which their sustainability forecasts are based. The 1997 reforms of the CPP system put CPP onto a sustainable track well into the future and ensured a lower contribution rate than otherwise. The CPP contribution rate is sustainable if plan assets at least match liabilities (i.e., the present value of expected plan benefits minus contributions). If adverse economic, demographic, or asset return shocks occur so as to push assets below liabilities, adjustments will be needed with their corresponding risks. The CPPIB seeks to reduce such adjustment risk through a Stochastic Liability Model which models CPP liability dynamics and risks, and provides input to the CPPIB's Asset-Liability Model. This model involves key demographic, economic (such as long-run productivity growth and rate of inflation) and fund return assumptions (from the Office of the Chief Actuary), and provides mean projections of asset-expenditure ratios and liability-expenditure ratios along with statistical confidence bands. Not surprisingly, the stochastic modeling shows that adjustment risk is sensitive to the above underlying assumptions. Indeed, higher expected returns and rate of productivity growth substantially reduce the level of adjustment risk in their results.

The final set of papers in this volume examine mandatory retirement and changing retirement prospects of several segments of the labour market. Rafael Gomez and Morley Gunderson provide a stimulating discussion of the "myths and realities" that surround the debate on retaining or abolishing mandatory retirement. A number of the myths they discuss include: mandatory retirement means having to retire from the labour force; mandatory retirement is an employer policy forced on employees; mandatory retirement has a disproportionate adverse effect on women and immigrants; and mandatory retirement constitutes age discrimination and fosters labour and skill shortages. Gomez and Gunderson do not favour legislatively abolishing mandatory retirement, but take a "pro-choice" position that it should be allowed in private contractual arrangements agreed to by employers and employees (or their union). The paper enumerates a number of reasons why both sides would want mandatory retirement to be part of a mutually agreed long-term employment arrangement.

Derek Hum and Wayne Simpson's contribution looks at the retirement prospects of immigrants and the pension gap between immigrants and non-immigrants in Canada. Using census data for 1981 to 2001, the authors estimate the difference in earnings profiles between immigrants and non-immigrants for four entry cohorts of immigrant men — those arriving in 1976–80, 1981–85, 1986–90, and 1991–95. They then use these "immigrant integration profiles" to calculate what they term the lifetime pension gap, or retirement gap, between each of the immigrant entry cohorts and comparable non-immigrant male workers. The pension gap is thus the difference between the discounted present value of lifetime Canadian earnings for observationally similar Canadian-born and foreign-born workers. Assuming equal savings rates between the two groups, Hum and Simpson find that a large pension gap indeed exists and the pension gap estimates are larger — on the order of 1.5 to 1.7 times larger — for more recent immigrant entry cohorts than for earlier ones.

Hum and Simpson also use the 2002 Survey of Labour and Income Dynamics (SLID) to provide additional evidence on the difference by age between immigrant and non-immigrant men in Registered Pension Plan (RPP) contributions for workers and private pension plan income receipts for retirees. Their analysis yields two findings. First, the mean annual pension contributions of immigrants are substantially lower than those of non-immigrants. Second, retired non-immigrants receive on average higher private pension income per year than immigrant retirees. They argue that this private pension income gap is likely to increase over time and will thus pose a challenge for the design and funding of Canada's public pension and income support programs.

Casey Warman and Christopher Worswick use Statistics Canada administrative data to provide evidence on how mandatory retirement has affected the salaries of university professors in Canada. Their analysis identifies the effects of mandatory retirement on the age-earnings profiles of university professors primarily from interprovincial variation in legislation governing mandatory retirement and secondarily from inter-temporal variation in the mandatory retirement status of individual institutions. The comparison of age-earnings profiles of professors at universities with and without mandatory retirement produces somewhat different findings for female and male faculty. For female faculty, the two profiles nearly coincide. For male faculty, the two age-earnings profiles are almost identical from ages 30 to 50 years, but then diverge substantially over the age range 50 to 65 years. In particular, after age 50, the profile of male professors at universities without mandatory retirement is below that at universities with mandatory retirement.


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