April 2, 2014 – Federal public servants have pension guarantees in their defined-benefit pension plans that are mispriced, causing Ottawa to seriously underestimate the cost of the pension plans and the total compensation of its employees, according to a report released today by the C.D. Howe Institute. In “Evaluating Public-Sector Pensions: Are Federal Public Servants Overpaid?” respected pension expert Malcolm Hamilton says this advantageous situation for members of the main Public Service Pension Plan exacerbates the growing compensation gap between federal public-sector employees and their private-sector counterparts.
“Back in 2006, a government report acknowledged that federal public-sector salaries generally out-stripped those for comparable jobs in the private sector,” notes Hamilton. “Steady pay increases since then and rising pension costs mean that federal employees are probably significantly overpaid by now. And while salaries for senior-level mandarins may still lag those in the private sector, they have some extraordinary pension benefits.
The federal government appears to believe that pay in the federal public sector should be comparable to pay in the private sector on a total compensation basis, he says, noting that recent government reports are generally consistent with this view. However, to implement this principle pensions must be valued appropriately.
“Fair values are the best measure of a pension plan’s worth in a transaction where employees provide their labour in exchange for compensation that includes a valuable pension,” says Hamilton. However, the government appears not to apply fair value principles, preferring instead to use funding estimates developed in accordance with public-sector accounting standards.
“It is undeniably more convenient for the federal government to continue to use the numbers it has been using. But it is also wrong,” says Hamilton. To do so is to collectively guarantee federal employees a 4.1 percent real rate of return on their retirement savings at a time when other Canadians must accept a 1 percent guarantee if they seek one or, alternatively, must bear significant investment risks in pursuit of a 4.1 percent real rate of return, says Hamilton. “These guarantees are very advantageous yet public-sector accounting standards attach no value to them and the federal government appears to ignore them when assessing the reasonableness of employee compensation,” he adds.
The payroll for members of the federal Public Service Pension Plan was about $20 billion in 2012, with pension contributions totaling about $4 billion, says Hamilton. The fair value of these pensions was about $8 billion. As a consequence, the federal government underestimated the 2012 compensation of these members by $4 billion and reached a long list of erroneous conclusions about the cost of its pension plans and the compensation of its employees.
How can this be? The culprits appear to be actuarial and accounting standards that are incompatible with market prices and designed for purposes other than compensation management. “In this sense, actuarial and accounting standards have become the enablers of bad financial practice even though the standard-setting bodies do not advocate or condone bad practice,” he says.
Hamilton does not advocate slashing salaries, setting absurdly high employee contribution rates or converting to defined-contribution pension plans. “The easiest fix is to eliminate the guarantee and transfer the investment risk to employees, as has become common in provincial public-sector plans and in Europe,” says Hamilton, who suggests shifting to target-benefit plans.
“If Ottawa is to meet the goal of general parity with the private sector, it needs to stop tinkering with its pension plans and to start making some meaningful changes,” concludes Hamilton.
The C. D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. It is Canada’s trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review. It is considered by many to be Canada’s most influential think tank.
For more information contact: Malcolm Hamilton, Senior Fellow, C.D. Howe Institute and former Partner Mercer; Alexandre Laurin, Associate Director of Research, C.D. Howe Institute, 416-865-1904; E-Mail: [email protected].