Problems With Pensions

If you're between the ages of 18 and 25, you probably don't spend a lot of time thinking about the pension you will receive when you retire at the end of your career. But here are some things you should know about pensions.

The first pension plan was introduced in Germany in 1889 for workers who had reached the age of 70 (life expectancy back then was just 45). The Social Security plan for U.S. workers who reached age 65 was set up in 1935 (life expectancy then was 62), and the Canada Pension Plan was introduced in 1966. Pensions were originally designed to be paid out to very few people, and then for only a very few years. But times have changed. Now, with dramatically increased life expectancy, the typical worker expects to spend many years drawing a pension during retirement.

There are two basic types of pension plans. Defined benefit plans, which guarantee employees a specific annual income when they retire, used to be the norm but these plans are rapidly declining in popularity because companies don't want the risk of having to pay out a specified amount of money regardless of economic conditions. Defined benefit plans are therefore being replaced by defined contribution plans, which guarantee only that the company will put aside a certain amount each year for employee pensions. Thus, in a defined benefit pension plan, employees know what they will receive when they retire, but in a defined contribution plan, what employees receive when they retire depends on the return the pension plan achieves with its investments.

The move toward defined contribution plans comes at a time when pension plans are having some serious problems, so greater uncertainty about retirement income now exists for employees. The typical pension fund declined in value by about 14 percent in 2008. The Ontario Teachers Pension Plan lost 18 percent of its value, declining from $108.5 billion to $87.4 billion. Caisse de depot et placement du Quebec did even worse, losing 25 percent of its value. It is estimated that in 2009 pension plans will earn about 7.5 percent on their investments. But this will not be nearly enough to offset the losses that were incurred in 2008. Even if annual returns of 7.5 percent are achieved regularly during the next decade, the typical pension plan will not be fully funded until 2021, according to the Mercer Pension Health Index.

During 2008, the solvency funded ratio (the market value of the pension plan's assets compared with its liabilities) dropped from 96 percent to 69 percent because of decline in stock markets. Companies will have to contribute more money to pension plans to increase the solvency funded ratio, but they don't have the money because of the recession. Companies are now being given longer time frames (up to 10 years) to replenish their pension plans, but they say that even this change isn't enough because they simply don't have the money to make contributions.

The problem with pensions is most obvious at Chrysler and General Motors. Both companies declared bankruptcy in the U.S., and workers are concerned about the state of their pensions. GM's pension plans for hourly and salaried workers were already badly under-funded even before the recent decline in the stock market occurred. Now they are in worse shape. The Canadian Autoworkers Union says that the province of Ontario should make up the funding shortfall because it allowed GM to reduce its funding of pensions in the 1990s. GM has received a $10 billion government bailout, and a lot of that money will be directed to paying off GM's pension commitments to its workers. Many Canadians don't have much of a retirement fund, and they make a lot less than auto workers do, so they are unhappy about having their tax money used to bail out the pensions of auto workers.

Air Canada is another company that has pension problems (its pension-solvency deficit is nearly $3 billion). During negotiations with its unions, Air Canada proposed a moratorium on pension plan contributions because it is also in financial trouble and wants to avoid declaring bankruptcy. The company and the union eventually agreed on a new contract with no wage increases, a no-strike provision, and a moratorium on a portion of their pension payments over the next two years. The unions got a small equity stake in the company as well.

Increased life expectancy, coupled with declining birth rates, has caused additional problems for pension plans in general. In the OECD countries in 1950, there were seven working people for each retired person, but by 2009 there were only four working people for each retired person, and by 2050 there may be only two working people for every retired person. In many western industrialized countries, retirement spending is currently more than 7 percent of GDP (in the U.S. in 1935, it was just 0.2 percent of GDP).

What is the solution to these problems? The simplest approach is to raise the age at which people can start drawing benefits from programs like the Canada Pension Plan. But this is politically unpopular. A related approach is to adjust the pensionable age based on the increased life expectancy of the population (Denmark has already done this). An even more radical idea is to gradually phase out pensions altogether, and have no formal retirement age. This would mean that people would essentially continue working their whole life.

Questions for Discussion

1. Which type of pension plan would you prefer to have: a defined benefit plan or a defined contribution plan? Explain your reasoning.
2. Some experts are predicting that pensions may eventually disappear, and that people will continue to work their entire life. Do you think this is likely? Explain your reasoning.
3. Consider the following statement: Federal and provincial governments should not provide money to support the pension plans of workers at companies like GM and Chrysler. This is unfair since many Canadian workers do not even have a pension plan, or if they do, their plan is not nearly as good as that of the auto workers. Do you agree or disagree with this statement? Explain your reasoning.

Sources: Janet McFarland, "Pension funds Turn the Corner," The Globe and Mail, July 9, 2009, p. B4; "The End of the Road?," Winnipeg Free Press, June 29, 2009, p. A12; Sheldon Alberts, "Air Canada Unions Relent on Pensions; Grim Financials," National Post, June 10, 2009, p. FP1; "Air Canada Unions Look for Pension Guarantees; Stake in Airline Touted as Way to Stave off Moratorium," National Post, June 2, 2009, p. FP2; Terence Corcoran, "Still the Same Old Auto Game," National Post, June 4, 2009, p. FP13;; Jacquie McNish, "The End of the Untouchable Pension," The Globe and Mail, May 20, 2009, p. B5; Boyd Erman, "Teachers Books Worst-Ever Year After 18 Percent Plunge," The Globe and Mail, April 3, 2009, p. B4; Janet McFarland, "Who's Responsible?," The Globe and Mail, March 6, 2009, p. B1; Lori McLeod, "Pension Plans Suffer Historic Losses," The Globe and Mail, January 9, 2009, p. A1; Janet McFarland, "Returns Forecast This Year Will Do Little To Offset 2008 Shortfalls," The Globe and Mail, January 14, 2009, p. B3; Janet McFarland, "Relief Falls Short, Pension Plans Warn," The Globe and Mail, November 28, 2008, p. B1.