Retirement (Special report): Inside the looming retirement crisis

Wilful neglect leading to inevitable disaster is quietly cascading across Canada’s entire retirement savings system. Many haven’t made sufficient provision, and a bailout seems neither feasible nor likely.

Aesop was a great spinner of children’s morality tales. Yet one of his 2,500-year-old fables should be read by modern financial planners and economists. It tells of a carefree grasshopper encountering an ant dragging an ear of corn to his lair. The diligent ant declined entreaties to kick back and converse; winter was coming, the ant warned, and all creatures should prepare. The grasshopper ignored this wisdom — until he found himself starving and cold as the first snows fell.

Aesop’s message: “It is best to prepare for the days of necessity.”

This year, current and former employees of General Motors Canada happened upon a novel solution to Aesop’s dilemma. As part of a huge bailout, the Ontario government will pay billions of dollars to help erase a yawning shortfall in their pensions. In entomological terms, they persuaded a passing swarm of cockroaches to replenish their stores.

Don’t blame auto sector turmoil, or falling financial markets. This mess stems from deliberate choices made by virtually everyone involved, over many years. Labour unions pressed for generous benefits that left their employer increasingly out of step with lower-cost competitors. The Ontario government in 1992 allowed GM to fund its pensions to a meagre standard. (It’s been called a “too big to fail” provision.) GM’s management underfunded pensions even in profitable years. Meanwhile, it was either unwilling or unable to remedy long-understood shortcomings in GM’s business model — thus ensuring it could never bridge the gap. Nobody should feign surprise at the resulting multibillion-dollar deficit. This was no accident.

Nor was the bailout. In 1980, Ontario became the first and only province to backstop private pensions. Yet in its 30-year history, the Pension Benefits Guarantee Fund never contained enough money to deal with sizable shortfalls. Even two decades ago, astute observers understood the risk. “If you have a major bankruptcy in a company with a defined-benefit plan, consider that only 37% of the people in Ontario have such plans,” John Kruger, then-chairman of the Pension Commission of Ontario, warned in 1988. “Suddenly you are going to hit all the taxpayers of the province to fund that plan? There’s no equity in that.”

There still isn’t. But GM’s pension bailout may presage something far worse. That same pattern — wilful neglect leading to inevitable disaster — is quietly cascading across Canada’s entire retirement savings system. Many of us simply haven’t made sufficient provision for the times of necessity. And a bailout for the rest of us grasshoppers seems neither feasible nor likely.

The grasshoppers’ great shopping spree

A generation ago, Canadians behaved more like ants. In 1982, we socked away one-fifth of our disposable incomes, partly owing to fears of runaway inflation. But by the end of the 1980s, that number dropped to just over one-tenth. It was considered faintly scandalous. Yet we continued saving less and less through the 1990s and 2000s, even as average incomes rose — until we saved hardly anything at all.

What were we thinking? One explanation is that the Bank of Canada managed inflation so adeptly that Canadians no longer felt the need for precautionary savings. And with interest rates so low for so long, there wasn’t much reward for saving. Meanwhile, rising home values and financial portfolios made us considerably richer. For lower-income citizens, the reason was more fundamental: there just wasn’t enough money.

Rock Lefebvre, vice-president of research and standards at the Certified General Accountants Association of Canada, perceives broad sociological forces at work. In the 1980s, he says, “one of the simplified rules of thumb within a family was you always tried to save 15% of your income,” he explains. We’ve since discarded such rules and surrendered to consumerism. “Today, we don’t make decisions based on what things cost, but rather how much we can afford per month,” Lefebvre says. “That really alters the way people behave, because it’s much easier to absorb a $300 a month car payment than pay $30,000 for a Mustang.”

Things truly got out of hand in the five years leading up to this recession. “Households bought new cars, fancy home furnishings, the latest fashions, and ate out at their favourite restaurants,” TD Economics claimed in a recent report — a performance the bank has compared to “drunken sailors.”

It gets worse. Much of our spending was facilitated by money we didn’t have. Canadians greatly increased lines of credit and credit-card debt, both in raw amounts as well as relative to disposable incomes and the value of household assets. We frenetically expanded our mortgage debt. Banks and other financial institutions lowered their standards to accommodate us. The average debt held by Canadian families rose faster than average family income — six times faster from 1990 to 2008.

Roger Sauvé, 65, a demographic and financial consultant, has watched this unfold over four decades and says our growing comfort with debt is the biggest change he’s seen in household finances. “We got to a point where it didn’t scare us,” he says. “People say, ‘Buy now, pay later.’” Even older Canadians fell into the trap. A recent survey by the Certified General Accountants Association of Canada found that more retirees (36%) reported their debts were increasing than in a similar survey a year earlier. “All of us, including the older folks, have learned to live with debt,” says Sauvé.

Sauvé says our debt burden has now reached “the danger zone.” It leaves us vulnerable to swings in interest rates, real estate prices and interruptions in income from, say, job losses. Even policy-makers, who have every reason to avoid inciting panic, are starting to worry. In June, the Bank of Canada warned that with households already so leveraged, there’s a small but growing chance that further deterioration could cast the whole damned financial system into a vicious downward spiral.

Canadians are increasingly falling into arrears on credit payments. And while bankruptcies accompany every recession, the flurry we’re currently witnessing is striking. Insolvent consumers are much deeper in debt, according to a recent TD report. And there’s been a significant spike in the number of older Canadians becoming insolvent. “We’ve gotten into unprecedented territory in terms of bankruptcy,” says Lefebvre.

Now that many have lost jobs, or watched their assets plummet in value, thrift is back in style. But it will take more than a few years of belt-tightening to put household balance sheets back in order. Many Canadians report racking up more debt simply to pay day-to-day expenses — clear evidence of distress.

All this amounts to a hell of a hangover. Too bad most of us have to work tomorrow.

Our drowning colonies

It’s no surprise that a nation of debt-fuelled spenders has neglected its retirement system. But first, some good news: Retirees get by on considerably less income than they did while working. That’s partly because spending on income taxes, union dues, office clothes, commuting, pension contributions and a whole lot more declines or ceases altogether upon leaving the workforce. Eager to profit off people’s savings, the financial services industry often suggests one needs as much as 80% of pre-retirement income to retire comfortably and securely. But others claim most can make do with as little as half.

As for the source of that income, Canadians typically rely on some combination of government programs, former employers and their own personal savings. These are the “pillars” of retirement finance. Historical evidence suggests they’ve performed admirably. In studies conducted by Statistics Canada in 1989, 1994 and 2002, about four-fifths of retired Canadians claimed they enjoyed life more than or the same as they did in their last year working. And among those few who enjoyed life less, most cited health problems, not financial ones.

Though predicting the collapse of government-driven retirement schemes is something of a national sport, many observers agree Old Age Security, the Guaranteed Income Supplement and Canada Pension Plan (or Quebec Pension Plan) benefits are on solid footing. Combined, they provide many Canadians with about half of their retirement income — and for some low-income Canadians, the whole shebang. But unless you’re comfortable living in poverty, government won’t provide enough. And sadly, our infrastructure for the aged is starting to look like those few buildings still standing from Aesop’s time.

Most Canadians expect to dip into personal savings. What savings? “The bottom 60% tend to put aside very little each year, because there’s nothing left over,” says Sauvé.

For the rest, the feds provided tools such as the redoubtable Registered Retirement Savings Plan (RRSP). The wealthy make vigorous use of it. Yet despite the attractive tax incentives offered, the percentage of tax filers making RRSP contributions peaked in 1997 at 30%. Slightly fewer do so today — but more importantly, the median contribution has also fallen. It stands at $2,780 — a fraction of the minimum amount recommended by the Canadian Institute of Actuaries. “Average RRSP balances are woefully short of the levels [necessary] to fund retirement,” Jim Leech, CEO of the Ontario Teachers’ Pension Plan, recently complained.

What’s going on? Keith Ambachtsheer, director of the Rotman International Centre for Pension Management at the University of Toronto, says behavioural finance predicts most of us will fail to build our own retirement savings. “Real people procrastinate, get emotional, do the wrong things at the wrong times. They worry a lot about tomorrow, and not a lot about 20 years from now.”

But even if we overcome our own psychological vulnerabilities, Ambachtsheer warns of another obstacle. He estimates that as many as 5.5 million Canadians invest retirement savings in retail products, notably mutual funds. Many of those products feature high sales and management charges — Canada’s mutual funds are among the most expensive in the world — meaning financial services companies swallow much of the returns. “If you leave 2% on the table for 40 years, guess what?” he says. “You’re not going to make it. The only winners in that game are the intermediaries.”

Many plan to sell real estate to fund retirement. After all, homes represent a good portion of Canadians’ net worths. But real estate markets are cyclical — prices aren’t always buoyant when seniors are ready to sell. Agents, lawyers, movers and the taxman can swallow much of the proceeds. And many retirement communities are just as expensive as the homes left behind.

Trouble at the anthill

That brings us to the last pillar: occupational pensions. Canadians rely more heavily on them than the residents of any other OECD country. And yet, only 5.9 million of us have a corporate pension, representing about 38% of the workforce. But just one in four private-sector employees are enrolled in such a plan.

Most pensions are of the traditional variety, known as defined-benefit (DB) plans. They represent a promise (generally by an employer) to provide steady, predictable benefits after retirement. Those payments are determined in various ways, typically taking into account the employee’s salary and length of service. They’re highly regulated, complex vehicles that enabled many Canadians to retire comfortably and securely. Now, many of them are falling apart.

Typically run by sophisticated asset managers, particularly the large ones, DB pensions pool so much money together that they significantly reduce certain risks. For example, it’s no catastrophe if a DB single member retires just days after a stock market crash, or if she lives to be 102. For sponsors, DB plans help attract and retain workers. Ants would love them.

Yet DB plans suffer from a host of deficiencies, which have persuaded many private-sector employers to abandon them. The biggest problem is that many pension sponsors are doing precisely the same thing individual Canadians are doing: not saving enough.

Pensions need sufficient assets to cover their obligations. Every three years, actuaries run the numbers. If assets exceed liabilities, a plan is said to have a surplus, and many enjoyed just that in the 1980s and 1990s. But such success raised a tricky question: could employers pocket those surpluses? Regulators and law courts struggled with this question, and sponsors generally lost. That struck sponsors as unfair, since they were still on the hook for all pension liabilities. Consequently, many started contributing the bare minimum. Goodbye, surpluses.

When assets fall short of liabilities, it’s called a deficit. Beaten down by a host of forces, most pensions had one even before the recession. Regulators insist sponsors make special payments to eliminate deficits, but they typically give them five years to pay, recognizing that large shortfalls can crush sponsors.

As pensions fell further into the hole during the past decade, funding regulations kicked in, and contributions rose sharply. Sponsors felt the pinch, and by 2006, most said pension funding had become a “crisis.” Government agreed. That year, the feds relaxed funding requirements. Then the financial crisis and recession smashed the stocks, bonds and other assets contained in many plans, thus increasing deficits. This cast sponsors and plan members alike into a quandary, pushing governments to relax funding requirements yet again.

This is somewhat akin to a “double-or-nothing” gamble. If looser funding rules help struggling companies survive, pensions can be topped up gradually. But few companies go bankrupt owing to pension obligations alone. Most face a plethora of other challenges. Every relaxation in pension funding requirements introduces greater risk for members. “If you look at the life-cycle of companies, the oldest companies in Canada are not that old,” says Lefebvre. “To believe that a company will be safe in perpetuity is a fallacy.”

Public-sector pensions are a lot like government debts: default is unlikely as the liability can be passed off to future taxpayers. But when private-sector sponsors go bankrupt, plan members usually get burned. That’s happening now in mature industries such as autos, forestry and airlines that are struggling under mounting global competition. “This is the unveiling for public display of what people have been writing about for a long time,” says Ambachtsheer. “If you put a lot of risk into a pension plan that’s sponsored by a low-credit employer, the possibility of a significant breakdown is there.”

These days, some workers find they can do little but watch their pensions crumble. For instance, when AbitibiBowater Inc. received protection in April from its creditors, a Quebec judge granted it permission to halt payments into its underfunded pensions. Dave Coles, president of the Communications, Energy and Paperworkers Union of Canada, called it “the first salvo in a larger attack to take away workers’ pensions.”

Nortel Networks, now in liquidation, also slashed pension payments to former employees while at the same time handing millions in retention and performance bonuses to remaining executives and employees. Speaking before the House of Commons in June, CEO Mike Zafirovski said it was the toughest choice of his career. But that didn’t stop him — and neither did the courts. That leaves about 11,700 pensioners and their spouses in limbo.

And while Air Canada’s still flying, its employee pension is also under threat. Last winter, executives began arguing that unless pension funding requirements were relaxed, the airline might fail. Though resistant at first, the unions soon caved to a “double-or-nothing” arrangement.

Lefebvre sees more of this. “There will be wind-downs of companies and pensions over the next 10 to 15 years as an outcome to what has happened over the last eight months,” he says. “In 10 years, it won’t be a surprise for many of us if people say, ‘My pension isn’t what I thought it was going to be.’”

Begging for government intervention is the last resort — albeit one rapidly arrived at. “You see how we behave?” Lefebvre says, pointing to the GM bailout. “There’s an expectation for government to get involved, and not leave these individuals in the lurch.” But backstopping pensions is a dangerous, costly business. The chief argument against it is “moral hazard”: that by providing an escape route for members and sponsors alike, guarantees encourage reckless behaviour. That’s certainly been the experience of the U.S. Pension Benefit Guaranty Corp., which critics say has become a convenient dumping ground for unwanted pensions.

Mounting deficits are perhaps the most serious problem eroding DB plans, but there are plenty of others. So it’s no surprise they’ve long been going out of style. In the United States, Britain and elsewhere, they’ve disappeared at a remarkable pace for several decades. In Canada, the trend began in the 1980s but has been more gradual. Today, employers are increasingly collapsing DB plans or blocking workers from participating in them. “We are dangerously near the brink already for defined-benefit plans,” wrote Brian FitzGerald, a Toronto pension consultant, in a paper last year. “And the closer to the brink we get, the fewer options that remain on the table.”

Private-sector sponsors are already voting with their feet, gradually shifting toward defined-contribution (DC) plans. DC plans don’t pay fixed retirement benefits — the payments members eventually receive depend on the size of contributions and the investment returns realized on them. More than a quarter of all private-sector pension members are now enrolled in them. By shifting to DC plans, sponsors effectively pass the risks associated with volatile markets and increasingly longevity to workers and retirees. If a DC member retires amid a stock market crash, that’s his problem. Ditto if he lives to 100.

This shift will likely accelerate. In one 2007 survey by the Pension Investment Association of Canada, a significant minority of private-sector sponsors say they’ve seriously considered ditching DB plans. (Ontario sponsors were particularly eager.) These days, doing so attracts little fuss. The next generation of workers may find themselves on their own.

Too many ants, too many grasshoppers

Canada has already squandered much of its opportunity to address the coming retirement crisis. The reason is demographics. Birth rates spiked following the Second World War and continued until the mid-1960s. At its peak, Canadian women of reproductive age had an average of four children. This created a bulge in population charts that contributed to a virtuous cycle: plenty of workers whose tax dollars easily supported a relatively small number of retirees. We’re still reaping the benefits. There are five Canadians of working age for each over 65.

Unfortunately, this cycle’s demise was seeded long ago. By the 1960s, women began enjoying better access to both career opportunities and birth control, and birth rates declined. A massive demographic reversal is now imminent, and the number of Canadians over 65 will expand rapidly beginning in 2011. By 2030, demographers expect that for every person over 65 there will be just three Canadians of working age, possibly fewer. Further complicating matters, we’re all living longer.

Kevin Page, the federal parliamentary budget officer, recently called this demographic change a “tsunami.” As the workforce dwindles, so does the nation’s ability to address the retirement crisis — and much else besides. “We have at most 10 years before the wave starts undermining Canada’s economic performance and social well-being,” the Conference Board of Canada warned in 2006. It will be more difficult than ever to paper over the country’s problems with strong economic growth, because the size of the labour force is a critical determinant of the economy’s productive capacity. And much of the economic growth of the past three decades was fuelled by consumer spending.

If the coming demographic shift causes plunging aggregate demand, it could also rapidly depreciate the value of the very assets many are counting on to fund their retirements. If many retiring boomers want to sell their houses at approximately the same time, real estate prices might collapse. The same might happen to stocks and bonds.

And with a diminishing tax base, how will governments pay to support the elderly — or anything else? The C. D. Howe Institute claims that governments face an “implicit liability” of $1.5 trillion stemming from the demographic shift, making pension bailouts even less affordable.

The solution? A second baby boom would help. So could welcoming a flood of talented young immigrants and taxing the hell out of them. Or we could embark on a patriotic orgy of smoking, drinking and debauchery to reduce our collective longevity. But according to the Conference Board, there’s really only one viable solution: Canadians will have to stay in the workforce longer. It’s already happening, but it’s not an option for everybody. Many older Canadians find themselves unable to work, for health or other reasons.

If misery loves company, we can comfort ourselves that most industrialized countries are in exactly the same boat and will be hit even sooner. But that doesn’t diminish our challenge. Forget the recession and financial crisis: Our aging population is the biggest threat to our collective security in retirement.

Back to the anthill

The idea that employers and the state should take care of workers in their golden years seems natural to many, but it’s actually quite new. In the late 19th century, an anonymously authored yet famous rule for office workers read: “Every employee should lay aside from each payday a goodly sum of his earnings for his benefit during his declining years so that he will not become a burden on society.”

In 1907, Sir Wilfrid Laurier echoed that sentiment when he derided government pensions as “public charity which would interfere with thrift and encourage fraud.” Such notions were pushed aside as we built our retirement system during the 20th century. But now the “every retiree for himself” mentality is returning. Are you ready?

Our three-pillared retirement acropolis still stands — barely. One-third of Canadian workers have no retirement savings at all, and many among the rest are not saving enough, according to the Canadian Institute of Actuaries. The inevitable result: a falling standard of living.

Since no two people’s finances are exactly alike, it’s difficult to speak about the retirement crisis without referring to aggregates. But for the wealthiest 20% of Canadians, the greatest threat may be that policy-makers will tax large portions of their assets away to subsidize those unwilling or unable to do the same. For those without adequate resources, the picture is bleaker. Ambachtsheer worries most about the estimated 3.5-million middle-income workers in the private sector whom he believes face a dramatically reduced living standard. But everyone will suffer to some extent.

In some modern tellings of Aesop’s fable, the freezing grasshopper visits the anthill and begs his wiser insect cousin for food. The ant refuses, and the grasshopper perishes. In real life, grasshoppers don’t always go quietly. The coming retirement crisis is ripe for conflicts: between those who’ve saved, and those who’ve not; between retirees who’ve paid their workforce dues and the dwindling numbers of younger workers taxed increasingly to support them; between those whose retirements are backed by taxpayers and those backed by nothing but empty promises. These conflicts could be nasty.

Sauvé, for one, thinks Canadians will adapt. “For a lot of households, their expectations when they’re 45 are greater than the reality when they get to be 65,” he says. “When people get to the reality, they adjust.” That means less spending. And provided the job market allows it, that means working later in life.

Politicians are also starting to take the issue more seriously, and some believe it will become the dominant issue of the next federal election. Intergovernmental pension summits are increasingly common, and some provinces are attempting to introduce plans for workers not covered by occupational pensions. This impetus for reform will likely continue, but progress will be difficult — it always is — because of various sets of rules and jurisdictions. Another problem? The lack of common ground between various stakeholders — it’s often a zero-sum game, where the “improvements” sought by one group come at the cost of another.

In sunnier versions of Aesop’s fable, the grasshopper’s fate remains unclear. Perhaps he somehow muddles through to spring, thinner and wiser. Never mind that a grasshopper’s adult life is measured in months: Canadians are not grasshoppers, and we have more than passing familiarity with changing seasons. The leaves are already falling. It’s time to start stacking the corn.