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Laurin, Robson – The Public Service Pension Plan Surplus is Not Real
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Page Title: | Laurin, Robson - The Public Service Pension Plan Surplus is Not Real – C.D. Howe Institute |
Article Title: | Laurin, Robson – The Public Service Pension Plan Surplus is Not Real |
URL: | https://cdhowe.org/publication/laurin-robson-public-service-pension-plan-surplus-not-real/ |
Published Date: | December 10, 2024 |
Accessed Date: | February 13, 2025 |
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From: Alex Laurin and William B.P. Robson
To: Canadian fiscal observers
Date: December 10, 2024
Re: The Public Service Pension Plan Surplus is Not Real
Last month, the federal government announced that the Public Service Pension Plan (PSPP) – the plan for its public-service employees – has an “excess surplus.”
By the government’s accounting, the plan’s assets exceed its liabilities by 26.3 percent, more than the 25-percent limit permitted by the Income Tax Act. The government plans to transfer the “excess” – approximately $2 billion – to the consolidated revenue fund. Doing that would reduce its fiscal 2023/24 deficit, which is likely to come in worse than its $40-billion target.
The dismal reality, however, is that this surplus is an illusion. It results from the use of an artificially high number to discount the PSPP’s liabilities – shrinking them by about $80 billion. Rather than pretending the plan has an “excess surplus” – or indeed any surplus at all – the government should reveal that Canadian taxpayers are on the hook for billions in underfunded pensions and set about reforming the plan to prevent the problem from getting worse.
Actuaries discount pension liabilities because a dollar today is worth more than a dollar in the future. The choice of the discount rate is crucial. A higher discount rate lowers the present value of the plan’s liabilities and reduces required contributions.
A sorry history of single-employer defined-benefit pension plans failing to pay their benefits alerted accountants and regulators, in Canada and elsewhere, to the dangers of allowing plans to choose their own discount rates in assessing their ability to pay future benefits. Plans would too often discount their liabilities at rates equal to their projected investment earnings. The higher the projected returns, the higher the discount rate, and the lower the present value of the plan’s liabilities. The temptation to inflate projected returns, flattering the plan’s financial position and avoiding the higher contributions actually needed to back the pension promises was irresistible and led to painful failures.
Private-sector accounting standards no longer assume that the cost of a guaranteed pension like the PSPP depends on the expected returns from risky investments in a pension fund. Instead, they require companies to calculate pension costs and liabilities by using yields from safe, long-term corporate bonds.
That makes sense. Promising to pay a pension is like promising to repay a loan. The obligation is a fixed amount. It does not change based on how the creditor’s investments perform – or whether the creditor has investments in the first place. Pension payments should be valued like bonds, which implies a fair-market value: the price at which employees and retirees would be willing to sell their pension entitlement.
International public-sector accounting standards align with this approach, stating that the discount rate should reflect “market yields on government bonds, high-quality corporate bonds, or another financial instrument.” Although Canadian Public Sector Accounting Standards align with international standards in most respects, Canada’s Public Sector Accounting Board has stated that this approach would not serve Canadians’ best interests. The Chief Actuary for the PSPP is therefore free to choose a discount rate for benefits earned after the PSPP became partially funded in April 2000. That estimate is central to the surplus the government is showing in the plan.
If the government applied a fair-market valuation to the PSPP, it would use the interest rate it pays on its real-return bonds, which, like the PSPP’s benefits, are indexed to inflation, as the discount rate. As of last March 31, real return bonds yielded 1.5 percent – 2.5 percentage points lower than the 4.0 percent real interest rate assumed in the PSPP Actuarial Report. A fair value approach using the real-return bond yield yields liabilities about $80 billion higher. As a small offset, the actual market value of the plan’s assets, which the government reports on a smoothed basis, would have been $8 billion higher. So, a fair-value calculation turns the reported $39-billion surplus into a $33-billion deficit. The PSPP is not 26.3 percent overfunded – it is 14.5 percent underfunded (see table).
Not surprisingly, the government’s proposed removal of the “excess surplus” in the PSPP is controversial. PSPP members would prefer lower employee contributions, richer benefits, or a pay increase – an option unhelpfully evaluated in the special actuarial report. But taxpayers are on the hook for the PSPP’s obligations. If a surplus exists, taxpayers should get the benefit.
Sadly, however, no economically meaningful surplus – excess or otherwise – exists. Acting as if one does is misguided. What the government should do is dispel the illusion – by aligning its financial reporting practices with international public-sector accounting standards and acknowledging that the PSPP’s financial health is not robust but actually quite poor. That would set the stage for a discussion of how to transition federal employee pensions to a shared-risk, jointly governed arrangement, like those that have proved so successful elsewhere in Canada’s public sector. That would produce a better deal for Canadians than a battle over a non-existent “surplus.”
Alex Laurin is Vice President and Director of Research at the C.D. Howe Institute where William B.P. Robson is President and CEO.
To send a comment or leave feedback, email us at blog@cdhowe.org.
The views expressed here are those of the authors. The C.D. Howe Institute does not take corporate positions on policy matters.
A version of this Memo first appeared in The Globe and Mail.
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