Thank you for the invitation to appear in front of the committee today. I don't know whether I'll succeed at entertaining the group, but I hope this will be informative. I'll also be glad to answer your questions.
You will know, I think, but I'll underline, that the federal government's pensions are a major component of the compensation of its employees, including members of Parliament. Ensuring that we have meaningful measures of the value of that compensation matters. It matters for getting the compensation right, paying federal employees properly for the work they do, and giving taxpayers value for their money. Meaningful measurement of those promises also matters when it comes to ensuring that we're funding them properly and allocating their costs fairly over time.
We don't have to look very far away or very far back in time to see how important it can be to get these things right, or conversely, to see the problems if you don't. In the United States in the last few years, we've heard a number of cautionary stories. Members of the committee will know of municipalities in California that have gone bankrupt. Closer to the Canadian border, we had Detroit. Puerto Rico made the headlines recently for similar reasons. All of these jurisdictions had great trouble actually coming up with the cash to pay their employee pensions, then discovering that the cost of these promises was much higher than they expected.
The common element in all those episodes was that the pension plans were underfunded. The main reason they were underfunded was that they discounted the payments that they had to make in the future, using discount rates that were much too high. They did that because it shrinks the liabilities on their balance sheet and it justifies charging contribution rates that are too low.
The managers liked it because it made everything look good. The elected representatives liked it because it helped keep taxes and market borrowing down. And the workers, or at least their representatives, liked it because it made their pensions look secure and left more money for current compensation.
Everybody likes it, until the Ponzi game of making payments not from returns on the investment but from incoming cash gets exposed. When that day comes and cash payments must be made but there isn't enough cash there to make them, nobody likes it.
The obvious question is this: Could that happen here in Canada? Happily, many pension plans in Canada's public sector are not like those that have caused trouble in the United States. They're not all equally healthy, but the shared risk plans in the broader public sector, in most provinces, have two key features. They use economically realistic, meaningful discount rates when they look at the future payments they have to make. They also have the flexibility for contributions and benefits to respond if the financial reports indicate that they should.
Unhappily, however, the federal government's pensions are not like that. They are pure defined benefit plans. They're relatively generous by the standards of other public sector plans in Canada, and private sector plans certainly. The financial reports we get on them use discount rates that are too high. Their liabilities on the balance sheet are too small. Their ongoing costs that we see in the federal government's statement of operations in the federal budget are too low. Those pensions are, in short, more valuable to their recipients than what the federal financial statements indicate, and they are correspondingly more costly to taxpayers.
I will mention, because you're members of Parliament, that the pension plans for federal members of Parliament are a particular problem. They are completely unfunded. You could be forgiven for not knowing that. You'd need to read the chief actuary's reports on them very carefully to discover that. The assets in these plans are simply bookkeeping items. The contributions that go into the plan actually buy no assets. The benefits that go out of them are funded by current revenue and market borrowing. The cost of the payments in the future will be higher than what you see in the financial statements.
That is not true of the big federal employee plans for the public service, the Canadian Forces and the RCMP. Those plans are partly funded. Contributions since 2000 have bought assets, but the pre-2000 obligations in those plans are completely unfunded. The value of all of the obligations, pre- and post-2000, are understated because of these excessive discount rates.
Why do I say the discount rates are excessive? The promises to pay these pensions are unconditional. They are like any other federal government debt that is an unconditional promise to pay. They are indexed to inflation, and that means there is a ready comparator for that kind of an obligation. They are like the federal government's real return bond.
If I were a federal public servant and someone offered to buy my pension from me, I would use the discount rate they yield on the federal government's real return bond in thinking about how much it's worth. If I were a taxpayer thinking about how much money I need to set aside, because one day I'm going to have to pay taxes to pay these pensions, I would look at the same thing. I'd look at the asset that matches the liability, and that 0.7% real return is the return that is applicable. That's the accumulation rate I could expect.
The problem is that the federal government's pension liabilities are discounted at much higher discount rates. I can go into that in response to questions. That used to be a common practice in many pension plans, but it's becoming less prevalent over time because of some of the problems that have emerged with pension plans.
If we use an economically meaningful discount rate, and if we think about the real return bond as the right benchmark to use in valuing the federal government's pensions, the federal government's pension obligation and its net debt are understated at the end of the last fiscal year by about $100 billion—$96 billion.
To put this in perspective on the way forward, recent reforms raised the share of participants in funding these plans—that applies to the MP plans too, thinking about the contribution rate—and it aims at a fifty-fifty split, more or less. But there's a problem with that formula because it's based on an ongoing cost that is held artificially low because of these high discount rates used to estimate the value of these plans.
Even as we get to 50% contributions by the employees, the true economically meaningful split of the cost will not be fifty-fifty. The taxpayer will still be left with the bulk of it, and when I say “the taxpayer” I mean much more the future taxpayer than the current taxpayer. We're storing up trouble for the future.
More economically meaningful reporting of these plans, benefit values and their cost to taxpayers, I think, would be a valuable step forward in helping the federal government think about its ongoing obligations and how to fund them.
I will add as a footnote, and then I'll close, that the Public Sector Accounting Board is currently consulting over key questions that relate to this, both the timing of recognition of changes in the value of a pension plan's assets and liabilities, and also the discount rates used. There may be changes in public sector accounting standards coming down the road that would encourage or mandate the federal government to move in this direction. Whether they do or not, I think it would make sense for the federal government to look at these things on an economically meaningful basis. I think if it did, there would be better funded pensions for federal employees, including members of Parliament, and it would also provide protection for taxpayers against risks that few of them know that they run, and against costs that they don't currently know they're shouldering.
Thank you for the opportunity to testify. I'd be glad to take your questions.