Pre-Funded Pensions and Social Solidarity

When finance ministers agreed to expand the Canada Pension Plan in June 2016, they didn’t give Canadians a simple expansion of the Canada Pension Plan. In important respects, they created a new and different social security benefit. And that’s the way governments view it.

As a social insurance scheme, the Canada Pension Plan reapportions and moderates the impact of misfortune.

In contrast with the principles of self-reliance, which benefits those already favoured by the distribution of market income, and commercial insurance, wherein the cost of protecting against financial losses is influenced by the individual’s risk profile, a social insurance scheme pools and distributes risk so that, in Peter Baldwin‘s words, “the stricken bear no more than an average burden and those spared assume responsibility for events not directly affecting them.”

To be sure, by linking benefits to contributions, social insurance schemes are intended to be conservative, rooting entitlement in desert and contract, rather than providing it simply by virtue of citizenship or need. But by bringing “the magic of averages to the aid of the millions,” CPP’s social insurance principles provide equal protection for plan participants against income losses brought on by living too long, having to retire early, or the death of a contributing spouse, partner, or parent.

The original CPP embodied social solidarity in ways beyond pooling risk. The original CPP, essentially a pay-as-you-go arrangement with a small reserve fund, included an accelerated phase-in of benefits in order to pay retirement benefits for Canada’s Depression-era and wartime generation. Old age poverty rates were relatively high, and average longevity at age 65 relatively low, so a societal decision was made to use PAYGO principles to provide benefits sooner than full funding could accommodate. Initial contribution rates were set high enough that contributors could fund both the benefits of the generation reaching retirement and their own future benefits, but not so high as to be onerous.

In addition to this expression of intergenerational solidarity, the CPP also provided young mothers with insurance against retirement income loss due to interruptions in earnings, and typically older workers with retirement income protections against severe and prolonged disability.

The 1997 agreement to reform the CPP was the first step in changing the way the plan redistributes cost and risk. The intergenerational transfer contained in the original design was now viewed as unfair and unsustainable, requiring that future “changes to the Act that increase benefits or add new benefits must be accompanied by a permanent increase in the contribution rates to cover the extra costs of the increased or new benefits.” The Year’s Basic Exemption on pensionable earnings, which partially subsidized the CPP benefits of very low earners, was reduced in real terms in order to reduce the overall contribution rate increase necessary to stabilize the plan – an instance of upward redistribution.

Twenty years later, the enhanced CPP benefit legislated in 2016 carried over the social insurance principles of pooling risk and protecting against bad luck. However, the requirement that new and additional CPP benefits be strictly pre-funded has consequences for the social solidarity manifested in the plan.

On the one hand, transfers between cohorts are forbidden, prohibiting a more rapid phase-in of the 2016 enhancement to assist that significant minority of boomers facing a sizeable drop in living standards in retirement.

On the other hand, the enhancement provided no drop-out protections against retirement income loss from disability and child-rearing.

In fact, in the strict pre-funded world-view, these subsidies (provided in the existing CPP) conflict with the principles of fully-funding. Rather than recognizing that (primarily women’s) child-rearing absences from the labour force benefit society, while concentrating the cost in the hands of the individual contributor, valuing this socially-necessary work within the CPP is today viewed skeptically as an unfair subsidy that erodes the tight link between contributions and benefits.

This weekend, finance ministers will again take up the CPP as part of its triennial review. It’s worth thinking about the distributional consequences of the decisions they make. Rather than simply expanding the CPP, the 2016 enhancement created a “Base Canada Pension Plan” and an “Additional Canada Pension Plan,” and in important respects, they should be thought of as different plans rather than a part of a continuum.

It’s apparent that government officials think along these lines. As ESDC’s director of CPP policy and legislation told parliamentarians in November 2016,

The social insurance portion of the CPP remains in the base. The enhancement is linked to people’s contributions. It’s like a top-up to your retirement or other survivors’ pension or disability pension, so you get your base CPP, which will cover your flat rates for your disability, your flat rates for your survivors, which are paid by contributions from all. Your top-up is linked to your own contributions.

While the witness wasn’t trying to imply that the enhanced CPP benefit doesn’t also increase ancillary benefits (it does), what’s interesting is the suggestion that the social insurance aspect of the CPP no longer characterizes the enhancement, but instead remains confined to the base benefit. Perhaps as much as anything, this change in world-view encapsulates the sea-change in CPP policy-makers’ thinking over the course of 50 years.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s

%d bloggers like this: