Episode 318 - Assia Billig: Is Canada Pension Plan (CPP) Sustainable?

0:03This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making from three Canadians. We are hosted by me, Benjamin Felix, and Cameron Passmore, Portfolio Managers at PWL Capital, and Mark McGrath, Associate Portfolio Manager at PWL Capital. Welcome to episode 318. And guys, after 318 episodes, I would suggest this one should be heard, listened to by 20 million or more Canadians. All those people in the Canada pension plan should listen to this. This was simply an incredible conversation. Ben, kudos to you for tracking down Canada's chief actuary, Asya Billig to join us and answer questions that come up all the time.

0:50As you said, Mark, between the segment here, if this does not instill confidence in you and give you pride in the assets that this country is building for our collective retirement, I don't know what does. I say this when I asked the second to last question in the episode, but this came about because we did some episodes earlier in the year on Canada Pension Plan and why it's actually a really great thing for Canadians and how it's a really valuable retirement asset. While that content was generally fairly well received, there were a vocal minority of podcast listeners, but also people on Twitter saying that what you guys are saying is fine, except that Canada Pension Plan is not going to be there.

1:30It's not going to be sustainable. It's not going to be around when I retire. How do you address that? But then of course, it is addressed every three years by Canada's chief actuary in an actuarial report on the sustainability of the CPP. But you can't send a 200-page actuarial report to someone and say, no, look, it's fine. You can't. You can't, but they're not going to read it. What's on them? I read it. It's great. Of course you can. I'll read the next one too. too. It's interesting, though, because I think a lot of people come at that question from a financial standpoint, like is financially CPP going to be here, but also from a governance standpoint, there's conspiracy theory type comments out there that the government's going to pilfer CPP to cover deficits and that type of thing.

2:12So hearing the chief actuary discuss a little bit about the quality of governance, and that was super fascinating as well. Super fascinating. So this was literally, who is the best person in the world to talk to about the sustainability of CBP. And then she is it. She's the person. And she loves it. She loves it. That was also further reassuring just to see how excited she is about the work she's doing for CBP and for Canadians. And some of it is world leading. The discussion around modeling climate change and the uncertainty around that and the impact of the pandemic and migration and things that you wouldn't normally think about would be part of her role.

2:50The intellectual horsepower that goes into the analysis and the modeling that they do is just incredible. And we only scratched the surface on it. Wow. And the independence, that's something that stood out to me as well, is that her office, the office of the chief actuary has a ton of independence to do the work that has to be done without government interference, but they also get external peer review from other actuaries. And other countries. She mentioned they have conversations with other countries or other continents even on to just collaborate in some scenarios, which is really fascinating.

3:24We'll talk about Asia a little bit. So Asia Billig is Canada's chief actuary. She was appointed chief actuary, which is within the office of the superintendent of financial institutions in April, 2019. Asia talks about her role and her office's role, but the chief actuary prepares actuarial reports on the Canada pension plan, the old age security program, Canada student loans program and pension benefits and plans for federal public servants. A few other things, she joined the office of the chief actuary in 2008. She's also the vice chair of the International Actuarial Association, social security committee, and the chair of the technical commission on statistical actuarial and financial studies of the International Social Security Association.

4:09She's also a fellow of the Society of Actuaries and the the Canadian Institute of Actuaries. She got her undergraduate studies at Moscow State University and has a PhD in mathematics from the University of Alberta. And she talked about her Alberta connection given the recent fires in Jasper, which is so incredibly tragic. She's the best person in the world to talk to, not just by the nature of the role that she has, but also her academic pedigree and background. I thought this was a fascinating conversation. And like you said at the beginning, Cameron, this is something that every Canadian should hear.

4:43You guys ready to go to the episode? Let's go. Let's go to the episode. All right. Here it is. Episode 318 with Asya Bilig.

4:53Asya Bilig, Canada's Chief Actuary. Welcome to the Rational Reminder podcast. Thank you very much for having me. We're very excited to be talking to you. To start off, Asya, can you talk about what the main function of the Office of the Chief Actuary is? Office of the Chief Actuary provides the independent valuation services and advisory services to the federal government. It includes the statutory actuarial valuations for such programs, the Canada Pension Plan, Old Age Security, Canada Student Financial Assistance Program, Employment Insurance Program, as well as the public sector pension and insurance plans, including benefits to veterans.

5:31So as you can see, we cover a very wide range of programs, and I probably should say that they cover every almost single Canadian age 18 and over. For example, for the Canada Pension Plan, the number of members is 23 million. For the Employment Insurance Program, it's 20 million. So these are big, big numbers, as you can see. The majority of our actual reports, they are statutory, so they are prescribed by legislation and at table in Parliament by an appropriate minister. I have a very dual situation within the Office of Superintendent of Financial Institutions, where we're located. I report to the superintendent, but I am solely responsible for the content and actual opinions of our reports.

6:17our work is informing the politicians, the parliamentarians, the public or the financial status of the plans and the risks these programs are facing. That's really interesting. It sounds like there's quite a bit of independence for your office to do the work that you have to do. Yes, there is quite a lot of independence. This independence is kind of enshrined in the legislation and the fact that we do work for the departments and we're located outside of all these departments. There are other safeguards to our independence. For example, our report for the Canada Pension Plan is reviewed by independent actuaries, and they pronounce themselves on the reasonableness of our assumptions, methodologies, and many other things.

7:04And what's the main purpose of the actuarial report on the Canada Pension Plan? For Canada Pension Plan, we produce the trial report every three years. It's more than 200 pages document. So if you have time, welcome to read it. You can find it on our website. It contains the wealth of information. And the main purpose is to determine the minimum contribution rates so that can sustain the plan. After we, both components of the plan, because the Canada Pension Plan, as you may know, has two components, the base plan, which was the benefits in existence prior to 2019, and the additional plan, which is the enhancement that was enacted in 2019.

7:48So we determined this minimum contribution rates and we compared these rates with the legislated contribution rates. Just to remind you, for the base CPP, the legislated contribution rate is 9.9 % on earnings up to the year maximum pensionable earnings, which are about$70 ,000 in the 2024. And for the additional CPP, these contribution rates are 2 % up to YMP, like year maximum pensionable earnings, we'll call it YMP, and another 8 % between YMP and additional YMP, which is 14 % higher than YMP. So we compare these two rates, the rates that we determine and the rates that are prescribed by legislation.

8:31And if the rates that we determine, If they are lower than the legislated rates, the plans are deemed to be sustainable. In addition to the minimum legislated rates, I said this report contains the wealth of information we project, the contributors, contributions, beneficiaries, expenditures, assets. And all this information surfaces a basis of the triennial review of this Canada Pension Plan by federal, provincial, and territorial ministers of finance, the stewards of the CPP. So in addition, of course, we inform the plan members on the financial status of the plan. And once again, let me repeat that the report is tabled in Parliament by the Minister of Finance.

9:15I do want to mention that just for listeners, the report is actually fascinating. It really is an interesting read. There is a ton of good information in there. I'm curious to ask you, what outcome of the report would trigger a change in the contribution or benefit rates? And I will talk about base CPP because additional CPP is not mature enough, but it's true for additional CPP as well. If we show the minimum contribution rate, which is higher than legislated contribution rate, of actually for additional CPP, it's falling outside the some prescribed ranges. So the Minister of Finance need to decide what to do, how they're going to address the situation.

9:52Many of their options is to change the contribution rate, to change benefits, to do both, or actually to do nothing, as long as they reach an agreement. And they reach an agreement if two-thirds of the provinces covering two-thirds of the population agree on the course of action. This is their role. If they don't reach their agreement, this is where the things are becoming interesting. because the legislation has so-called the self-sustaining mechanism. And if they don't reach an agreement and the trigger in the report happens, then certain actions occur. For the base CPP, it's the increase in contribution rate and freezing of the indexation benefits.

10:34And for additional CPP, it's also changing indexation, changing accrual and benefits, and the last resort increase in the contribution rate. But once again, self-sustaining mechanism. They are kind of the safety net, basically coming into place if politicians cannot agree on the course of action. What also can happen, there may be changes to the plan if minimum contribution rates are actually lower than the legislated contribution rate. This is normally done when there is a sufficient margin between the rates that we determine and the legislated contribution rates. And the plans need to be modernized to be better aligned with the labor market and retirement behavior of Canadians.

11:20How common is it for the actual report to actually result in changes to benefits or contribution rates? Not very common. I should say that over the last one in 20 years, from 2023, the legislated rates stayed at 9.9%. And in every single report, we showed the minimum contribution rate less than 9.9%. And over the last couple of reports, less than the contribution rates for the additional CPP. However, the benefits were changed. Several years ago, the benefits were changed to introduce, for example, the post-retirement disability benefits for early retirees and to remove some reduction in the survivor benefits for younger survivors.

12:04Going back in history, in 2009, a major reforms package was introduced when people were allowed to work after retirement and still continue to earn the CPP benefits. This was a major thing because it's really kind of aligned with the retirement behavior of Canadians. Changes happen, but normally the changes happen, as I said, to align better the plan with the reality of the Canadian realities. Every time the changes happen, the cost implication of these changes are very extensively discussed. And I should say that the governance mechanism of the plan with the federal provisional discussions, the requirement of agreements of the two-thirds of the provinces with two-thirds of the populations, make imprudent changes very unlikely.

12:54A lot of those changes you just mentioned sounded like enhancements. Is that correct? Yeah. Interesting. Asya, what are the main revenue sources for CPP? So both base and additional CPP are financed by the contributions that are paid in the equal measure by employers and employees, 50-50, and by investment income. So CPP fund, which you probably hear quite a lot about in the news, is a segregated fund. It's totally segregated from the government and it's governed by its own legislation. So it's totally arm-leg from the government. Its mandate, it's invested by the organization which is called the Canada Pension Plan Investments.

13:39And its mandate is to invest the money in the sole interest of contributors and beneficiaries. So as of March 31st, 2024, the fund was$632 billion. So I like to digest this number,$632 billion. It's a very large number. About 94 % of this fund was in respect to the base CPP and 6 % with respect to additional CPP, which is in the early stage of its existence currently is maturing. I'm curious, how much of the base CPP benefit payments are funded by contributions versus investment income? The contributions to the base CPP fully cover the outgoing payments from the plan. So basically, the whole investment income, as we speak now, stays in the fund.

14:32We're projected by 2030, about 9 % of investment income will be needed to pay for the benefits. And this number is projected to increase to 16 % by 2050. So even then, a large portion of the investment income still will stay in the fund and will be invested. What is the funded status of base CPP? Oh, this is an expression that I don't like, funded stars. To answer your question, let's go a little bit in history and talk about the financing, the history of financing of the plan. So as you know, the plan was introduced in 1966 as a pay-as-you-go plan with very small reserve. When I'm saying pay-as-you-go, it means that the contributions are supposed to cover the benefits.

15:24Basically, what we collect, we pay out. Over the years, the contributions were increased, the benefits were improved, and we ended up, by 1997, which is a plan with a very small reserve of 36 million, not billions, millions, 36 millions, and the prediction by the chief actuary at that time that the contribution rates need to increase to more than 14 % by 2030. So then in 1997, the major reform was introduced and main features of the reforms, the contribution rate was gradually increased by to 9.9%. But what was also very important, it was decided to create the Canada Pension Plan Investment Board and to invest the excess of contributions on the markets that needed to pay benefits in the markets.

16:19So today, the base CPP is a partially funded social insurance program. Contributions still play an extremely important role in the life of the base CPP. Right now, 70 % of the total revenues of the plan are coming from contributions and only 30 % from investment income. As you understand, contributions is the main source of revenues. We project that it will continue. So the plan is financed using approach was used. It's called steady state approach. And sorry, I'm getting a little bit technical here, but I think it's important to understand. This is the approach which is basically stabilize the ratio of assets to the expenditure.

17:08So it looks how many years of expenditure can be paid from the actual asset, existing asset. And this approach is supposed to stabilize this level. Another thing that was introduced in the 1997 report that all new benefits are supposed to be fully funded. And when we're talking about fully funded, we're talking about the present value of future contributions related to those benefits should be equal to present value of future benefits. But basically why I'm telling you all this, the EBS CPP is a social contract. It's not your regular defined benefit pension plan. It's a social contract. And you today as a young people, and I think you're all younger than I am, allow today to take your contributions and pay benefits to the current beneficiaries.

17:56But you're doing this in exchange and with understanding when you need the benefits, the future contributors will do the same. They will pay for your benefits from their contributions. So what it means in practice, when we assess the sustainability of the base CPP and the additional CPP as well, we need to consider the contributions and benefits of future contributors and future retirees. Saying that, the fully funded or like funded status as understood by the private pension plans is not really applicable to the base CPP. And the CPP was never, never intended to be fully funded in this sense.

18:39If you're interested, once again, in the degree of pre-funding, I think it's nice to look at the ratio of the importance of the investment income for the plan. And as I said, today it's 30%, and we project by 2050 to be about 40 % of the total revenues coming from investment income and 60 % still coming from the contributions. Okay, that's really interesting. So base CPP is not designed to be fully funded ever? No, it's not designed. It's a partially funded program. And I should tell you that basically, if you look around the world, I think I probably know one social security program, which is so-called fully funded, and it is a Middle East.

19:24The rest of the programs, they are either partially funded or pay-as-you-go. You mentioned this briefly, but I want to come back to it to make sure the listeners understand. Can you talk about how funding is different for base CPP and additional CPP? When additional CPP was introduced, basically the idea is that the generations are paid for their benefits as they earned. So it was achieved through the fact that the money were invested in the market right away. The link between benefits and contributions was strengthened and the benefits were accrued gradually. Right now, the plan is not mature.

20:04So let's not look at the plan right now, because right now, contributions, of course, constitute a huge part of the revenues because there is a very small fund. But at maturity, the investment income will constitute about 70 % of the revenues. So basically, it's inverse with respect to the base CPP. And as of the last actuarial report, how sustainable is base CPP at the current contribution rate? I have good news for you. It's sustainable for the next 75 years. The minimum contribution rate that we determine is 9.54%, which is quite lower than 9.9 % of the legislated rate. And if we talk about the asset to expenditure ratio right now, it stands at 8%.

20:54And it's projected to increase to 11 % to 2050 under the legislated contribution rates. And we also projected that the asset will reach$1.2 trillion in today's dollars by 2050. So$1.2 trillion in today's dollars. I don't know, guys, but that all sounds pretty good to me. That sounds good. These are very big numbers, yes. And how sustainable is additional CPP? Initial CPP is sustainable as well. The minimum contribution rates are slightly lower than the legislated contribution rates. And at maturity, we expect that asset to expenditure ratio will stabilize at the level of about 25 to 26. And we project the asset to be reached by 2050 to 800 billion in today's dollars.

21:47Think about two trillions in the asset. Wow. Those are big numbers. These are big numbers, but these are good news. These are all good news. Sounds like really good news. You've mentioned the minimum contribution rate. When we're talking about plan sustainability, how is that being measured? What is the metric that says, yes, this is sustainable? There's a lot of mathematics. I'll try to describe it in the high level. So basically what we do for the BCPP, we find the minimum rate. First of all, there are two components to the minimum contribution rate. There is a steady state rate and full funding rate.

22:18And right now, the steady-state rate is 9.53, and the delta, which is a very small amount, is the full funding rate. So what we do to determine the steady-state contribution rate, we stabilize asset and expenditure ratio in two points in time, which is right now in two years, which are 50 years apart. Today, these years are 2034 and 2084. For additional CPP, it's a little bit more complex model, but basically we are sure we find the stable minimum contribution rate such that basically there are enough contributions and investment income to pay for benefits. And I can go to the complex mathematical explanation, but I don't think it's probably will be very interesting for your listeners.

23:11If you're interested, you can go and look at our report. Ben's very interested. What are the main assumptions that go into the sustainability analysis at a high level? Oh, a lot of assumptions. First of all, I mentioned in the beginning that CPP covers all workers and retirees in Canada except Quebec. So basically what we need to start with is to project the population of Canada and population of Quebec. And to do that, we make assumptions about the fertility, the migration rates, as well as mortality rates. after we project the population we need to project the labor force because basically the population of contributors and then eventually beneficiaries is based on the labor force so we make assumptions regarding the labor force participation rate unemployment rates we make assumptions about earnings growth and earnings distribution and then eventually we make assumptions about the behavior, retirement behavior, Canadians.

24:16When do they retire? Do they work after retirement? And finally, last but not least, we make assumptions about returns on the assets invested by the CPP investments. The report is more than 200 pages, which describes a lot of these assumptions. So once again, you're welcome to read the report. But I should also say that the report has a very nice two-page executive summary, which can give you an idea of what's going on with the plan. The executive summary is great. My favorite part of the report, though, is the sensitivity analysis at the end. And we're going to ask some questions about that in a minute, but that stuff's a lot of fun to read.

24:53So how do you approach making best estimate assumptions for the projections? It's a mixture of science and art. We make assumptions for the next 75 years. So, of course, we don't have crystal balls. Nobody knows what will happen over 75 years. So what we do, we look at the past trends. We examine them very carefully. We look at the existing environments. We look at the emerging trends, for example, climate change or AI or geopolitical tensions. And we kind of decide to which extent these trends are going to continue, both past and emerging. We apply mathematical models. And then at the end of the day, we apply judgment.

25:38And this is how we make the assumptions. You see, our reports are every three years. So our assumptions are self-correct. Every three years, we reflect the experience of what is happening and see how well our assumptions are aligned with the reality. And I should tell you, I'm pretty proud about it. Our mortality assumptions over the last three years prior to report will almost bang on, except COVID, of course. That is very cool. What information sources are you drawing from when you start making all these assumptions? We do our own research. We look at the papers. We look at the relevant papers.

26:15We consult with our colleagues at the different government departments and the outside organizations, such as Statistics Canada Conference Board of Canada, Department of Finance Investment Board. In the beginning of each triennial review, we organize the interdisciplinary seminar where we consult with the demography, economy and investment experts. One of such seminars is coming this coming September. And when we develop our assumptions, we present these assumptions as well to specialists just to check for their reasonableness. Saying all this, the ultimate responsibility for the assumptions rests with the chief actuary.

26:57So as I mentioned before, I'm solely responsible for the assumptions going and for the actuarial conclusion going in our report. I also mentioned before, we have the independent peer review, that part of this independent peer review process is to opine on the reasonableness of our assumptions. And we have so far nine independent peer reviewers, and every time they opine that our assumptions are within the reasonable range. How do you estimate expected returns for the assets that are managed by CPP investments? And it's an interesting question because it's one of the most complicated assumptions to develop.

27:36As you can understand, CPP investment employ active investment strategies, but we do not develop the assumptions on active investment strategy. According to our actuarial standards and we are governed by actuarial standards, we look at the semi-passive equivalent of their investment strategy. So we develop the assumptions for the wider classes, such as the private and public equity, fixed income, credit, real asset. After we develop these assumptions, and very often they are so-called select and ultimate. So they are variable for the first, say, 10 years, and then they gradually converge to their ultimate value when we have more uncertainty.

28:20And you should understand that when we come to CPP investment, for example, and ask them, what's this their long-term assumptions? Their long term is five years. For us, long term is 75 years. Really, we need to apply a lot of judgment. And even when we go to any investment board or any investment forecast, for investors, long term is five, 10 years. It's incomparable with what we project. So after we develop the assumptions by the class, we apply the asset allocation to these assumptions and we adjust them for the investment returns. Something that needs to be mentioned with respect to the asset allocation, the CPP, base CPP and additional CPP have two different asset allocations.