Federal Employee Pension Reforms: First Steps – on a Much Longer Journey

Abstract

Ottawa's proposed changes to the pension plans of MPs and federal employees are a move in the right direction. Currently before Parliament, the new provisions include increasing employee contributions to the plans and raising eligibility ages for new employees' benefits. But much remains to be done. Better funding and a more reasonable division of obligations and risks between taxpayers and public servants will require more fundamental revisions to what increasingly stands out as Canada's most important dysfunctional pension system. Legislation currently under consideration in Parliament would make important changes to the pension plans of federal employees. 1 Starting next year, new hires to the public service would become eligible for unreduced pensions at age 65, rather than the current age 60. 2 The eligibility age for members of parliament (MPs) would also go to 65, up from the current 55, starting in January 2016. 3 The contributions made by most employees and MPs themselves to their pension We would like to thank members of the C.D. Howe Institute's Pension Policy Council for comments on an earlier draft, particularly, as well as Institute colleagues Philippe Bergevin, Colin Busby, Ben Dachis, and Finn Poschmann. Responsibility for the conclusions and any errors is ours. 1 Changes to federal employee pension plans are in Bill C-45, introduced in the House of Commons on October 18. Changes to the MPs' pension plan were put in a separate Bill (C-46) on October 19; approved by the House of Commons, this bill is currently before the Senate.

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PENSION POLICY
Federal Employee Pension Reforms:
First Steps – on a Much Longer Journey
by
William B.P. Robson and Alexandre Laurin
Ottawa’s proposed changes to the pension plans of MPs and federal employees
are a move in the right direction. Currently before Parliament, the new
provisions include increasing employee contributions to the plans and raising
eligibility ages for new employees’ benefits. But much remains to be done.
Better funding and a more reasonable division of obligations and risks between
taxpayers and public servants will require more fundamental revisions to what
increasingly stands out as Canada’s most important dysfunctional pension system.
Legislation currently under consideration in Parliament would make important changes to the
pension plans of federal employees.1 Starting next year, new hires to the public service would
become eligible for unreduced pensions at age 65, rather than the current age 60.2 The eligibility
age for members of parliament (MPs) would also go to 65, up from the current 55, starting in
January 2016.3 The contributions made by most employees and MPs themselves to their pension
We would like to thank members of the C.D. Howe Institute’s Pension Policy Council for comments on
an earlier draft, particularly Keith Ambachtsheer, Stephen Bonnar, Leo de Bever, Malcolm Hamilton,
Claude Lamoureux, and James Pierlot, as well as Institute colleagues Philippe Bergevin, Colin Busby,
Ben Dachis, and Finn Poschmann. Responsibility for the conclusions and any errors is ours.
1 Changes to federal employee pension plans are in Bill C-45, introduced in the House of Commons
on October 18. Changes to the MPs’ pension plan were put in a separate Bill (C-46) on October 19;
approved by the House of Commons, this bill is currently before the Senate.
2 New hires who put in 30 or more years of service will become eligible for an unreduced early retirement at
60, up from 55 at present. Changes to pension eligibility age for new hires do not apply to members of the
RCMP and Canadian Forces.
3 Although the eligibility age to an unreduced pension will go up by 10 years, MPs will still be eligible for
a pension at age 55, reduced by a 1 percent penalty for each year of age below 65, and only one-fifth the
reduction applying to public-service employees.
Essential Policy Intelligence
e-Brief
November 1, 2012
Updated on December 14, 2012

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e-Brief
plans would rise to 50 percent of the current service cost of the plans.4
The prospective increases in employee contributions would start saving taxpayers money in the short term,5
and raising eligibility ages for new employees’ benefits would reduce the growth of these plans’ liabilities in years
to come. While MPs and the public servants who designed the changes deserve recognition, not least for their
personal sacrifice, the flaws in Ottawa’s employee pension plans are so serious that these steps should – and
almost certainly will – not be the end of the journey. The guaranteed incomes those plans promise participants
are far more valuable, and their costs and obligations on taxpayers are far larger, than reported. Better funding
and a more reasonable division of obligations and risks between taxpayers and public servants will require more
fundamental revisions to what increasingly stands out as Canada’s most important dysfunctional pension system.
Background on Key Federal Employee Pension Plans
The federal government has many pension plans for its employees. The three with the largest impact on Ottawa’s
finances, all affected by the proposed changes, are the Public Service (PS), the Canadian Forces (CF), and the
Royal Canadian Mounted Police (RCMP) plans. The changes also affect the MPs’ plan, which naturally has a high
public profile.
These plans, like others6 the legislation will leave unchanged, have key common elements. They are classic
defined-benefit plans that promise annuities calculated with reference to salary and years of service.7 They are all
badly underfunded – the PS, CF, and RCMP plans only began investing in segregated assets in 2000 – or totally
unfunded. They are sponsored and administered by a single employer, the federal government, which treats the
plans like a subsidiary of its own operations.
The key focus of discontent about these plans, and the proximate cause of the reforms, is the rich retirements
they offer compared to what other Canadians can hope for, and the modest contribution the employees
themselves make.
One way to summarize the plans’ generosity is their current service cost: the retirement wealth that accrues
annually to the average participant. Even the understated amounts reported by the government (shown in the
first column of Table 1) show accruals above the limit of 18 percent of pay that applies to participants in defined-
contribution pension plans and RRSP savers – a clear case of unequal treatment compared to non-federal
employees.8 The inequality is enormous in the case of MPs, whose reported current service cost is more than
50 percent of pensionable pay.
4 The exceptions are employees of the Royal Canadian Mounted Police and Canadian Forces, who will contribute less
than 50 percent of their costs (about 44 percent for RCMP and 43 percent for the CF).
5 Taxpayers will save money only if wages and salaries are not adjusted upward to compensate for increased employee
contributions.
6 Some professional categories, such as federal judges, have separate plans; other employees have special retirement
compensation arrangements beyond their pension plans.
7 Some pension plans that call themselves defined-benefit plans, or are often referred to that way, are actually target-
benefit (sometimes referred to as “shared-risk”) plans, with provision for downward adjustment of benefits when
assets are below certain thresholds. Major plans covering the broader public sector in Ontario, Alberta and British
Columbia are of this type. The federal plans contain no such provision.
8 The proposed modifications to age of eligibility of benefits will slightly alleviate this inequality in the longer run as
new employees come in.

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As for contributions, the deductions from employee paycheques for the PS, RCMP and CF plans were between
6.5 and 6.9 percent of their average annual wages and salaries in 2011, covering no more than one-third of
the reported current service cost of these plans (see the middle two columns of Table 1).9 MPs contributed, on
average, 7 percent of their pensionable pay – an even smaller portion of the reported cost of their pensions.
The Plans’ True Cost
The actual cost of these plans, moreover, is higher than reported. The estimate of current service costs that
determines contributions depends on the Chief Actuary’s projections of the returns on a risky portfolio of assets.
But these plans are largely unfunded, and the returns on what assets exist may differ from the Chief Actuary’s
projections. Taxpayers are the guarantors of benefits in the event of shortfalls.
As we have documented elsewhere (Laurin and Robson 2010, 2011; Robson 2012), the appropriate way to
value these guaranteed benefits is to ask what it would cost someone not in one of these plans to build a nest-
egg promising a similar retirement. Because the annuities in these plans are indexed to inflation and backed by
Table 1: Current Service Cost for PS, RCMP, CF, and MP Pension Plans, 2012
Notes: Contributions and current service costs are for 2012 before the proposed changes. Fair-value refers to the cost of
funding the pension obligations based on the market yield for matching ination-indexed, taxpayer-backed bonds
(real return bonds).
Revisions on 12/14/2012: Because the RRB yield is currently well below the range the Chief Actuary presents in his
sensitivity analysis, dierent methods for extrapolating current service costs to such low yields produce quite dierent results.
Of the various straightforward methods for extrapolating, the log linear gives higher estimates while the polynomial and
exponential methods give similar and lower numbers. e original version of this E-Brief presented loglinear estmates. is
revised version presents the polynomial estimates.
Sources: Authors’ calculations based on OCA 2011a, 2011b, 2012a and 2012b, and the RRB yield as of March 31st
2012 (0.51%).
Pension Plan
Reported
Current Service
Cost
Contributions:
Employees
Contributions:
Taxpayers
Current Service
Cost at Fair-Value
(percent of pensionable pay)
Public Service (PS) 19.8 6.7 13.1 47.7
Royal Canadian Mounted
Police (RCMP) 22.5 6.9 15.5 56.9
Canadian Forces (CF) 23.1 6.5 16.6 60.2
Members of Parliament (MP) 51.5 7.1 44.5 72.1
9 The rates above represent average contributions for all employees. Individual contribution rates for employees in
the plans mentioned above in 2012 were 6.2 percent on pensionable earnings up to $50,100 and 8.6 percent on
pensionable earnings above $50,100.

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taxpayers, the closest parallel available to that non-participant is a portfolio of the federal government’s real-
return bonds (RRB).10
Those bonds are currently very expensive. High-quality debt has become precious in recent years, the
counterpart of its low yield, which reflects expectations of slower economic growth and – in the case of some
countries, including Canada – savers’ search for safer havens in a world of much heightened credit risk.
Therefore, the size of nest-egg needed for any future taxpayer-guaranteed payout has gone up.
The Public Accounts as of March 2012, the most recent available, showed Ottawa’s obligation for employee
pensions – the liability on its balance sheet representing the amount it would need to meet the various payments
as they come due – at $231 billion. But that amount was calculated assuming rates of return of 6.0 percent after
inflation on invested contributions, and 4.8 percent on the unfunded portion. Using the actual real-return bond
yield prevailing at the time, the total obligation was more than 40 percent higher: $331 billion.11
The MPs’ plan does not appear separately in the Public Accounts, but a similar calculation based on the
most recent valuation from the Chief Actuary as at 31 March 2010 raises the present value of its pension
obligation from $817 million to more than $1 billion (Robson 2012). Since the MPs’ plan is completely
unfunded – the contributions MPs notionally make to their plan simply disappear into the consolidated revenue
fund, and the same will happen to the higher ones these reforms propose in the future – that entire amount is an
unfunded liability.
The same logic – what it would cost to add enough RRBs to these plans every year to match the new benefits
they promise – yields annual accruals of retirement wealth for an average participant in the PS, RCMP and CF
plans that is not the roughly 20 percent of pensionable pay shown in their actuarial reports, but 48 percent or
more of pay (shown in the fourth column of Table 1). And the annual wealth accrual for an average MP is not the
51 percent of pensionable pay shown in the actuarial report on the MPs’ plan, but 72 percent.
So whatever the split between employer and employee contributions after the changes, the underfunding of
these plans, and therefore taxpayers’ exposure, will still increase.
Deeper Reforms Needed
Notwithstanding the merits of increasing the employees’ share of the current service cost of these plans,
taxpayers will still bear more than half of the risk of changes in the cost of new obligations and – more important
– the entire risk of changes in the cost of servicing past obligations. Mitigating that risk would require converting
the federal plans to target-benefit plans – in which benefits adjust depending on funding – such as exist in the
broader public sector in many provinces and are envisioned in recent legislation in New Brunswick (Steele
2012), or capping taxpayers’ contributions – to, say, 9 percent (half the 18 percent maximum tax-deferred limit
available in RRSPs and DC plans) – with the rest of the amount needed to fund the plans at their actual current
service cost coming from employees (Laurin and Robson 2012).
10 Since RRBs are indexed to inflation and backed by taxpayers, they strongly resemble the promise made to
participants in federal plans. The suitability of yields on RRBs as a discount rate for government pensions is not
universally accepted, but they are better than any alternative (Laurin and Robson 2009). The thin float of these
bonds is not an argument against using their yield, since that scarcity makes inflation protection more valuable; it is
an argument for issuing more RRBs, which would be desirable in any event (Bergevin and Robson 2012).
11 Authors’ calculations using RCA 2012 and the RRB yield as at 31 March 2012.

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Equalizing the tax-deferred saving opportunities available to different classes of workers is another task
still outstanding. Why should federal employees get tax-deferred saving that is triple or more what Canadians
contributing to defined-contribution pension plans or RRSPs get? One option that deserves more attention is
a uniform lifetime accumulation limit (Pierlot and Siddiqi 2011). Failing that, Ottawa could go further than
suggested in the previous paragraph, and convert all federal plans to defined-contribution plans (Laurin and
Robson 2012).
In the case of the MPs’ plan, one further change deserves underlining: the contributions of MPs and of
taxpayers as their employers should, whatever the structure of the plan, become actual cash contributions that
buy assets. Even after the 2012 reforms, the only backing for the pensions Canada’s political leaders promise
themselves will be their power to tax in the future. But funding pensions with assets that represent claims on
someone other than the sponsor is a key discipline; the need to achieve, rather than simply assume, higher
investment returns curbs tendencies to promise overly rich benefits. Fully backing their own plan with real assets
would earn MPs valuable moral authority to lead the ongoing process of pension reform in Canada.

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e-Brief
is E-Brief is a publication of the C.D. Howe Institute.
William B.P. Robson is President and Chief Executive Ocer of the C.D. Howe Institute.
Alexandre Laurin is Associate Director of Research at the C.D. Howe Institute.
is E-Brief is available at www.cdhowe.org.
Permission is granted to reprint this text if the content is not altered and proper attribution is provided.
References
Bergevin, Philippe, and William B.P. Robson. 2012. More RRBs Please! Why Ottawa Should Issue More
Ination-Indexed Bonds. Commentary 363. Toronto: C.D. Howe Institute. September.
Laurin, Alexandre, and William B.P. Robson. 2009. “Supersized Superannuation: e Startling Fair-Value
Cost of Federal Government Pensions.” Backgrounder. Toronto: C.D. Howe Institute. December.
Laurin, Alexandre, and William B.P. Robson. 2010. “e Public-Sector Pension Bubble: Time to Confront
the Unmeasured Cost of Ottawa’s Pensions.” E-Brief. Toronto: C.D. Howe Institute. November.
Laurin, Alexandre, and William B.P. Robson. 2011. “Ottawa’s Pension Gap: e Growing and
Underreported Cost of Federal Employee Pensions.” E-brief. Toronto: C.D. Howe Institute. December.
Laurin, Alexandre, and William B.P. Robson. 2012. Achieving Balance, Spurring Growth: A Shadow Federal
Budget for 2012. Commentary 344. Toronto: C.D. Howe Institute. March.
Oce of the Chief Actuary (OCA). 2011a. “Actuarial Report on the Pension Plan for the Members of
Parliament as at 31 March 2010.” Ottawa: Oce of the Superintendent of Financial Institutions. March.
––––––––––––. 2011b. “Actuarial Report on the Pension Plan for the Canadian Forces, Regular Force, as at
31 March 2010.” Ottawa: Oce of the Superintendent of Financial Institutions Canada.
––––––––––––. 2012a. “Actuarial Report on the Pension Plan for the Public Service of Canada, as at 31
March 2011.” Ottawa: Oce of the Superintendent of Financial Institutions Canada.
––––––––––––. 2012b. “Actuarial Report on the Pension Plan for the Royal Canadian Mounted Policy, as at
31 March 2011.” Ottawa: Oce of the Superintendent of Financial Institutions Canada.
Pierlot, James, and Faisal Siddiqi. 2011. Legal for Life: Why Canadians Need a Lifetime Retirement Saving
Limit. Commentary 336. Toronto: C.D. Howe Institute. October.
Robson, William B.P. 2012. “Fixing MP Pensions: Parliamentarians Must Lead Canada’s Move to Fairer,
and Better-Funded Retirements.” Backgrounder 146. Toronto: C.D. Howe Institute. January.
Receiver General for Canada (RCA). 2012. Public Accounts of Canada, Vol. 1: Summary Report and
Financial Statements. Ottawa: Minister of Public Works and Government Services. October.
Steele, Jana. 2012. “New Brunswick’s Innovative Answer to Pension Reform.” Benets Canada: September 26.
Available at http://www.benetscanada.com.

Essential Policy Intelligence
The Pension Papers Program
e C.D. Howe Institute launched the Pension Papers in May 2007 to address key challenges facing
Canada’s system of retirement saving, assess current developments, identify regulatory strengths and
shortfalls, and make recommendations to ensure the integrity of pension earnings for the growing number
of Canadians approaching retirement. e Institute gratefully acknowledges the participation of the
Policy Council for the program.
Pension Policy Council:
Co-chairs:
Claude Lamoureux
Former President & CEO of the Ontario Teachers’ Pension Plan
Nick Le Pan
Former Superintendent of Financial Institutions, Canada
Members:
Keith Ambachtsheer,
Rotman International Centre for Pension
Management;
Bob Baldwin;
Leo de Bever,
Alberta Investment Management
Corporation (AIMCo);
Steve Bonnar;
Caroline Dabu,
BMO Financial Group;
Peter Drake,
Fidelity Investments;
Brian FitzGerald,
Capital G Consulting Inc.;
Bruce Gordon,
Manulife Financial Canada;
Barry Gros,
AON Consulting;
Malcolm Hamilton,
Mercer Human Resource Consulting Limited;
Siobhan Harty,
Human Resources and Skills Development Canada;
Bryan Hocking,
Association of Canadian Pension Management;
Bill Kyle,
The Great-West Life Assurance Company;
Bernard Morency,
Caisse de depot et placement du Québec;
Michael Nobrega,
Ontario Municipal Employees’ Retirement System;
Jim Pesando,
University of Toronto;
James Pierlot,
Pierlot Pension Law;
Tom Reid,
Sun Life Financial Inc.;
Jeremy Rudin,
Department of Finance, Canada;
Tammy Schirle,
Wilfrid Laurier University;
Terri Troy,
Halifax Regional Municipality Pension Plan;
Randy VanDerStarren,
Open Access Ltd.;
Fred Vettese,
Morneau Shepell;
Barbara Zvan,
Ontario Teachers’ Pension Plan.
The views expressed in this paper are those of the author, and do not necessarily reflect those of Council members,
or other members, staff and directors of the C.D. Howe Institute.