Tuesday, October 22, 2013

New Study on the Benefits of DB Pensions

The Canada News Wire reports, New analysis confirms that defined benefit pensions provide significant benefits to Canadian economy:
Canadian retirees with defined benefit (DB) pensions are far less likely than other retirees to collect the government's Guaranteed Income Supplement (GIS), shows a study on the economic impact of DB pension plans.

The study, conducted by the Boston Consulting Group (BCG), confirms that an estimated 10 to 15% of DB beneficiaries collect the GIS, compared with 45-50% of other Canadian retirees. DB pensions reduce the annual pay out of GIS, a supplementary government benefit provided to low-income seniors, by approximately $2-3 billion a year. The study also finds that defined benefit recipients contribute $14 - $16 billion annually to government coffers across Canada through income, sales and property taxes.

The study was commissioned by a group of Canada's leading DB pension plans: Healthcare of Ontario Pension Plan (HOOPP), Ontario Municipal Employees Retirement System (OMERS), OPSEU Pension Trust (OPTrust) and Ontario Teachers' Pension Plan (OTPP).

DB pension plans are retirement vehicles under which the plan sponsor, typically a large employer, commits to a specified, predictable monthly benefit on retirement based on the employee's earnings, years of service and age. Both the member and the employer contribute, with the vast majority of pensions paid coming from investment returns on these contributions. An analysis by the four plans that commissioned the study found that as much as 80 cents of every pension dollar comes from investment returns - a testament to the sound funding and "best in class" investing of the pension funds.

Conclusions of the BCG analysis included:
  • In the years analysed (2011 and 2012), DB beneficiaries spent $56-63 billion annually on durable and consumable goods;
  • DB pension beneficiaries paid taxes estimated at $14-16 billion annually: about $7-9 billion in income tax, $4 billion in sales tax and $3 billion in property tax;
  • DB pension benefits had the greatest impact on small towns, with DB pensions forming on average 9% of the total earnings in those communities versus 6% for large metropolitan areas;
  • The impact of DB pensions was especially strong in Ontario, translating into $27 billion in expenditures on consumables and durables, shelter, recreation, and services; and generating $6 billion in taxes.
"The two most significant advantages DB plans offer members are pooling longevity risk and pooling asset risk. A DB plan allows members to save at a collective rate consistent with the average life expectancy or distribution within the group. Similarly with asset risk, DB plans can typically maintain an asset mix reflective of the group rather than any one individual. Both advantages provide stability for members, allowing for a consistent standard of living throughout their lives," said Michael Block, BCG Principal and project lead.

A separate analysis by BCG released in June found that Canada's ten largest public pension funds - which include the defined benefits plans in this new analysis - provide Canadians with one of the strongest retirement income systems in the world and also contribute significantly to national prosperity.

Among the key findings of the June study:
  • In 2011, these pension plans collected more than $70 billion in contributions and in that same year, paid out $74 billion in retirement benefits to Canadians, or 49% of all non-OAS retirement benefits, and invested approximately 35 per cent - or $714 billion - of Canada's total retirement assets
  • The Top Ten pension funds have invested roughly $400 billion in Canada, including $100 billion in real estate, infrastructure and private equity;
  • They comprise four of the top 20 global commercial real estate investors and four of the top 20 global investors in infrastructure assets;
  • They directly employ 5,000 professionals in the Canadian financial sector and an additional 5,000 employees in their real estate subsidiaries.
CEO Quotes

Bill Hatanaka, President and CEO, OPTrust said: "DB retirees can count on greater certainty in retirement with a stable monthly income based on the number of years they contributed to their plan, so they are more comfortable in spending what they receive, helping fuel the Canadian economy. Not only do they pay up to $63 billion annually for goods, services, and related sales and property taxes, they pay an additional $7-9 billion in income taxes every year."

Jim Keohane, President and CEO, HOOPP, said: "Most people aren't aware that up to 80 per cent of the funds used to pay defined benefit pensions come from returns on plan investments. Canadians should look at how we can replicate this success story for those without adequate, or in many cases any, workplace pensions."

Jim Leech, President and CEO, Ontario Teaches' Pension Plan said: "DB retirees are far less likely to rely on government social assistance in retirement, freeing up funds for other government programs or priorities. Their financial independence is a direct result of the pensions made possible by the asset management expertise in our DB pension plans."

Michael Nobrega, President and CEO, OMERS, said: "We need to change the conversation. We must not allow "pension envy" to define the debate on the reform of our pension system. Let's work together to fix what's really broken - the lack of adequate retirement savings among the majority of Canadians."

About the analysis
The analysis was conducted by the Boston Consulting Group and commissioned by a group of Canada's leading DB pension plans, including Ontario Municipal Employees Retirement System (OMERS), Ontario Teachers' Pension Plan (OTPP), Healthcare of Ontario Pension Plan (HOOPP) and OPSEU Pension Trust (OPTrust).

Disclaimer: Information in this document is sourced from a Study conducted by The Boston Consulting Group (BCG) and commissioned by Healthcare of Ontario Pension Plan (HOOPP), Ontario Municipal Employees Retirement System (OMERS), OPSEU Pension Trust (OPTrust) and Ontario Teachers' Pension Plan (OTPP). The materials excerpted by commissioners from the Study referenced are provided for discussion purposes only and may not be relied on as a stand-alone document. Additional analysis has been done to the data and analysis contained within the Study by third parties other than BCG. BCG has not independently verified this additional analysis and assumes no responsibility or liability for it.

SOURCE Healthcare of Ontario Pension Plan, Ontario Municipal Employees Retirement System, Ontario Teachers' Pension Plan, OPSEU Trust Pension Plan
I thank Martin Biefer, Director of Public Affairs at HOOPP, for alerting me of this new study. The Ontario Teachers' Pension Plan also provides a press release here as well as a summary of the findings here. You can also download another report on HOOPP's website, The Emerging Retirement Crisis, by clicking here.

The study basically confirms what I've been arguing for a long time on my blog, namely, Canada's top ten are a success story on the world stage and we need to bolster them to improve our retirement system. It's also important to debunk myths on public pensions and understand the long-term benefits of expanding DB coverage to all working Canadians.

Apart from pooling longevity risk and asset risk, the study shows DB pensions reduce the annual payout of GIS by approximately $2-3 billion a year. The study also finds that defined benefit recipients contribute $14 - $16 billion annually to government coffers across Canada through income, sales and property taxes.

So I ask business groups warning of Canada's two-tier retirement system, where are you getting your facts? Do you really think we can't afford enhancing the CPP because it will crush public debt? This is pure rubbish and this study basically confirms that expanding DB coverage will help reduce the long-term debt profile of the country by reducing the government's Guaranteed Income Supplement (GIS) and increasing income, sales and property taxes.

I'll add this. If Warren Buffett's pension strategy is to honor the DB plans he inherited through acquisitions, why is the federal government still dithering on enhancing the CPP, pushing Ontario to consider starting its own pension plan? I agree with those who argue Canada needs reforms to the federal pension plan, not a duplicate system in Ontario.

There are many benefits to DB pensions. They are far superior to any DC pension because they actually provide predictable monthly benefit on retirement based on the employee's earnings, years of service and age. This way people don't have to worry about the wolf market, the scars of 2008 or the new pension poverty. They can enjoy retiring in dignity and security, spending money, contributing to economic activity.

In a nutshell, here are the main benefits of DB pensions worth highlighting:
  • Provide predictable retirement benefits not subject to vagaries of market
  • Pool longevity risk and asset risk
  • Lower costs significantly by bringing assets internally, avoiding fees charged by many closet indexers and external managers
  • Invest in public and private markets directly or externally with some of the best global money managers. Private equity is trying to tap the DC pension space but this won't change the fact that DB pensions have an advantage because they invest directly into private markets and funds, and co-invest with GPs on large transactions.
  • The alignment of interests is much better in DB pensions than DC pensions
Finally, there is one big myth that really irks me which I want to lay to rest. The assets of Canada's top ten and most other DB pensions are a product of investment gains over the long-run. Contributions from employees and sponsors make up a small part of assets. Over 2/3 of the growth in assets comes from investment gains, not contributions, a true testament of the power of compounding but more importantly, of  the governance of these plans which allows them to attract professionals who can add significant value-added over public market benchmarks, lowering the cost of these plans.

Jim Keohane, CEO of the Healthcare of Ontario Pension Plan (HOOPP), shared these insights with me:
The study found that in aggregate for all Canadian DB plans that for growth in assets in the study that more than two thirds came from investment returns and one third from employer and employee contributions. Because our fund earned higher returns than the average it was much higher than that. But that doesn’t tell the whole story.

We went through the exercise of following a pensioner through the entire life cycle of being in the plan. During the accumulation phase, the ratio would be slightly less than 80%, but once a member retires, there are no further contributions and returns continue to accumulate. So if you follow the average plan member over the entire life cycle, the 80% number is correct.

Obviously, there are several variables that influence the answer to the question. For example, if a member joins the plan later in their career, then ratio of investment gains would be lower, and for members who live longer, the ratio would be higher, but on average 75% to 80% would be accurate.

The study also showed that the funds had very high quality management at a very low cost. Boston Consulting Group found that members were getting world class actively managed returns at the cost of passive management.

There are some great facts in the study which contradict a lot of the misinformation that is being propagated about DB plans.
So the next time someone tells you that DB pensions are all a "Ponzi scheme" and that we should switch everyone to DC pensions, remember this comment and tell them to get their facts straight. The only Ponzi is in their head because if you look at the facts, DB pensions are far superior to DC pensions and their benefits to society are grossly underestimated and under-appreciated.

Below,  Jim Leech, CEO of the Ontario Teachers' Pension Plan, talks with Bloomberg's Erik Schatzker about the fund's investment model. Leech also discusses the state of the financial markets and the risk of inflation (from February 2012 but worth watching to understand the benefits of OTPP's governance).