Worse Than It Looks: The True Burden and Risks of Federal Employee Pension Plans

Abstract

Federal government employees enjoy pure defined-benefit pensions that promise relatively generous benefits to a large current and former workforce. Being largely unfunded, these plans impose on taxpayers obligations running into the hundreds of billions of dollars. What is worse, misleading accounting understates the true burden and risks these plans create for Canadian taxpayers. This Commentary provides more economically meaningful estimates of the value of federal employee pensions to their participants, and the cost to taxpayers. Its goal is twofold: to alert Canadians to the fiscal burdens and risks created by these plans; and to prompt discussion of reforms that could produce more durable and affordable pensions for federal employees. Official figures on the current cost of these plans and their accumulated obligation use notional interest rates to calculate their value. Because their pension promises are guaranteed by taxpayers and indexed to inflation, the appropriate discount rate is the yield on federal-government real-return bonds (RRBs), which for years has been much lower than the assumed rate in official figures. Correcting this distortion produces a fair-value estimate for Ottawa’s unfunded pension liability of $269.3 billion at the end of 2014/15 – around $30,000 per family of four, and $117.9 billion higher than the reported number. Because the unfunded pension liability is part of Ottawa’s debt, the fair-value adjustment also raises the net public debt by $117.9 billion: from the $612.3 billion reported at the end 2014/15 to an adjusted $730.2 billion. The authors note that recent changes will raise the share of these plans’ costs that their participants must fund, but object that the reported current costs of these plans – and therefore the total contribution rates that determine employer and employee shares – are too low. With RRB yields at recent levels, even the higher employee contributions anticipated by the reforms would leave the taxpayers’ true share far above 50 percent. A fair-value approach to the current service cost can ensure that participants and taxpayers equally share the cost of accruing benefits. The authors further note, however, that even 50:50 sharing of the true current service cost of federal pensions would leave taxpayers exposed. This exposure would apply not only to fluctuations in the annual costs as interest rates, experience, and plan provisions changed but – far more important– to fluctuations in the value of previously earned benefits as well. Ottawa could protect taxpayers from this risk by capping employer contributions at a fixed share of pensionable pay. To relieve taxpayers of their current sole responsibility for risks in the federal plan, Ottawa would need to switch to a shared-risk, target-benefit model already common in much of the provincial public sector, which calculates benefits with reference not only to salary and years of service but also to the plans’ funded status.