Low interest rates, market volatility and an aging population have created a dangerous environment for pension plans, and the system must become more flexible and agile to be sustainable in the long term, according to Malcolm Hamilton, partner at Mercer (Canada).
The actuary and pension expert spoke at an outlook event at the Toronto Board of Trade on Tuesday about the widespread challenges facing both pension sponsors and individuals saving for retirement in Canada and around the world.
“Plans, retirement systems, they’re always hostage to the economic environment in which they operate, and we are hostage to this high uncertainty, low interest rate environment in which we find ourselves,” Hamilton said. “There’s no escaping this – it’s a global economic challenge that creates a very difficult environment for retirement savings and a very difficult environment for sponsoring pension plans.”
Hamilton said he expects the uncertain global economic environment to persist for some time. The United States is dealing with a “barely contained depression”, he said, and interest rates are unlikely to increase anytime soon.
This creates major risks and rising costs for pension plans, according to Hamilton.
“Pension plans are promising lifetime secure adequate incomes, in an age where promising lifetime, secure, adequate incomes is a highly dangerous thing to do,” Hamilton said. “It’s a wonderful thing for plan members to have; it’s a terrible thing for plan sponsors to have to deliver.”
In order to adapt to this environment, and to prepare for similar challenges that are certain to arise in the future, Hamilton said pension systems around the world must become more resilient.
It’s impossible to design a system that will perform perfectly in all kinds of economic environments, market cycles and demographic trends, Hamilton said. But he said systems must be flexible enough to at least survive these ebbs and flows.
“A sustainable pension plan is one that can struggle through the rough patches – and there are going to be rough patches,” he said. “In this environment – in tough environments – you want pension plans that can adapt, you want pension plans that can bend.”
To ensure they’re resilient, Hamilton said pension plans should face more frequent stress tests. “We don’t do enough of that.”
Hamilton said it won’t be possible to find a single solution to the problems plaguing the pension system. The federal government’s proposal to establish Pooled Registered Pension Plans could help some Canadians better prepare for retirement – particularly those with above average income – but not all Canadians, he said.
He pointed out that Canadians earning minimum wage throughout the course of their working years actually tend to be better off in retirement if they don’t save with a registered savings vehicle. Those who haven’t saved will end up having annual income in retirement – through the Canada Pension Plan, Old Age Security, the Guaranteed Income Supplement and tax credits – that’s higher than their annual income during their working years. In contrast, those who contribute to an RRSP during their working years will end up facing hefty clawbacks in retirement.
Hamilton said an expanded CPP and/or the creation of PRPPs would be worthwhile initiatives for Canadians with above-average incomes, but he warned that these aren’t one-size-fits-all solutions.
“This is a problem for politicians. They want a simple solution, they think it’s a simple problem, but it isn’t,” he said. “We’ve made the system so complicated that simple strategies don’t really work for a broad spectrum of Canadians.”