At a European pension industry conference in 2012, Keith Ambachtsheer declared that “Canadians have the best pension institutions in the world”. Discounting somewhat for national pride, Ambachtsheer should know. As director of the international Center for Pension Management at the Rotman School of Management at the University of Toronto, Ambachtsheer is one of the world’s foremost authorities on the design and delivery of pensions.
Now Canada’s largest defined benefit pension funds have a slide deck of data to prove how they benefit the Canadian economy.
Boston Consulting Group (BCG) has laid out the economic impact of Canada’s large defined benefit pension plans, showing how taxpayer-supported pension benefit payments cycle through the economy from Toronto’s Bay street to Main streets across the country. The BCG reports also illustrates how the structure and mission of Canada’s big DB plans, which are mostly based in Ontario, have created global investment giants with a powerful competitive edge resulting from continual inflows and a long time horizon.
The heads of communication at the major plans were facing similar questions about the costs of providing benefits through DB plans and the burden on taxpayers who often didn’t have a pension at all. Following the bi-annual meeting of communication directors in mid-2012, the plans retained BCG to conduct an economic impact study. BCG had previously studied Canadian pension investing for the Toronto Financial services Alliance, which promotes Toronto as a global financial centre.
In the first report, released in June 2013, the key finding was the magnitude of the increase in assets resulting from investment returns, says Michael Block, a principal at BCG Canada. Between 2003 and 2011, assets under management at the top 10 increased from CAD350bn (€240bn) to CAD714bn (€490bn), with two- thirds of that gain, CAD240bn, resulting from investment returns. The remaining CAD125bn came from net contributions by members and employers. “During a highly volatile period of time,” he says, “the top 10 more than doubled their pension assets, primarily through investment activities”. That performance, Block adds, “underscores their role as a cornerstone of Canada’s retirement income system”.
All told, the 10 largest plans managed 35% of total Canadian retirement assets in public and private sector pension plans at the end of 2011. And while they are significant home-country investors, with CAD400bn in Canadian assets, the big plans are some of the most innovative investment organisations in the world. According to BCG, the top 10 comprise four of the top 20 global real estate investors, and four of the top 20 global infrastructure investors. They are also active in the corporate governance arena, having voted on nearly 200,000 issues ranging from board composition, management compensation, shareholder rights, capitalisation and share- holder protection.
Two key features underpin the success of Canada’s large DB plans, says Block. The funds are managed as a business, with a clear performance mandate and few top-down restrictions. This gives the funds wide latitude to seek potential returns on behalf of plan members from diverse assets, including private transactions and illiquid holdings such as ports and infrastructure. The second factor is scale. “Expense ratios on average are much lower than other actively managed pension funds, comparable to the cost of passive index ETFs,” says Block. The average expense ratio is 0.3% of assets, below the 0.3-1.0% average BCG cited for many Canadian pension funds. Fund management companies take note: BCG says a major reason for the low cost structure is that the funds typically manage about 80% of their assets internally, compared with less than 20% for many pension funds.
Four large Ontario plans commissioned a second BCG study to illustrate how DB benefit payments flow into the Canadian economy. Released in October, the second report found that DB plans provide a significant financial boost, with up to 80 cents of every pension benefit dollar coming from investment returns; 10 cents came from employee contributions, and 10 cents from employer contributions, which, at public plans, means taxes from working Canadians.
The research proves the value of the pooled investment model underlying the DB plans, says Deborah Allan, vice-president of communications at Ontario Teachers’ pension plan (OTPP). In addition to the cost efficiencies that can be achieved from a large internal investment team, Allan notes that investing large pools of assets for plan members of varying ages allows the big plans to aggregate the key risks of investing for retirement income – longevity and mortality. Teachers’ outgoing CEO Jim Leech, who recently wrote a book on the global pension crisis, The Third Rail, says the single biggest advantage of the DB model is the ability to pool mortality risk (see off to the pole). A DB portfolio only needs to achieve returns that satisfy the actuarial mean for the membership pool. In a DC plan, an individual would need to save 40% more money in
order to generate the same level of benefits. That is the essence of the retirement income gap. Canada’s large plans are able to close that gap in part by investing in a wide range of assets that are difficult or impossible for individuals to access; they hold 35% of their asset in alternatives. The big DB plans can source returns from “class dominant assets”, says John pierce, vice- president of public affairs for the Ontario Municipal employees Retirement system (OMERS). OMERS, which invests on behalf of 400,000 members from more than 900 employers, seeks to buy the premier real estate, infrastructure or other assets in any given market. An OECD study of infrastructure investing published in July 2013 identified a ‘Canadian model’ – large pension funds investing directly in major projects. The report noted that OMERS posted a 12.7% return on its infrastructure assets in 2012, compared with an 8.6% gain for its benchmark. “The longer-term focus of direct investing allows for optimisation of value and better matches the fund’s liability profile,” the OECD study says.
Those investments fuel the Canadian economy. BCG says DB pensioners paid between CAD14-16bn in federal, provincial and local taxes in the 2011-12 tax year – CAD7-9bn in income tax, CAD4bn in sales tax and CAD3bn in property tax. pensioners also pumped between CAD56-63bn into the economy in spending on consumer and durable goods, shelter, recreation and services. The impact is biggest in Canada’s small towns, where pension benefit payments account for an average of 9% of total earnings, compared with 6% in major conurbations.
The reports were released as the debate about pension provision reached a fever pitch in Canada. About 80% of Canadians don’t have DB pension income during retirement, and the Canadian second pillar, the Canada pension plan, replaces just 25% of average pre-retirement income up to CAD51,000, for a cap at just over CAD12,000.
Teachers’ Leech predicts in The Third Rail that workers earning between CAD50,000 and CAD100,000 will be hardest-hit by the lack of retirement income. Reaction was swift when the federal government said in December that it would not act to increase the CPP benefit. Ontario’s premier, Kathleen Wynne, and finance minister Charles Sousa, held a briefing a week before Christmas and promised a ‘made in Ontario’ solution open to all provinces by this spring.
The briefing followed a meeting with Canada’s pension A-team, including Ambachtsheer and William Morneau. As an adviser to the Minis- try of Finance, Morneau in 2012 recommended creating a new Ontario investment Management Corporation to invest on behalf of Ontario public-sector pension funds that did not have their asset managed by oMeRs, Teachers’, or the Healthcare of Ontario pension plan. Morneau targeted at least CAD50bn in assets in order to achieve cost and investment advantages similar to the existing large plans.
The OIMC hasn’t been launched, but some- thing like it might not be far off. Wynne says the province will develop a new pension plan for all Ontario workers, targeted at the middle-income earners that are most at risk. “We will move ahead with a solution that comes from Ontario” said Wynne. “Charles has already had contact with some other colleagues in other provinces that might be interested in working with us. But Ontario is going to have to take the lead.”
One possible model is the UK’s national employment savings Trust (NEST), she says. But the premier has a deadline and Toronto’s pension experts faced a short holiday hammering out a plan. “We’ll be bringing forward the plan in the spring,” says Wynne. Echoing the message of the BCG reports, Wynne says: “We’re talking about an investment in the future, money that gets reinvested in the economy once it goes into these plans.”