Book Review: The 3Rd Rail

In "The Third Rail: Confronting Our Pension Failures" (2013), Jim Leech as well as Jacquie McNish beak over the problems with the Canadian pension system, every bit good every bit offering some solutions. The background fabric is international inward scope, but the give-and-take of solutions is Canada-centric. The volume could perchance last interesting for readers exterior Canada who are interested inward the political aspects of pension reform, but the give-and-take of solutions would last less relevant, every bit the gritty details vary from country-to-country. In this review, I attempt to locomote on my give-and-take relevant for an international audience.

Book Description

Jim Leech was the CEO of the Ontario Teachers' Pension Plan (known every bit "Teachers") when the volume was written, but he retired inward Nov 2013. Teachers is ane of the largest property managers inside Canada (about C$130 billion inward assets at the halt of 2012). Jacquie McNish is a senior author at the Globe as well as Mail, as well as the author of other best-selling books. Accordingly, the volume is slick, as well as offers a goodness thought of the pension province of affairs from an institution perspective.

The volume consists of five chapters:

1. Canada's Pension Promise - a history of pensions. It explains how Canada was a pioneer inward the initial developments of pension plans.
2. New Brunswick - the story of pension reforms inward New Brunswick (a Canadian Province on the Atlantic coast, for those of y'all who are non experts on Canadian geography).
3. Rhode Island - authorities pension reform inward the province of Rhode Island, inward the United States. Includes a history of the evolution of the state.
4. The Netherlands - the story of the Dutch pension scheme since its evolution after World War II.
5. Solving Canada's Pension Crisis. The volume also mentions reforms inward some other countries inward this chapter, every bit models for Canadian reforms.

The volume is largely non-technical inward its discussions. So the give-and-take of the excitement around liability discounting - which roiled the euro expanse swap marketplace - is exclusively mentioned inward passing. This likely makes goodness commercial feel - a volume that covered the details of euro expanse swap trading would probable sell literally dozens of copies. What the volume mainly provides the reader is a give-and-take of political strategies around pension reform inward the start 4 chapters, every bit good every bit a journalistic history of pension evolution inward a few countries.

The volume is aimed at a full general audience of Canadian readers. For someone exterior of Canada (the mass of my readers), the volume could last a useful resources if y'all direct keep already developed an involvement inward pension reform. The volume provides a quick overview of strategies that direct keep been used inward a number of countries. However, it does non give y'all the tools to analyse the details of reforms, as well as hence if y'all are already a specialist inward the area, y'all may honour the handling also simplified.

I do non direct keep much noesis of the details of the histories presented inward the volume (other than what was going on inward euro swap markets at diverse points), as well as hence I volition non comment on those parts. I volition instead facial expression at the give-and-take of solutions.

How Big Is The Problem?

The occupation with writing for a full general audience is that if y'all suppress all the messy details of the analysis, y'all cannot guess how large the occupation genuinely is. In a previous article, I gave a summary of why I direct keep ignored the alleged demographic financial fourth dimension bomb that faces the developed countries - the expectation is that financial policy volition last gradually tightened inward reply to increased transfer payments to the aged, every bit it makes no feel to tighten policy now. Some of the pension problems identified yesteryear the authors tin dismiss last lumped inward with this full general "demographic" analysis. I volition last writing out my ain arguments elsewhere, as well as hence I volition non beak over this signal inward especial inside this review.

My concern with the analysis inside the volume is that it is written from the signal of thought of a pension innovation officeholder or an actuary (which is non surprising, given that ane of the authors presumably plowed through hundreds of detailed actuarial reports during his career [note: I updated the phrasing hither since the previous text was non clear.]). In fact, that is a full general defect of almost all analysis of pension plans, every bit they are typically written yesteryear actuaries. Throughout the book, the critical importance of funding ratios is assumed. However, funding ratios exclusively affair if at that topographic point is a run a jeopardy that the sponsoring entity (employer) volition larn bankrupt; if nosotros assume that the employer is a going concern, the funding ratio loses some of its significance.

If nosotros assume the employer is a going concern (will non larn bankrupt), a defined do goodness pension innovation tin dismiss last dissever into 2 components:

1. a pay-as-you-go plan, where the inflows from the employer as well as electrical flow employees are used to brand payments to retirees; and
2. a puddle of assets which is existence accumulated, which are meant to generate cash flows to encounter hereafter deficits on the pay-as-you-go portion of the plan.

The start pillar of the Canadian pension scheme is a government-provided pension as well as former historic flow supplement, which tin dismiss supervene upon most of the income of the poorest-paid workers (up to C$30,000 annual salary). Outside of Québec, the Canadian Federal Government runs the program. Since Canadian dollars are liabilities of the Canadian Federal Government, it makes petty feel to worry nigh the Canadian Federal Government running out of them, as well as and hence it should last analysed every bit a going concern. (The Government of Québec is non inward that position, as well as and hence it needs to follow the same strategies that corporate plans do, which way that financial assets require to last accumulated inside a plan.)

Properly analysed, the "funding" of a pension fund yesteryear the Canadian Federal Government is genuinely only an emission of debt to purchase private sector financial assets. In other words, it is attempting to arbitrage the upper-case alphabetic quality markets; it is assumed that private sector assets volition render to a greater extent than than the debt it issues. The query is: does it brand feel for the authorities to number debt to purchase upwardly x% of corporate securities outstanding (in monastic tell to larn a junior claim on x% of the earnings of public corporations) - or to only increment the corporate taxation charge per unit of measurement yesteryear y% (in monastic tell to larn a senior claim on the start y% of earnings of all Canadian corporations)? This is a query of populace policy objectives, as well as is a sentence telephone phone yesteryear economists, politicians as well as citizens. Actuarial analysis gives us petty insight into these trade-offs. (I explicate these assertions  in to a greater extent than especial inward this later on article ("Government Pensions Are Always Pay-As-You-Go").)

As a result, the discussions of the start pillar - the basic income provided yesteryear the authorities - genuinely ends upwardly exterior of the range of the book. If at that topographic point are reasons to last concerned nigh those demographic trends - which I grant is possible - it requires a deep analysis of the economy, with macroeconomic models that genuinely piece of work (which is non a holding of almost all the models existence used yesteryear diverse bodies to do the analysis). 

Supplementing Government Transfers

The existent debate is around supplementing the retirement income for those with annual incomes greater than $30,000. Even for this, the solutions discussed inside the volume are somewhat calorie-free on detail.

For example, it is stated that the voluntary retirement plans (tax shelters, known every bit RRSP's as well as TFSA's inward Canada) direct keep failed. I handgrip with this assessment, but to a greater extent than especial to dorsum this upwardly this presumably controversial thought would direct keep been nice. The ground the programmes appear to last a failure is that non everyone has taken wages of these plans, as well as and hence a goodness number of citizens human face upwardly rather catastrophic drops inward income after retirement. How is social club going to react to these citizens' woes is non obvious, to say the least. 

The volume discusses the usage of compulsory and/or automatic enrolment inward defined-contribution pension plans. (In a defined contribution plan, y'all ain a specific puddle of assets, as well as your pension income is derived from your property returns. In a defined do goodness plan, the innovation sponsor guarantees a for certain income based on your working salary, as well as years with the plan. The sponsor takes the investment risk.) Although I am inward favour of people saving to a greater extent than for retirement, I dislike some of the implications of the authorities forcing people to purchase especial private sector services. For example, although I retrieve that nosotros bloggers supply extremely valuable services to society, it would brand petty populace policy feel for the authorities to forcefulness people to divert 1% of their incomes towards us. Similarly, ane has to last concerned nigh the authorities forcing people to paw coin over to favoured private sector financial "partners".

In improver to this concern, government-mandated savings brings with it an implicit authorities guarantee. What happens if a goodness number of people stick all of their assets into a Treasury Bill fund, as well as the key banking concern follows some crazy macroeconomic theory that tells it to locomote on brusk rates close 0% for a pair of decades? In the end, the authorities is likely going to direct keep to bail out people whose funds direct keep underperformed on humanitarian grounds. In whatever event, such a innovation is also piece of cake to do anything nigh the bulge of the population that is close retirement already.

Additionally, if the authorities creates a forced puddle of savings that cannot last touched until retirement, it is non useful for dealing with personal financial crises before retirement. Such earmarked savings plans are genuinely argued against inward the volume "The Two Income Trap" (which I of late reviewed). If people process such forced savings every bit existence equivalent to voluntary savings that y'all tin dismiss tap into, the financial province of affairs of many households may last worse every bit a outcome of the reform, non better.

The authors repeatedly stress how much ameliorate run the large pension funds are than Canadian funds marketed to retail clients. I volition annotation that I am biased - I was of late a low-level functionary at some other large Canadian pension property manager. I handgrip that the cost of many Canadian retail usual funds is also high. However, fifty-fifty I retrieve the authors lay it on a chip thick, for representative when they complain nigh the fragmentation of having millions of private funds. The reality is that ane time the dorsum business office infrastructure is inward place, a usual fund director does non attention whether it has ane customer or millions. The exclusively cost of increasing the number of clients is on the back upwardly side, which is also faced yesteryear the large pension funds.

The volume talks glowingly nigh the usage of annuities, nigh which I direct keep reservations every bit a full general solution. The wages of a defined do goodness innovation is that longevity run a jeopardy is spread out with innovation members; people who keel over shortly after retiring eat real petty of innovation assets, allowing to a greater extent than benefits to last paid to long-lived members. Someone with a defined contribution innovation has to create into their spending plans an supposition of living long, which way that many volition cash inward one's chips with a lot of assets. This is goodness for heirs, but it way that retirement income is good below what it would direct keep been if y'all knew your life expectancy inward advance. (Teachers' had a especial occupation with longevity risk; most of their innovation members are sensible women, whose life expectancies were good beyond before projections.) In an annuity, a sponsoring organisation (e.g., an insurance company), pools people together as well as hence that retirement assets are matched ameliorate to average life spans. The thought is that y'all tin dismiss purchase annuities with your defined contribution innovation assets, giving y'all a guaranteed income for life (like a defined do goodness plan).

The select handgrip of is that annuities are expensive. Insurance companies are forced yesteryear regulators (and shareholders) to cost longevity run a jeopardy conservatively, as well as and hence the annuity providers select handgrip of a lot of the upside gained yesteryear pooling mortality risk. I would fence that annuities tin dismiss last a goodness production for individuals, depending on circumstances. However, forcing everyone to subscribe to an inherently expensive financial production is a spectacular transfer of resources to the financial services manufacture that would require to last carefully analysed.

Corporate Pensions

I also direct keep some reservations with the give-and-take of corporate pensions inside the book. Once again, the occupation is thinking similar an actuary or financial analyst, as well as non considering a "going concern" signal of view.

Corporate defined do goodness pensions made a lot of feel when:

1. Corporations employed a lot of people.
2. Corporations followed conservative financial plans, with fortress residue sheets as well as AAA credit ratings.
3. Corporations genuinely paid income tax.

Influenza A virus subtype H5N1 pension fund does non pay tax, as well as and hence it allows corporations to accumulate financial assets inward a tax-advantaged vehicle. Even if the sponsoring venture could non direct acquit upon the pension innovation assets, whatever surplus inward the innovation provides it with range to heighten compensation, giving it a competitive advantage. If the inward a higher house atmospheric condition are true, the calculation of the cost of a pension fund needs to direct keep into describe of piece of work concern human relationship the wages of pre-tax returns of sheltered investments over the after-tax returns on non-sheltered investments. Once this adjustment is made, the cost of a pension innovation is a lot smaller than it appears than when the innovation is analysed a stand upwardly lone entity. However, the problem is that none of the inward a higher house assumptions handgrip whatever more. 

Once this is taken into account, the authors' complaints nigh the Canada Revenue Agency blocking reforms or allowing plans to accumulate huge surpluses band hollow. Corporations were never going to last allowed to accumulate huge state of war chests of tax-sheltered assets, fifty-fifty if that makes the innovation managers' jobs easier. 

Given these changes inward corporate describe of piece of work concern practices, private defined do goodness pension plans brand express sense. Creating pooled managers for many sponsoring organisations is ane possibility suggested yesteryear the authors. However, it volition last necessary to retrieve real carefully nigh the national interest, such every bit the value of the implicit or explicit authorities backstop those pooled plans volition halt upwardly with, as well as the existent resources cost of running those funds.

Conclusions

Although the volume is interesting, it needed to house the concerns nigh pensions inside the overall economical province of affairs facing the country. It may last that their suggested reforms brand sense, but it would nonetheless last necessary to facial expression at other analysis to depict that conclusion.

I direct keep spent real petty fourth dimension looking at the trends inward pensions, but I hold off that I volition increasingly facial expression at demographics over time. For to a greater extent than analysis of pensions, I recommend reading The Pension Pulse, a weblog written yesteryear a hard-working ex-colleague of mine, Leo Kolivakis. He discusses the trends inward property management, every bit good every bit the problems associated with reforms, for the North American pension manufacture (with an accent on Canada).

Final Note: The volume is available at: The Third Rail: Confronting Our Pension Failures (Amazon.ca affiliate link).

(c) Brian Romanchuk 2014