E pluribus CPP - Macleans.ca

E pluribus CPP


My recent piece on the Caisse de debacle elicited this strange response from Erin Weir at the Progressive Economics Forum, a frequent (and friendly) critic of this page:

Coyne’s secondary headline (and primary argument) is, “Compulsory plans like the CPP expose older investors to risks they shouldn’t have to face.” His logic is that, whereas risky assets with potentially high returns (e.g. stocks) make sense for young people with decades ahead of them, safer assets with modest returns (e.g. bonds) make sense for people closer to retirement. In buying some risky assets, the CPP Investment Board allegedly forces excessive risk upon older Canadians.

What Coyne seems to miss is that younger Canadians are also members of the CPP. If risky assets are appropriate for young people and safe assets are appropriate for old people, then the CPP should buy a combination of risky and safe assets . . . which is what it does.

Weir represents my point fairly: the Caisse fiasco is only an extreme example of a basic problem with compulsory public pension funds — that they expose everyone to the same risk, regardless of their tolerance for it.

It’s his rebuttal that’s baffling. Whatever combination of risky and safe assets the CPP buys, it’s only one combination. That combination will be optimal for some of its clientele, and entirely wrong for the rest. That’s the point: by throwing everyone, young or old, into the blender, the CPP homogenizes into one what are in fact a heterogeneous mix of risk preferences.

Isn’t this just risk-pooling, as in life insurance? No: the pensioner is not the risk, here. It’s the stocks that are risky. So it makes sense to buy a broad mix of stocks — ideally, the index — as well as bonds and other things. But it equally makes sense to leave it up to different individuals — or age groups, at least — which asset mix is right for them.

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E pluribus CPP

  1. Here’s an even better idea — let’s leave any decision on the mix to experts like Jim Cramer.

  2. But it equally makes sense to leave it up to different individuals — or age groups, at least — which asset mix is right for them.

    And if they make the wrong choice – and they will – is it cat food for grandma?

    • Better that than making us all eat the same dog food.

  3. Imagine that CPP were broken into a hundred seperate funds with each fund responsible for managing the assets of a different group of people based on their risk-tolerance. Collectively those funds would buy a certain basket of investments. It would be a hundred different mixes.

    There really no differrence between and CPP buying the same collective set of assets as one fund.

    • There’s additional overhead for that kind of scheme.

      This is what Coyne misses. There are economies of scale and reductions in overhead present from having a single all encompassing fund. The more you split that up into “risk groups” the less that each individual group is able to leverage and the more it costs the fund in total to manage everything.

      • I totally agree T. Thwin. My only point is that if you DID have enough seperate funds to address any difference in risk tolerance, at the end of the day one fund could just as easily buy the exact same mix of assets so there would ultimately be no difference.

        What Coyne doesn’t understand (and this is pretty basic for someone who writes about economic issues) that CPP is a defined BENEFIT plan not a defined CONTRIBUTION plan. If one’s benefits were determined by the day to day ups and downs in CPP’s investment portfolio it would be very problematic to have all types and ages of investors in the same fund. But since the payout for individuals is fixed, all a fund like CPP has to do is select a mix of investments that maximizes gains subject to the constraint that they have to always have enough cash on hand to payout current benefits (which is where the risk-mix comes in).

  4. Andrew,

    Why limit the argument to the CPP or the Caisse? Why not extend to private sector pension plans – eliminate them completely (ie pay everyone out at the time of their employment and let them invest as they see fit). Recent GM negotiations demonstrate that retired GM workers risk having their pensions cut back due to current problems in their industry.

    The examples are endless to reduce risk
    – The GM employee making Minivans uses his pension money to invest in fuel efficient and cost effective Toyoto
    – The lifetime employee at McDonalds uses their pension money to invest in diabetes clinics
    – Employees of CanWest use their pension money to invest in Google
    – Suncor employees invest in retirement communities in sunny locales

    -Isn’t your argument, when you boil it down, that you are against ALL pension plans? Let the employee decide if and how to invest? And if they make bad decisions and go bankrupt, what then?

  5. There’s nothing wrong with homogenizing heterogeneous risk preferences. It’s the rule, rather than the exception. What is the actual risk that older pensioners are exposed to? As long as the pension plan is solvent they will continue to receive their payments regardless of asset mix. It’s the younger CPP contributors who face the most risk, given long-term uncertainty.

    • Oh, I get it — the old ones work hard and contribute for 45 years to so the young ‘Masters of the Universe’ can steal it from them to buy stuff they refuse to work for and earn.

      • No, archangel, I don’t think you do get it. We’re talking about the CPP here, not some fly-by-night hedge fund in the United States. This isn’t an “old vs. young” thing. Andrew’s argument was based on the premise that old people have lower risk tolerance, which is true. But he has failed to demonstrate that older people face actual risks, rather than theoretical risks, from the asset mix of compulsory public pension funds.

        • Thank you, CR, for trying to clarify your position. Unfortunately, older people do face ‘actual’ risks — without the benefit of time and energy to pull themselves out of the jam that unregulated ‘free-market’ proponents have created. Today’s market might correct itself over the next ten years and 65 year-old retirees might wind up back where they were a year ago. In the meantime, they have the meager CPP to carry them through — if they live that long. It’s all well and good to theorise about ways and means when you are not the one suffering from the ideological inanity and downright criminality that has been so prevalent for the past few decades.

  6. It is not a question of a “mix” of investments, or investing wisely, or being fortunate in one’s speculations.

    Central banks, at all times but especially when they are feeling frisky and literally hosing fiat currency around like water, make normal savings and investment redundant. It is far easier and cheaper for companies to borrow money at low interest rates from the banking system, ultimately funded out of thin air from the central bank, than to raise money from investors’ savings.

    It is the financial bubbles created by the central banks, and the dearth of opportunities for people to invest their savings in real (non-bubble, non-ponzi scheme), profit-generating businesses, which results in the poor performance of retirement savings plans – whether professionally invested or not. The past 10 years have been a time of exceptionally active monetary pumping by central banks around the world, which is why the rate of return of retirement savings plans have been exceptionally bad.

    The result of these problems is that (a) central banks are being told by the politicians to pump even more pretend-money into the system rather than less (the so-called “stimulus” policy), leading to (b) even worse performance by retirement savings plans, then (c) government will respond to the cries of anguish by seizing whatever retirement savings remain and placing them directly under government control (“for your own good”), (d) they will then loot the nationalized savings to achieve their short term political goals, and finally (e) everyone will end up flat broke and chained to the government like propertyless serfs.

  7. I apologize for spamming, but I have more thoughts. I’m going to make this a multi-parter, then I’ll go away.
    In addition to the problems identified by AC, there are the additional inherent problems with pooling people’s retirement savings into a coerced government monopoly. Such as, the moral hazards which arise.
    Firstly, anything the government does is run by politicians, and politicians do not work on a long term time frame. When they legislate a retirement plan it is not the long term health of the plan which concerns them, but their own short term electoral goals, with no more than a 5-10 year horizon. If they can fool the public into voting for them by offering a slick-looking but deceptive ponzi scheme, they will be able to retire comfortably with an extremely generous and inflation-indexed parliamentary pension, possibly a party slush fund pension, plus all the double and triple dipping that they can cram in.
    If their ponzi scheme pension plan collapses 10 or 20 years after they retired, so what? They are independently wealthy and they have virtually ironclad protection from civil and criminal legal liability for having implemented a crooked scam.

  8. I wonder how the national pension plan in Chile is doing.

  9. Two thoughts …..

    The principal reason why the CPP is in the investment business is to limit the potential fluctuations of employee/employer contributions.

    The only consistent winners of a system that allows individual control of investment decisions are the money management mavens of Bay St. Strangely, they are also the people that that the media use for the presentation of “expertise” and big buyers of advertising. Especially at this time of year.

  10. What percentage of Canadians actually retire on the CPP? (by which I mean, let’s not say 100%, but, say, more than 85% of their pension income comes from the CPP). Does anyone know? To me, the point of the CPP is as a backstop for those who don’t have company pensions, or RRSPs, or for those unfortunate enough to have their company pensions wiped out when the company goes down, or lose their shirts because they were too exposed to the market. Shouldn’t the CPP have a generally “conservative” investing philosophy, as it’s mostly what we rely on if other options fail us?

    I’m still a long way off from retiring, but I for one have no problem with not getting an aggressive bang for my buck from the CPP. I’ll contribute to RRSPs to take advantage of my long-term horizon (as for my RRSPs today… shiver… but I’m not worried as I have lots of time left…). I rely on the CPP in my planning only to ensure that I won’t be completely destitute if it all goes to Hell, and my company pension plan goes belly up as well.

    Am I completely missing the point?

  11. It seems like there’s really two risks involved. One is the performance of the endowment, which Andrew talks about. But the second is the incoming contributions. Talking about risk without mentioning the contributions is pointless. It’s like saying, “I need a 6% return on my RRSP to retire with one million dollars” .. but the major source of that million dollars is your annual contribution. That builds it up far more.

    The risk then is that, as seems to be the case now, more and more pensioners are supported by fewer and fewer contributors. This pretty much compels the CPP to seek out more risk in the returns to compensate.

    • “The risk then is that, as seems to be the case now, more and more pensioners are supported by fewer and fewer contributors. This pretty much compels the CPP to seek out more risk in the returns to compensate.”

      This is why the CPP investment fund was created in the first place: we are paying more in CPP contributions now than the system requires for current beneficieries so that money can be invested to cover future years when it’s expected that contributions will not be enough to cover benefits.

  12. That combination will be optimal for some of its clientele, and entirely wrong for the rest.
    That’s a pretty misguided statement about the CPP/QPP, I fear. And one that complicates unnecessarily.
    The individual client is pretty agnostic as to asset mix, as long as the cheques clear. The clientele is pooled in a pension fund. You have a simultaneous mix of new entrants, stable accumulators, soon-to-be beneficiaries and beneficiaries. It is the MIX of those individuals that defines whether there is inflow or outflow now and in various pictures of the future. It is the MIX of those individuals that should provide the actuaries with the best-guess of the risk tolerance and investment horizon of the fund.

    • Put another way, it is the FUND ITSELF that is the client here (“keep me solvent so I can pay the bills when revenues fall below expenses!”). It really is that simple.

  13. I like to take a cost accounting approach when I think of Pension Funds. The Pension Fund is already like a huge annuity with guaranteed, indexed payments — the payments are individualized in that way. How much to guarantee and how to index are determined by a kind of stock order …older pensioners get theirs First (FIFO) …those are employees on that shelf…now those investments…are LIFO…that is, you keep what is good for as long as good expecting that it will stay good and the rest is risk.

    • I think you’ll find that pension plan managers are dealt with in a slightly different manner than FIFO (First In, First Out) and LIFO (Last In, First Out).
      It is also called FIFO (Fit In or …

  14. Here’s the thing, I have a friend who’s grandparents just moved in with her.

    Grandpa saw that the markets were going up and up and up a couple of years ago, so he switched 60% of his portfolio to riskier instruments.

    He thought it would be very, very cool to retire with 4 million dollars in assets rather than 1.2 million he had at the time.

    He now has a heart condition and $600K. And his basic work pension that guarantees them $1200 a month.

    Just because people are given choices doesn’t mean that they’re going to make good ones. I’d rather put my lot in with CPP, thanks.

    PS: I’m 34.

    • Just because people may make bad choices doesn’t mean they should lose the freedom to make choices.
      Although we now seem to live in an environment where it is improper for anyone to ever experience the consequence of a bad choice. So now everyone gets to share the consequences of all the bad choices.
      “We know what’s good for you better than you know yourself.” When untrue, this is how tyranny begins. When true, this is how tyranny begins. Beware.

      • I think it’s pretty plain that we’re sharing in the consequences of thousands of people’s bad choices right now. That’s the point of having large national pools of risk. It makes the bad choices less severe and more people benefit from the good choices.

        I’m not saying that people shouldn’t have a choice with their own money, participating in the greater good builds nations.

        Every wo/man for themselves causes the regionalism/separatism that we face every damn day.

        • It makes the bad choices less severe and more people benefit from the good choices.
          Spread the wealth around to those who did not earn it.
          Share the pain with those not responsible for it.
          Impose the above through the power of the state.

          • Except it’s not just those responsible who suffer. To think that a person exists in isolation, and is the sole beneficiary or sufferer of their own actions is naive.

  15. Hmm, I submitted a comment but it hasn’t passed even though others have, later on.

  16. Andrew, you have a basic fact wrong here, for a rare time.

    The Caisse doesn’t put all savers into one basket. It has a range of portfolios, some riskier with more stocks, some safer with more bonds. Each depositor (mostly pension plans) can pick how much it wants to invest in each portfolio. Therefore, a depositor that has an older workforce and more retired workers will pick safer investments.

    So, you cannot say that people’s money is exposed to the same risk no matter what profile people have. Of course, they don’t get to pick their portfolio individually, they have to go with their employer’s choices.