Canadian taxpayers are providing $22 billion each year to the country’s public sector pension plans by assuming undisclosed investment risks, according to a new report by public policy think-tank the Fraser Institute.
In the report, its author Malcolm Hamilton suggested public pension funds view the income they provide to plan members on retirement as 20 per cent from member contributions and 80 per cent from investment returns. The fundamental reality of investing, which rewards investors for taking on more risk, means the riskier portfolios that DB plans take on, the less members have to contribute, the report noted.
“The reward for risk-taking is determined by the plan actuary and distributed to contributors as a reduction in their contribution rates,” it said. “The plan actuary anticipates the additional returns that the pension fund will earn over the remaining lifetime of plan members. The actuary estimates by how much contribution rates can be reduced as a consequence. Contributors pay this lower rate immediately. This means that the reward for risk-taking, as estimated by the actuary, is typically distributed about 20 to 25 years before the risks are actually taken.”
Rather than estimating the cost of the pension plan by assuming the rewards of taking on the investment risk, plans should be considering the cost of the pension as the amount members would have to pay to receive the same pension benefits without taking on the risk.
As an example, Hamilton laid out a pension investing solely in government bonds and achieving a rate of return of one per cent, an extremely low-risk portfolio. In that scenario, contribution rates would have to be 43 per cent as opposed to the 21 per cent contribution rate members would pay given a riskier stock and bond portfolio that achieves a consistent return of 3.5 per cent.