Wednesday, January 20, 2010

The Assault on Public Service Pensions Begins

The inevitable assault on public service pensions appears to be underway. Many have assumed that the problems of private pension plans would not carry over to public pensions, but this is just wishful thinking. Just because governments can borrow hundreds of billions of dollars to cover promised pension payments doesn’t mean that they are willing to do so.

Superficially, the problems of both public and private sector pensions are similar. Too little money has been saved to cover future promises. If that money isn’t made up, then something has to give. If a plate has ten cookies, and ten people have been promised three cookies each, we may not know who will get their cookies, but we can be sure that not everyone will get all three.

An important difference between public and private sector pension plans is that the government has greater scope to lie to themselves about the real costs of future pension obligations. As explained in the C.D. Howe Institute’s backgrounder The Startling Fair-Value Cost of Federal Government Pensions, government plan valuations “often use aggressive assumptions about future returns on investments in their discount rates for liabilities.” This makes future costs look smaller than they really are.

I have no idea whether the current government is serious about dealing with this problem now. It’s always easier to leave huge problems like this to future governments. But we will have to face this issue at some point.

There are a number of ways of dealing with this issue:

1. Run huge deficits for many years to pay pensions with borrowed money.

2. Reduce benefits somehow, such as tinkering with the inflation indexing, or something more drastic like switching to a defined contribution plan.

3. Make plan participants pay a larger share of their salaries to save in the pension plan.

In the fullness of time, the government may do all three to some degree.


  1. Thanks for the reference to the C.D. Howe paper. Quite interesting. Yes there is currently a big shortfall in the funding of the public service pension plan that tax payers are currently on the hook for.

    One way of dealing with future public service pension plan deficits is to shift some of the responsibility for addressing possible future deficits onto the employees. This is happening under a new scheme which started in 1999 with the Public Sector Pension Investment Board
    Act (PSPIBA). Under this scheme, employer and employee contributions are actually invested in a pension fund managed by the Public Sector Pension Investment Board. As the decades roll on, any shortfalls in this pension fund will have to be dealt with by some negotiation between the employees (public servants) and employer (federal gov't) whereby the employee will have an obligation to make up a portion of the shortfall. This could be dealt with through lowered benefits or higher future contributions.

    Yes the federal gov't and thus taxpayers would still be on the hook, but I think it is a fairer arrangement than the scheme before 1999 where the employee didn't seem to have any obligation to make up any shortfall (as I understand it).

  2. Blitzer68: The C.D. Howe paper discussed this 1999 change, but it seems that while it may have helped, the problem is still large. It will be interesting to see what happens.

  3. So does this make me Typhoid Mary because I leave Nortel which had pension issues and join the public service and now they are having Pension Issues.


  4. Someone refresh my memory. Didn't the federal pension plan have a big multi-billion dollar surplus in it just a few years ago?

    Didn't the gov't take that surplus? Or rather, they were "forced" to because pensions cannot carry more than a certain level of surplus.

    Would this supposed shortfall in funding even exist if the pension had been allowed to keep the surplus it had?

    I don't recall CD Howe objecting when this surplus was used to pay debt. In fact I think they supported it. So CD Howe supports taking the surplus out of the pension plan and then whines that it is underfunded. A little self-serving isn't it?

  5. Ghostryder: I think you're talking about the 1999 grab of the pension "surplus". I doubt that there ever was a surplus in any real sense. But the money is long gone now.

    I should emphasize that I'm not taking sides on this issue. Whether government employees are due their full promised pensions or not, the costs of providing these pensions is not properly accounted for now and will cause major stress to government finances for many years. In my opinion, this has made it inevitable that the government will try to water down pension benefits at some point whether it is the right thing to do or not.