The Future Sustainability of the Canada Pension Plan and Old Age Security Program

The Future Sustainability of the Canada Pension Plan and Old Age Security Program Private Pensions and Income Security in Old Age: An Uncertain Future Where are we now? How secure is the future? Presentation to the SEDAP Conference (Social and Economic Dimensions of an Aging Population) at McMaster University, Hamilton 16 November 2006 1

Presentation 1. Canadian Income Retirement System 2. Canadian and Global Aging 3. CPP Steady-state Funding and OAS Funding 4. Peer Review Process 5. Stochastic Analysis: a tool to measure the volatility and the uncertainty 2

Canadian Retirement Security Canadian retirement system with mixed funding approaches is well recognized in the world for its capacity to adapt rapidly to changing conditions. - Full funding (RPP/RRSP) - Partial funding (CPP/QPP) - Pay-as-you-go funding (OAS/GIS) 123 The Canadian retirement system could be viewed as about 40% to 45% funded. 3

Income Replacement Rate of Public Pension Plans (Canada and United States, 2002) 100.0% 100.0% 90.0% 90.0% 80.0% 80.0% Replacement Rate 70.0% 60.0% 50.0% 40.0% 30.0% GIS OAS US Social Security: OASDI 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 20.0% 10.0% CPP 10.0% 0.0% 0.0% 0.5 1 1.5 2 2.5 Salary as Multiple of Average Wage 4

Presentation 1. Canadian Income Retirement System 2. Canadian and Global Aging 3. CPP Steady-state Funding and OAS Funding 4. Peer Review Process 5. Stochastic Analysis: a tool to measure the volatility and the uncertainty 5

Purpose of the CPP Triennial Actuarial Report 21 st Actuarial Report Tabled by the Minister of Finance on 8 December 2004 Inform on the current and projected future financial status of the Canada Pension Plan Calculate the steady-state contribution rate 6

(in millions) 12 10 8 6 4 2 Canadian Aging Population 65 and over Increase of of 150% From 2005 2005 to to 2050 2050 (% of population) 25% 20% 15% 10% 5% 0 1966 1976 1986 1996 2000 2010 2020 2030 2040 2050 Number % of population 0% Increase of 250% for 80+ Increase of 250% for 80+ 7

Global Aging Projected number of years needed to go from 12% to 24% of 65 and over as a % the total population QPP 25 years 30 years 40 years 60 years 65 years 65 years 1960 1970 1980 1990 2000 2010 2020 2030 2040 8

Working Age Population (ages 20-60) (indexed 2000=100) 130 120 110 100 90 80 70 60 50 40 US Canada France UK Japan Spain Italy 100 Germany 2000 2005E 2010E 2015E 2020E 2025E 2030E 2035E 2040E 2045E 2050E Source: UN World Population Prospects 9

Presentation 1. Canadian Income Retirement System 2. Canadian and Global Aging 3. CPP Steady-state Funding and OAS Funding 4. Peer Review Process 5. Stochastic Analysis: a tool to measure the volatility and the uncertainty 10

How do we position for the aging of the Canadian population? : CPP Steady-state Funding Effect of the 1998 Amendments Increase the contribution rate by 65% over 6 years (1997-2003) and keep the same rate thereafter Moderate the future growth of benefits by 10% on a long-term basis (in 2050). Creation of the CPP Investment Board to diversify the CPP reserve fund and increase investment returns (www.cppib.ca) 11

CPP Steady-State Funding (Ratio) 8.0 7.0 6.0 5.0 4.0 3.0 2.0 Asset/Expenditure Ratio 9.9% Legislated contribution rate 9.8% Steady-state rate In 2020, CPP/QPP assets are projected to be equal to 17% of the GDP. 1.0 0.0 2005 2015 2025 2035 2045 2055 2065 2075 12

CPP Steady-State Funding If the steady-state rate is higher than the legislated contribution rate AND if finance ministers cannot reach agreement on a solution, then: Contribution rate increased by ½ of excess over three years, subject to maximum increase of 0.2% per year Benefits frozen At end of three years, next review performed to determine financial status of Plan. 13

3.5% 3.0% How do we position for the aging of the Canadian population? Evolution of Old Age Security Expenditures in % of GDP 2004 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Between 2010 and 2030, the ratio of expenditures to GDP increases from 2.4% to 3.2%, driven largely by the retirement of the babyboomers. 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 1990 2000 2010 2020 2030 2040 2050 2060 2070 0.0% $28 billion in 2004; $37 billion in 2010; $110 billion in 2030 14

Presentation 1. Canadian Income Retirement System 2. Canadian and Global Aging 3. CPP Steady-state Funding and OAS Funding 4. Peer Review Process 5. Stochastic Analysis: a tool to measure the volatility and the uncertainty 15

Independent Peer Review Process Auditor General and Selection Process Overseeing of the Peer Review by the UK Government Actuary s Department The Independent Review Panel confirmed: That actuarial standards of practice were met; That assumptions were reasonable; That the report fairly communicates the results; The actuarial conclusions reached by the Chief Actuary about the soundness of the CPP. and made a series of recommendations. March 2005 16

Presentation 1. Canadian Income Retirement System 2. Canadian and Global Aging 3. CPP Steady-state Funding and OAS Funding 4. Peer Review Process 5. Stochastic Analysis: a tool to measure the volatility and the uncertainty 17

CPP Actuarial Report as at 31 December 2003 Sensitivity Analysis Vary values of 9 key assumptions individually Two tests performed with respect to each assumption High cost: alternative assumption increases steady-state contribution rate Low cost: alternative assumption decreases steady-state contribution rate Stochastic Analysis Using historical data, stochastically determine the probability that the actual value for selected assumptions will fall outside the range of potential outcomes determined by the high- and low-cost scenarios 18

Historical Fertility Rate (Children per woman) 4.5 4.0 Geometric Mean (1941-2002) = 2.5 σ = 0.9 3.5 3.0 2.5 2.0 Geometric Mean (1977-2002) = 1.6 σ = 0.07 1.5 1.0 0.5 0.0 1941 1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 19

Fertility Rates Historical period used: 1977-2002 Stochastic Analysis 20-year periods µ = 1.62 σ = 0.02 100% High-Cost Scenario High-Cost 1.3 at 1.3 10.1% Low-Cost Scenario High-Cost 1.3 at 1.9 9.5% 1.58 1.59 1.60 1.61 1.62 1.64 1.65 1.67 20

Historical Real Wages Differential 10.0% 8.0% Geometric Mean (1924-2003) = 1.4% σ = 2.3% 6.0% 4.0% 2.0% 0.0% 1924 1930 1936 1942 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002-2.0% -4.0% 21

Real Wage Differential Stochastic Analysis 20-year periods Historical period used: 1924-2003 4% 84% 12% µ = 1.4% σ = 0.5% High-Cost Scenario : 10.3% Low-Cost Scenario : 9.2% 22

Historical Canadian Equity Return (1938-2005) 50% 40% 30% Geometric Mean (1938-2005) = 6.4% σ = 16.1% 20% 10% 0% -10% 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003-20% -30% -40% 23

Real Rates of Return Historical period used: 1938-2005 Stochastic Analysis 20-year periods CPP Reference Portfolio (40% Foreign Equities, 25% Canadian Equities, 25% Nominal Bonds, 10% Real Return Bonds) 16% 23% 61% µ = 5.8% σ = 2.7% High-Cost Scenario : 10.3% Low-Cost Scenario : 9.3% 24

CPP Actuarial Report as at 31 December 2006 How uncertain is the certainty? How certain is the uncertainty? Stochastic analysis Determine confidence intervals for assumptions such as fertility, migration, mortality, inflation, wages increases, investment returns Uncertainty of results a new section will be added explaining the uncertainty involved in estimating future contribution rates as per the peer reviewers recommendation. 25

Private Pensions and Income Security in Old Age: An Uncertain Future Presentation to the SEDAP Conference (Social and Economic Dimensions of an Aging Population) at McMaster University, Hamilton Thank you 16 November 2006 26