The Drummond report’s pension recommendations

On Feb. 15, 2012, the Commission on the Reform of Ontario’s Public Services released its report. Chaired by noted economist Don Drummond, and announced in the March 2011 Ontario budget, the commission was given a mandate to review Ontario government spending. A key motivator for creating the commission is the province’s worsening fiscal position. With no change to current fiscal policies, the report projects that Ontario’s deficit could grow from an expected $16 billion in fiscal 2012 to more than $30 billion in fiscal 2018, and its accumulated debt from 35% to 50% of GDP in the same period.

In its 20 chapters and 562 pages, the report makes more than 360 recommendations intended to improve program delivery and reduce costs, with a view to balancing Ontario’s budget by 2018 and transforming Ontario into a province that “provides the best public services, delivered in the most efficient manner, in the world.” According to the report, balancing the budget by 2018 would require that total program spending grow by no more than 0.8% per year—an annual per-capita decline of 2.5% from current spending.

The report makes a number of recommendations on public sector pensions, as summarized below.

Containing pension costs
The report recommends that the Ontario government cap employer contributions at current rates and deal with future funding deficits by reducing benefit reductions “on a prospective basis,” particularly with respect to inflation indexing and early-retirement benefits. It also suggests that the government should “accelerate work” on pension plan design to contain benefits costs as part of “compensation negotiation.”

Administrative consolidation
Noting that there are currently 29 pension plans for Ontario’s 23 universities and colleges, the report recommends that the province establish a single administrator for post-secondary institutions and look for opportunities across the public sector—particularly in the energy sector—to consolidate “fragmented” pension administration and achieve economies of scale through asset pooling and consolidation of administrative functions.

Compensation benchmarking
The report recommends that a “comprehensive and transparent” compensation benchmarking system be implemented for the entire public service that reflects the full cost of compensation, including pension benefits.

Managing, funding and reporting pension liabilities
The report recommends that the Ontario government develop its own publicly accessible “liability management assessment report” for public sector pension liabilities, develop a plan to contain “fiscal risks” of pension plans and clarify who has financial responsibility for funding pension deficits. Noting that the Ontario government discounts pension liabilities at nominal rates of 6.25% to 6.75% under Public Sector Accounting Board rules, the report suggests that these rates may be too high and that more conservative assumptions regarding future rates of return “could reveal significant funding deficiencies.” To address this risk, the report recommends that the government’s assessment of the financial health of public sector plans should include a sensitivity analysis that considers the probability of discount rates being “higher or lower than assumed.”

Noting that current financial reporting practices make it difficult to determine the Ontario government’s total pension expense, the report recommends that the government disclose its pension expenses more clearly in the Public Accounts and other financial statements, to contribute to a better understanding of the total value of public sector compensation.

Pension Benefits Guarantee Fund (PBGF)
Noting that Ontario is the only “sub-national jurisdiction in the world” with a guarantee fund for private sector pensions, the report states that significantly higher assessments would be required to “insulate the PBGF from catastrophic claims” and to update coverage. Citing an independent study of the PBGF from 2010, the report states that PBGF premiums would have to increase 1,000% to provide the coverage levels recommended in the 2008 Report of the Expert Commission on Pensions, and that PBGF risks are not “spread according to insurance principles” because there are only 1,600 plans contributing to the PBGF and coverage is concentrated in specific industries.

The report concludes that the PBGF is not sustainable and exposes the province to a “large fiscal risk” in the event of an economic downturn. It recommends that the PBGF be wound up or transferred to a “private insurer.”

As noted in the report, pension assets and liabilities reflected in the province’s financial statements are about $180 billion and $200 billion, respectively. Given the relative importance of pension expenses to the Ontario budget, it is perhaps not surprising that more than 10 of the report’s recommendations relate to the administration, funding and reporting of public sector pension benefits.

The report is as notable for what it does not say about pensions as for what it does. For example, there is no suggestion that Ontario should abandon its current model for delivery of public sector pensions by converting to DC plans. Rather, the report’s focus seems to be to manage costs, improve reporting and make public sector DB plans sustainable over the longer term through greater leverage of the economies of scale now realized by Ontario’s largest public sector plans.