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FMI
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IGF JOURNAL
VOLUME 25, NO. 2
There has been an increasing level
of angst about public sector defined
benefit pensions in the public domain.
Whereas there is some truth to some
of the concerns raised, claims are
made that do not necessarily apply to
pension plans in the Ontario Public
Service (OPS) and more broadly to
the public sector. Further some of the
suggested solutions to the problem will
be at best a zero sum game and will
more likely lead to a less favourable
outcome. Below, I have attempted to
synthesize the more common claims in
the press and have provided a response
that includes contextual information
that impact the discussion and may lead
to unexpected outcomes. This is not
meant to be an exhaustive study but
rather an examination of some of the
more common claims made in the press.
Claim: Pension payouts to retirees
are paid for by current workers
(retiring baby boomers will crash
the Ponzi scheme)
There are two basic methods of funding
the benefits of Pension Plans. Pay as
You Go
1
and Funded Pension Plans.
In Pay as You Go Plans, new entrants
in the plan pay the obligations of pension
recipients who are currently reaping the
payoff from the plan. This becomes
dangerous when the number of retirees
(recipients) exceed the number of new
entrants (contributors) as is the case
demographically with the baby boom
generation retiring.
In the Funded Pension Plan current
pension contributions are set such that
future payouts will have been funded
by annual contributions by the pension
recipient over his or her working life
2
.
Ontario Public Service (OPS) pension
plans, and public sector pension plans
more broadly, are funded pension
plans
3
. There is no ‘ponzi’ scheme.
Claim: Defined Benefit Plans will
lead to a deficit
To properly discuss this claim we first
have to define a few terms. Within the
subset of funded pension plans - where
plan beneficiaries are intended to fund
their own retirement - there are two
major types of pension plans.
o
Defined Benefit
plans guarantee a
benefit to the recipient at retirement
based on an agreed formula. OPS
Pension Plans and Public Sector
Pension Plans more broadly, are
defined benefit plans.
o
Defined contribution
plans specify
the amount to be contributed (saved)
but make no guarantees as to payout
on retirement. Payout in these plans
is based on the performance of the
invested contributions. Many private
sector plans are defined contribution
plans.
The argument regarding deficits
made in the press (stated above) is based
on the fact that funding shortfalls in
defined benefit pension plans are the
responsibility of the plan sponsor. If
that plan sponsor is the government
(employer,) then the argument is pension
plans will lead to government to pay
into the plan thus adding expenditure
pressures to a limited tax base resulting
in a (worsening) deficit.
This assumes public sector defined
benefit pension plans will always be in
an unfunded position. This is by no
means necessarily the case. A pension
shortfall today can become a pension
surplus tomorrow. A cost to the public
purse today can become a boon to the
public purse tomorrow. Plan sponsors
are responsible for funding shortfalls
and are entitled to plan surpluses
(which could potentially be used to
reduce
any existing deficit). During the
1990s, some plans ran surpluses when
investment returns were significantly
above forecasted returns on pension
plan investments. One cannot have it
both ways; if the surplus is to accrue to
Popular (Mis)perceptions Regarding Pension Plans:
Relationship to Public Sector Pension Plans
Richard Wright, MA (Econ), MBA
1
In Pay as You Go Plans, new entrants in the
plan pay the obligations of pension recipients
who are currently reaping the payoff from the
plan. This becomes dangerous when the number
of retirees (recipients) exceed the number
of new entrants (contributors) as is the case
demographically with the baby boom generation
retiring. Old Age Security is an example of a
pay as you go plan. The Canada Pension Plan
(CPP) was formerly pay as you go plan but was
gradually moved to a funded model.
2
Of course, actual plan performance will likely
differ from projections resulting in a surplus or
shortfall of assets relative to contributions. Any
surpluses or shortfalls relative to planned levels
accrue to the plan sponsor.
3
The percentage contributed by the employee
and the employer vary among the plans.
