The Fraser Institute’s recommendation that the Province of Ontario adopt an Australian model of pension reform instead of expanding the Canada Pension Plan (CPP), as proposed in the Ontario Retirement Pension Plan, pits the collective approach to pension provision as now exists in the CPP with the Individual Accounts Social Security approach (very much like RRSPs) as defined in Australia.
The Fraser report noted several apparent advantages of the Australian system, but each of the advantages are fraught with difficulty and may, in fact, prove to be disadvantages.
The authors of the report correctly point out that the Australian system of mandatory employment-based RRSPs provides greater choice and flexibility in both the investment of funds and in their allocation for retirement expenditure. Individuals can choose an investment strategy based on their preferences and circumstances.
But substitute the word “responsibility” for “flexibility” and the argument takes on a new feel.
Yes, you are able to invest as you wish. In fact, you are responsible for investing your dollars to achieve the highest rate of return available. Is this something for which you feel capable?
Of course, you can buy investment advice. But this will cost you anywhere from 1.5 to 3 percent in management fees, killers in a low return economy such as we have today. Every additional 1 percent fee over a 40-year period reduces final assets by about 20 percent. Stated another way, a 3 percent fee per annum will cut in half your standard of living versus an account with no fees.
And Australia is no shining example when it comes to fees, which range from 1.5 percent to 1.75 percent. The CPP operates with an expense ratio of less than 1 percent.
Finally, there is no evidence that these active management fees reap the fund holder any higher returns. Passive accounts do just as well on average (and after the impact of the fees is taken into account, passive investing does much better on average).
And, in Canada, under the CPP you just let them know you are retiring and they start sending monthly benefit checks that will last your lifetime. And the benefits are inflation indexed.
But in the Individual Accounts world of Australia, you are responsible to draw down your funds on your own as your fund pays out a lump sum upon your exit from the labour force. How can you do this wisely when you have no idea how long you will live?
Two outcomes are likely.
You will draw down your funds too rapidly and run out of money and be dependent on GIS benefits for your retirement security. Or, you will draw down funds too slowly and live your life at a standard of living below what you could have provided. The CPP handles this by pooling all the funds of all participants and thus assumes the longevity risk (which is very small given the size of the CPP participant pool).
What evidence do we have on outcomes from the two systems?
The Melbourne Mercer Global Pension Index ranks Australia number two in the world with a rating of 79.9 in terms of the viability and sustainability of its pension system. Denmark is number one at 82.4. Canada slides in at number seven (with an Index of 69.1).
The index is based mostly on the fact that Australia has a mandatory pension system so that coverage rates are almost universal. In Canada, however, coverage rates outside of the Canada Pension Plan are less than universal. While 86 percent of workers in the public sector have a pension plan, only 25 percent of workers in the private sector have anything at all.
Finally, if the goal is not just coverage, but actual retirement income security, then Australia receives failing grades.
One in three Australian seniors live in poverty despite being among the most highly educated senior citizens in the world. This rate is comparable to Thailand, Ecuador and Bolivia. For Canada, the OECD reports that the poverty rate amongst the elderly is at 7.2 percent – third lowest in the OECD.
So before we blindly adopt the Australian pension system as our own, we need to take several long moments in deep thought and contemplation – and look at the evidence.
Robert Brown is a Retired Professor of Actuarial Science, University of Waterloo and Immediate Past President of the International Actuarial Association.