In Canada, as in other countries around the world, the pension system must adapt to the realities of an ageing society. Until now, the Canadian system has been effective in fulfilling its two primary objectives: ensuring a minimum income for the elderly and assisting seniors to maintain pre-retirement living standards after retirement. Whether the Canadian pension system will be able to continue to meet these objectives in the coming decades will depend largely on how well it responds to the economic and social challenges of population ageing.
This paper starts by describing the Canadian pension system, which consists of a mix of public and private elements. It then focuses on the reforms made to the public parts of the system in recent years. In particular, the paper examines the ground-breaking changes to the financing of the Canada Pension Plan, a publicly administered, mandatory social insurance programme. The paper concludes with some of the lessons learned from Canada’s experience that are relevant for both developing and developed countries seeking to adapt their pension systems to the challenges posed by population ageing.
Canada has a “three-pillar” pension system. Using the terminology of the World Bank’s 2005 report, Old-Age Income Support in the Twenty-First Century: An International Perspective on Pension Systems and Reform
, these are: a “zero” pillar consisting of a non-contributory, residence-based scheme that ensures a minimum income for all of Canada’s elderly; a “first pillar” made up of the mandatory, contributory Canada Pension Plan and its sibling-scheme, the Quebec Pension Plan; and a “third pillar” composed of voluntary, tax-assisted mechanisms for retirement savings, including occupational (employer-sponsored) pension plans and individual retirement savings accounts. Unlike the World Bank model, Canada does not have a “second pillar” consisting of mandatory
individual retirement savings accounts.
In the mid-1990s, public policy attention in Canada turned to the financing of the Canada Pension Plan. This plan, which began in 1966, was originally designed as a pay-as-you-go, defined-benefit scheme with a small reserve fund equal to two-years’ costs (benefits and administrative charges). By 1995 it had become apparent that the plan, unless reformed, would become very costly for future cohorts of workers—more costly, in fact, than what the future workers would otherwise have to pay for comparable pensions. The reasons for the increase in the costs of the plan were complex and included economic, political, demographic and administrative factors.
After an extensive consultation process, a proposal emerged for the reform of the Canada Pension Plan. The proposal consisted of a package of measures centring on the financing of the plan, but also including some small reductions to benefits. The financing reforms were made up of four parts:
• rapidly increasing the plan’s contribution rate over a period of seven years, in order to achieve a “steady-state” rate (one that, according to actuarial evaluations, can be maintained without change for the indefinite future);
• as a result of increasing the contribution rate, building up a substantial fund (projected to equal more than five times annual costs) that can be invested and used to finance part of the pensions of the baby-boom generation;
• adopting a new investment policy that allows the plan’s fund to be invested in a wide range of asset classes, including equities, whose long-term real rates of return should exceed those of the bonds in which the plan’s fund was previously invested; and
• establishing an independent agency, the Canada Pension Plan Investment Board, charged with implementing the new investment policy.
The paper concludes that drastic changes to benefits—for example, severe reductions in retirement pensions or increases in the retirement age—or the wholesale replacement of public defined-benefit programmes by privately administered defined-contribution schemes are not necessarily the only alternatives for preparing pension systems for population ageing. Through reforms that are carefully thought out and planned, existing programmes can be made sustainable at a reasonable cost.
Ken Battle is president of the Caledon Institute of Social Policy, a think-tank based in Ottawa, Canada, and is one of Canada’s leading experts on social policy. In 2000 he was awarded the Order of Canada, social sciences category, for his work on the National Child Benefit and his contributions to the reform of Canadian social policy. Edward Tamagno is a policy associate with the Caledon Institute of Social Policy. Prior to this, he worked for the Canadian federal government administering Canada’s public pension programmes, and was responsible for the negotiation and administration of social security agreements that coordinate the Canadian public pension system with those of other countries around the world.