In a recent nation-wide commentary, authors Charles Lammam and Stephen Kirchner of the Fraser Institute urge the Province of Ontario to adopt an Australian model of pension provision instead of expanding the Canada Pension Plan as proposed in the Ontario Retirement Pension Plan. This creates an interesting debate as it pits the collective approach to pension provision as now exists in the Canada Pension Plan (CPP) with the Individual Accounts Social Security approach (very much like RRSPs) as defined in Australia.
The authors note several apparent advantages of the Australian system, but each of the advantages are fraught with difficulty and may, in fact, prove to be disadvantages.
The authors correctly point out that the Australian system of mandatory employment-based RRSPs provides greater choice and flexibility in both the investment of funds and in their allocation for retirement expenditure. Individuals can choose an investment strategy based on their preferences and circumstances.
All true. But substitute the word “responsibility” for “flexibility” and the argument takes on a new feel.
Yes, you are able to invest as you wish. In fact, you are responsible for investing your dollars to achieve the highest rate of return available. Is this something for which you feel capable? Would you like to take on this responsibility or would you rather an arms-length agency like the Canada Pension Plan Investment Board do this for you?
Of course, you can buy investment advice. But this is expensive. You will pay anywhere from 150 to 300 basis points (1.5% to 3.0%) in management expense fees for these services. These high expense ratios are at least partly the result of very intense competition among private sector retirement funds for your dollars with lots of advertising and high commissions on sales.
These fees are killers in a low return economy as we have today. Every additional one per cent fee over a 40-year period reduces final assets by about 20 per cent. Stated another way, a three per cent fee per annum will cut in half your retirement replacement rate (your standard of living) versus an account with no fees.
In this matter, Australia is no shining example. Despite its mandatory “Superannuation” system, management fees still range from 1.5% to 1.75%. The CPP operates with an expense ratio of less than one per cent. And, finally, there is no evidence that these active management fees reap the fund holder any higher returns. Passive accounts do just as well on average (and after the impact of the fees is taken into account, passive investing does much better on average).
Then you retire. Again, in Canada, under the CPP, you just let them know you are retiring and they start sending monthly benefit checks that will last your lifetime. And the benefits are inflation indexed.
In the Individual Accounts world of Australia, you are responsible to draw down your funds on your own as your fund pays out a lump sum upon your exit from the labour force. How can you do this wisely when you have no idea how long you will live? Two outcomes are likely.
You will draw down your funds too rapidly and run out of money and be dependent on GIS benefits for your retirement security. Or, you will draw down funds too slowly and live your life at a standard of living below what you could have provided. The CPP handles this by pooling all the funds of all participants and thus assumes the longevity risk (which is very small given the size of the CPP participant pool).
What evidence do we have on outcomes from the two systems?
The Melbourne Mercer Global Pension Index ranks Australia number two in the world with a rating of 79.9 in terms of the viability and sustainability of its pension system. Denmark is number one at 82.4. Canada slides in at number seven (with an Index of 69.1).
The index is based mostly on the fact that Australia has a mandatory pension system so that coverage rates are almost universal. In Canada, however, coverage rates outside of the Canada Pension Plan are less than universal. While 86 per cent of workers in the public sector have a pension plan, only 25 per cent of workers in the private sector have anything at all.
Finally, if the goal is not just coverage, but actual retirement income security, then Australia receives failing grades.
One in three Australian seniors live in poverty despite being among the most highly educated senior citizens in the world. This rate is comparable to Thailand, Ecuador and Bolivia. For Canada, the OECD reports that the poverty rate amongst the elderly is at 7.2 per cent – third lowest in the OECD.
So before we blindly adopt the Australian pension system as our own, we need to take several long moments in deep thought and contemplation – and look at the evidence.
