What would Withdrawing from the Canada Pension Plan Mean to Albertans?

By Ellen Nygaard and Virendra Gupta, Edmonton, AB, October 2021

The United Conservative Party (UCP) government, shortly after taking office in 2019, created a panel to consider whether Albertans are getting a “fair deal” as part of Canada. One of its assignments was whether Alberta should withdraw from Canada Pension Plan (CPP) and create its own pension plan, taking our portion of assets and liabilities from the Canada Pension Plan and running a pension plan for Alberta workers. The Panel recommended that the Government:

“Develop a comprehensive plan to create an Alberta Pension Plan and withdraw from the Canada Pension Plan. Subsequently, provide Albertans the opportunity, via a referendum, to vote for or against withdrawing from the Canada Pension Plan and creating the Alberta Pension Plan.”

Unsurprisingly, given that it was one of the Panel’s assigned tasks, the Government accepted the recommendation “with support for further analysis” by the appropriate Ministries. The UCP’s apparent determination to carry on down this road makes it vital for Albertans to consider: what would we gain, what would we lose, and what are the risks?

Evolution of CPP

First, a brief summary of what CPP offers us and how it has evolved. CPP was started in 1966 as a pension plan for Canadian workers financed by contributions linked to employment earnings. Employers and employees contribute equally. Pensions replace 25 per cent of earnings up to the average industrial wage and are indexed to inflation. Maximum annual pension in 2021 at age 65 is $14,110 (the average pension is $7,437). Contributions and pensions are set at the same rate across the country.

It was designed to be essentially a “pay-as-you-go” (PAYGO) plan where current contributions pay current pensions. In effect, each generation of workers would pay for the pensions of the preceding generation and they would in turn receive their pensions from the contributions of a succeeding generation. As a result, only a small reserve fund was built and that reserve was lent to provinces at long-term bond rates. This was a common model among national, universal pension schemes internationally. Canada’s birth rate was high, and the economy and labour force were growing.

But, just as the plan commenced, the Baby Boom came to an end. The birth rate fell sharply and has remained low. While Canada has had sustained economic and labour force growth since then, it became obvious by the 1980s that contribution rates would have to rise sharply – possibly too sharply to be   politically and economically acceptable – as the Baby Boomers reached retirement.

CPP is governed jointly by federal and provincial governments. Changes must be approved by two-thirds of the provinces representing two-thirds of the population. Quebec has had its own Quebec Pension Plan (QPP) from the start.

In 1997 the governments (including Alberta) agreed on a package of amendments to the CPP legislation that put the plan on a path to long-term stability and sustainability. Among the chief features:

1. Contribution rates rose gradually to 9.9% of eligible salaries (in 2021 the maximum is $61,600). Contributions in excess of the amount required to pay pensions were put in an Investment Fund. The main purpose was to stabilize contribution rates when the Baby Boom cohort began retiring and keep them steady thereafter.
2. To manage the Fund, an independent CPP Investment Board (CPPIB) with a mandate to invest solely in the interests of plan beneficiaries was established.
3. The Board’s members are selected by a committee composed of nominees from the federal and provincial governments. This appointment method and a number of other safeguards ensure that CPPIB can invest strictly in accordance with its mandate and without political interference.
4. Actuarial valuations of the plan are performed every three years by the Chief Actuary of Canada. The funding objective is to keep contribution rates steady over the long term (projections testing stability are made over as many as 75 years into the future). To ensure high professional standards, the actuarial report is reviewed by an independent panel of actuaries appointed by the Chief Actuary of Great Britain.
5. As a fail-safe, the legislation requires that if contributions become inadequate and the federal and provincial governments fail to agree on rate increases, rates will increase automatically and inflation adjustments will be suspended until long-term funding stability is restored.

The reforms worked as the governments intended. A large fund has been built up. Contributions still slightly exceed annual benefits and the current rates could be adequate for 75 years. CPP’s last actuarial report, as at December 31, 2018, estimates current contribution rates can remain stable for at least 40 years.

Meanwhile, the CPPIB has built up a fund of half a trillion dollars, investing in a widely diversified portfolio of Canadian and international investments. Its average rate of return has been over 10% a year.

In 2016, governments agreed to increase the percentage of pre-retirement earnings the CPP would replace, over time, to 33% from 25%, and increase the earnings level eligible for pension coverage. The pension enhancements will be “fully funded” – that is, the contributions made by workers and their employers, plus investment earnings, will fund their own enhancement. The portion of the pension (the “base benefit”) that is calculated according to the original formula will continue to be funded as per the 1997 reforms.  The remainder of this paper will concentrate on the base benefit as it will continue to provide most of the pension.

Canadians who move within the country can rely on CPP as a secure source of retirement income. It is universal, stable, portable, well managed, has inflation-protected benefits and is well regarded internationally. Why would Albertans pull out now? Let’s look at the arguments.

Is it unfair?

The alleged unfairness about Albertans contributing disproportionately is argued based on the balance derived by deducting aggregate annual benefits from annual contributions. The calculation ignores several aspects of the CPP.

All Canadians and their employers make contributions and receive pensions at the same rate. CPP is not a regional or individual income redistribution scheme.

Higher total contributions come from Alberta relative to its share of the total population because Alberta has a higher percentage of working age population with a higher participation rate who make higher wages than the Canadian average. Even in 2019, after our recent downturn but before the pandemic, current average employment income in Canada was $47,300, and in Alberta, $55,300. The current labour force participation rate in Canada (May 2021) is 65.3 per cent and in Alberta is 69.5 per cent of the labour force. As a result, a larger percentage of Albertans are earning and building higher CPP pensions than residents of other provinces.

As for the lower aggregate pension payments, sometimes a handful of opposing factors can lead to a non-intuitive net result. As Albertans have a long history of higher average wages, individual average pensions would tend to be higher, but for now this factor is offset by the smaller proportion of the population that is on pension. We can account for that by worker mobility as well as retiree mobility: many of Alberta’s workers come for a few years to work, and then leave. Many (even lifelong Albertans) retire elsewhere and thus their CPP pensions are attributed to that other jurisdiction in the “balance” calculation.

Most importantly, however, this simple balance calculation is contrary to what the CPP legislation says about how the assets and liabilities would be calculated and transferred to any province that withdraws and sets up its own plan (see below).

The prospect of lower contribution rates

That simple calculation, however, has led some people to claim that Albertans could have an equivalent pension plan for lower contribution rates. The Fraser Institute has suggested it could be as low as 5.85%, compared with the current 9.9%. A small reduction might be possible in the short term, but that would likely leave future Albertans facing higher unfunded liabilities.  First, it’s important to recognize that the current contributions to CPP are significantly higher than would be necessary to pay for newly earned benefits because they are deliberately set to whittle down the unfunded liability so that contributions can remain stable (the “steady-state rate”) even as the Baby Boom generation moves into retirement.  (The oldest Baby Boomers are turning 75 this year but those born in the peak birth rate years are just now reaching retirement.) In fact, they are higher than the 2018 Actuarial Report found would be necessary to maintain steady contributions.  The rates for the base plan are currently 9.9% of salary (half by employers, half by employees), whereas the minimum “steady-state rate” would be 9.75%. 

The long-term stability of CPP’s contribution rates for the “base benefit” depends on a steadily growing employment earnings base. This is particularly relevant for Alberta given our heavy dependence on volatile commodity prices. Two realities of setting a low contribution rate in the largely PAYGO financing method would combine to produce negative shocks during a prolonged downturn. The first is that a lower contribution rate automatically results in less of a contribution toward the unfunded liability.  Like any debt for which repayments do not entirely cover the accumulating interest, it grows even faster due to compounding.  The second is that if those contribution rates became unsustainable, they might have to increase by a large percentage, given that the unfunded liability would be supported by a flat or even declining earnings base.  If the required rates were deemed unfeasible, benefits would have to be cut.

We are better protected as part of a larger, diversified whole. Currently, the total Canadian labour force is estimated by Statistics Canada to be 20.42 million. Subtracting Quebec’s labour force of 4.55 million, the labour force to which CPP applies totals 15.87 million. Of those, 2.46 million are Albertans, or 16 per cent. Alberta Finance has published statistics showing that while the Alberta population continues to grow, it has not had net interprovincial migration since 2015. Prior to that, interprovincial migration strongly favoured Alberta.  While not creating a worrisome reversal yet, it is an indicator that Alberta’s position may be vulnerable.

The stresses on the QPP are illustrative: Quebec, with a labour force less than a quarter the size of Canada’s as a whole, has been under some strain in offering the same benefits for the same contribution rates as the rest of Canada, thanks to a birth rate that dropped precipitously just after the plan was launched, and relatively weaker economy than the nation as a whole over that period. Quebec’s contribution rates for the base plan, which is essentially identical to the CPP’s, are nearly one full percentage point higher.

(The recent enhanced benefits portion of the plan is not especially sensitive to changes in the economic and demographic characteristics of the contributing population because each cohort funds its own enhancements.)

 Assets and liabilities on withdrawal

No province has attempted to withdraw from CPP. Quebec set up its own plan from Day 1. How a withdrawal request would be treated by the federal and other provincial governments is hard to know.

Although CPP has about $500 billion in assets, its liabilities are much higher because the base plan is not designed to be a fully-funded plan. The Chief Actuary, in the 2018 Actuarial Valuation Report, estimated CPP’s liability if no further contributions or benefit credits were made, known as a “closed group” estimate. This would likely be how Alberta’s share of the liabilities would be calculated. The total at the time was $1,257.1 billion. (Net assets at the time were $371.7 billion, for an unfunded liability of $885.4 billion – a “funded ratio” of about 30%).

The Canada Pension Plan legislation permits a province to withdraw from the plan if it sets up an equivalent plan. Under the CPP legislation, an Alberta plan would inherit liabilities for all benefits workers earned while working in Alberta since 1966. Because so many Canadians have moved into and out of Alberta since then, determining Alberta’s liabilities would not be easy.

There is no detailed formula in the CPP legislation for determining Alberta’s share of the total liability. A likely way of determining it would be to use the same proportion as the proportion of total contributions and the related pension credits attributable to Alberta workers over the years. The total contributions are in respect of all those who have CPP credits for any period worked in Alberta, not just those currently working in Alberta.

We have no way of knowing what the proportion would be, but as an example, 16% is roughly the proportion of the Canadian (excluding Quebec) labour force living in Alberta now. On that basis, the liability assumed would be more than $200 billion based on the 2018 figures.

Alberta would also get a share of assets of the CPP Fund, pro rata based on all contributions made by workers and their employers while working in Alberta. The net investment income on those assets would also be shifted to the Alberta plan.  Some have suggested that it could be about $40 billion although that number is not verifiable.

In summary, liabilities and the unfunded liabilities assumed by an APP would be considerably larger than proponents of an APP seem to have contemplated.

Proponents of Alberta’s withdrawal from CPP have suggested that Alberta could persuade the federal and other provincial governments to strike a better deal than what would result from the legal requirements outlined above for transferring assets and liabilities.  This would require an amendment to the CPP legislation and that would require the agreement of 2/3 of the provinces representing 2/3 of the population and the federal governmental.  It is unlikely that the provinces or the federal government would agree to make a better deal for a province leaving the CPP.

Managing the assets

It’s been suggested that an Alberta plan’s assets could be managed by AIMCo, the Alberta government’s investment management corporation. The CPPIB enjoys a wide reputation for its independence, focused mandate and performance. In contrast, AIMCo has multiple clients with multiple mandates, some of which are directed by the provincial government. As a result, AIMCo essentially operates like a mutual fund company that runs many funds from which the clients can choose. AIMCo also made headlines in 2020 when it lost around $2 Billion in a volatility- based investment strategy.

There is also a question of AIMCo’s independence from political interference. Alberta legislation, in addition to the sole authority to appoint AIMCo’s Board, gives the Alberta Government considerable powers over AIMCo. The government has shown that it is willing to use it. The current government has changed laws to deny pension plan boards the ability to leave AIMCo and make other investment arrangements if they so choose after giving due notice. It has also forced Teachers Retirement Fund Board to use AIMCo for investment purposes. These actions have impacted the relationship between AIMCo and large pension plans’ boards.

CPP’s investment costs are high for some asset classes, but in this case, you get what you pay for.  CPPIB is a world leader in expanding into non-traditional asset classes, which sometimes carry fairly high costs but are a small factor in contribution rates.  The shift to alternative asset classes was prompted by declining traditional asset returns; an Alberta plan would be subject to the same pressure to look elsewhere for return.

Proponents of an Alberta Pension Plan dangle, as an incentive, that Alberta would gain high-paying jobs in asset management. Again, this implies a transfer of value from the many contributors to a highly-paid handful of people.

“Investing in Alberta Companies”

Some anticipate that the assets of an Alberta Pension Plan could be directed towards investments in Alberta companies, promoting Alberta growth – often characterized as “province building”.

Building a local economy is not the purpose of a pension plan. The purpose is to deliver promised pensions at a reasonable and stable cost, fairly distributed between generations, optimizing return with acceptable risk. A directive that mandates investing in provincial companies would be contrary to the clear and well-established fiduciary obligations of pension trustees: to act in the interests of current and future beneficiaries.

It is always tempting to point out that tomorrow’s beneficiaries (pensioners) are today’s workers, and they need jobs today. But that is a misunderstanding of the mandate of a pension plan and its trustees.  A pension trustee’s job is to look out for the interests of our “future self” – a retired citizen who needs income security – as distinct from and sometimes in conflict with our current self, who is concerned about jobs, debts, necessities and discretionary spending.

Increased Risk

Whatever our share, a large unfunded liability and a smaller population base with a volatile economy is a risky proposition. If Alberta continues to have its advantageous circumstances, this liability should be manageable, but if not, optimistic predictions of a lower sustainable contribution rate would vanish quickly. If a separate Alberta fund underperformed because of investment in a suffering Alberta industry, workers would face multiple blows: fewer jobs, lower wages and higher contribution rates.

As predicted when the 1997 reforms were implemented, starting early in this decade, employer and employee contributions will no longer be sufficient and some of the income of the fund will be needed to pay for pensions. By 2050, it is projected that in addition to contributions over 1/3 of the annual investment income of the fund will be needed to pay the benefits.

The Chief Actuary has done extensive tests to determine which assumptions are the most sensitive when they are making predictions of the long-term future. These tests identify which variables that affect the plan’s long-term stability and affordability will have the most impact if the future unfolds less (or more) favourably than assumed. The assumptions with the greatest impact are: 1) the real (after inflation) rate of return on assets; 2) birth rate (and thus the population of future contributors); 3) real (after inflation) wage growth. On all three counts there are concerns about Alberta’s vulnerability.

Other concerns

 There are many other concerns and potential disadvantages:

1. A duplicate bureaucracy would have to be set up to replace the one currently in place in the Government of Canada to administer the contributions and benefits. This would add costs at the outset, and could well be more expensive on an ongoing basis because of smaller scale. Such complex transitions are lengthy and error-prone. The annual cost of CPP administration (excluding investment costs) is about $780 million a year including the enhanced benefits portion. With a reasonable adjustment for lower economies of scale, Alberta could expect administration to cost more than an amount proportional to its number of contributors and pensioners. Pension expert Keith Ambachtsheer has estimated that total administration costs (not including investment costs) could be anywhere from $260 million to $525 million. Even his lowest estimate represents a significantly higher per-member cost.

The Fraser Institute claims that CPP has higher administrative costs than comparable pension plans, and an APP might have lower administrative costs than CPP. Its studies are unpersuasive. They use as a yardstick the cost per dollar of assets in CPP and in five Ontario public sector pension plans, an apples-to-oranges comparison in which CPP’s costs look artificially high because its assets comprise less than one-quarter of its total liabilities (by design). Fairer comparisons would be per member or per dollar of liability. Besides CPP is a universal national plan with many complex features.

2. The federal government has 59 reciprocal social security agreements with other countries so that Canadians working abroad, or foreigners working in Canada, do not suffer from either double coverage and taxation or a lack of coverage. All these agreements would have to be renegotiated to avoid hurting Alberta’s mobile workforce.

3. Canadians who have participated in the CPP and the Quebec Pension Plan have their pension entitlements in both plans recognized wherever they retire. This has been feasible because the plans have the same benefits and, until a few years ago, the same contribution rates. Such harmonization would be uncertain for a separate Alberta plan if contributions and benefits were not the same. Labour force mobility and pension security for Alberta workers could be negatively affected.

Conclusion

There are many unknowns to such a monumental change. Once done, it cannot be undone. The potential disadvantages and risks to Albertans of establishing an Alberta Pension Plan are significant, while the case for the move (excluding any purely partisan political considerations) seems to hinge mainly on capturing a short-term advantage and possibly using investments for riskier assets in the service of “province building”.

Albertans could lose a lot. It’s not clear what they would gain. Over the years, CPP has been reformed, strengthened, and expanded.  By all accounts, it is working well. Why would we walk away from that?  Why would we leave a national plan where decisions are made through negotiations and agreement among the provinces and the federal government and where no single government of the day holds all the powers over the plan? Why expose ourselves to the risk that an Alberta government might someday declare the plan unaffordable and amend it to deliver a lower pension?

About the Authors

Ellen Nygaard is a retired Alberta government manager specializing in pension policy, living in Edmonton. She was responsible for Alberta’s pension policy. She is currently a member of three pension boards. Virendra Gupta is retired and was Executive Director of the Universities Academic Pension Plan. Previously he was responsible for pension policy with the Alberta government.