Crunch Time Looms For Public-Sector Pensions?

The speedy passage of the bill to end the Canada Post lockout marked the beginning of a much larger battle to bring burgeoning public-sector compensation costs under control.

The key issue in the postal dispute was reform of Canada Post's inflation-indexed, defined-benefit (DB) pension plan that guarantees up to 70 per cent of earnings, starting as early as age 55. The C.D. Howe Institute warns that the unfunded pension liability for federal workers is some $65-billion higher than noted in the public accounts. Across the country, financially strapped provincial and municipal governments face huge and growing pension liabilities as a wave of baby boomer workers retires.

There's also a strong and growing sense of unfairness among workers who don't work in the public sector, two-thirds of whom don't have any kind of company pension plan. Many of those who do have company plans have seen them converted to defined-contribution (DC) plans, wherein the size of their pension depends on what the invested funds provide at retirement. Implementation of this pay-as-you-go type of plan is the only way to get government pension costs under control.

Air Canada's costly DB pension plan, a legacy of its former Crown corporation status, was also the main issue in its recent strike. Chief executive officer Calvin Rovinescu made it starkly clear why the airline has no choice but to move away from DB pensions: “We are an airline of 26,000 employees supporting 29,000 retirees.” Air Canada's pension deficit is already $2.1-billion, and it will have to finance another $1.5-billion over the next four years.

The main issue in both labour disputes may have been the same, but the reality facing Air Canada and its unions is drastically different than for postal workers. WestJet Airlines Ltd., Air Canada's main domestic competitor, has a highly motivated non-unionized work force, all of whom are shareholders in the carrier. Rather than a pension, WestJet employees earn a share of profits. Air Canada must compete, and that's simply not possible unless it is able to change to its pension plan.

Failure to achieve competitive compensation has forced many unionized businesses into bankruptcy. The result is a precipitous drop in Canadian private-sector unionization rates, down to 16 per cent. In contrast, public-sector unionization rates have grown steadily to 71 per cent. Taxpayer-financed monopoly status has empowered government unions to extract ever more extravagant wages, benefits and even “no contracting out” clauses that block competition. Strike-fearing governments have repeatedly capitulated to these demands. A recent study by the Frontier Centre for Public Policy found that the wages of federal public administration workers grew by 59 per cent between 1998 and 2009, twice as much as across the entire economy.

Public-service wages and benefits have mushroomed at all levels of government, and not only in Canada. A report earlier this year in The Economist stated that dangerous levels of debt and deficits throughout the Organization for Economic Co-operation and Development are leaving governments with no choice but “to stand and fight.” Here again, the most urgent battles will be about pensions. American states have a combined unfunded pension deficit of some $5-trillion (U.S.) and many European Union countries also face debilitating pension liabilities.

In Britain, Prime Minister David Cameron has vowed to reduce the power of public-sector unions by creating “a new presumption … that public services should be open to a range of providers competing to offer a better service. … The state will have to justify why it should ever operate a monopoly.”

Introducing private-sector competition for government-financed services should also be a fundamental objective in Canada. But even if that were done with vigour and determination, there are parts of government where contracting out is impractical. So what should the Conservative government do to rebalance the unsustainable and unfair imbalance between public and private sector compensation? Here are two simple but powerful rebalancing measures that should be legislated by Parliament:

Classify public services that do not face significant private-sector competition to be essential service monopolies, where strikes are forbidden and union/government disputes are settled by arbitration.

Mandate that arbitrators must consider private-sector wages and benefits, including pensions, as fundamental factors in their settlement rulings.

These are fair measures, but they would be fiercely opposed by union leaders who never should have been allowed to extract such excessive compensation in the first place. The legacy of these excesses is that taxpayers are no longer willing, and governments are no longer able, to pay for them.

My trainer showed me no mercy early this morning at the gym so let me be blunt and to the point. First, take anything that the C.D. Howe Institute publishes with a shaker of salt. They are a conservative think tank financed by banks and insurance companies. Even the right-wing Economist is jumping on the bandwagon warning of the "debilitating pension liabilities" of public-sector pensions and how they will crush debt-ridden countries.

There is no question that we need pension reform to bolster our retirement systems. And concessions have to come from all stakeholders. Public sector unions have to understand that people are living longer and they can't demand gold plated pensions when private sector pensions have been decimated. They must accept increases in premiums and the retirement age, cuts in benefits, and cost-of-living adjustments. If they don't, there will be no public sympathy for them.

Having said this, governments need to adopt meaningful pension reform building on what already works. We know public defined-benefit plans are better than private defined-contribution plans but politicians and policymakers are dragging their feet, tinkering at the edges, instead of adopting a radical, wholesale approach which will bolster retirement plans for everyone for the future, not just for the public sector. Read my comment on why the fuss over pensions to gain a better perspective on what's really at stake.

Companies like Air Canada now have competent pension fund managers but I believe that companies shouldn't be in the defined-benefit pension business at all. They should worry about business and the government should worry about bolstering our retirement systems by building on what works and by introducing meaningful reforms to our pension system. Everything else you read in mainstream media or from "reputable think tanks" is just a smokescreen. Keep this in mind the next time you read anything claiming "crunch time for public-sector pensions."

***Feedback***

Bernard Dussault, the former Chief Actuary of Canada, shared his thoughts on this article:

For your information, DC plans are not pay-as-you-go plans (re: “Many of those who do have company plans have seen them converted to defined-contribution (DC) plans, wherein the size of their pension depends on what the invested funds provide at retirement. Implementation of this pay-as-you-go type of plan is the only way to get government pension costs under control.”) .

In fact, by virtue of pension legislation, any registered plan (RPP, PRPP, RRSP etc.) must be fully funded. By definition, a DC plan is always fully funded (... what you see is what you get).

Only social insurance programs such as OAS and GIS may normally (and actually are) financed on a pay-as-you-go basis, The CPP is not fully funded but it is not either in a pay-as-you go (i.e. no funding at all). In such case, we have to say the plan is partially funded (only about 15% in the case of the CPP).