About those "unfunded liabilities"

August 9, 2011

2-minute read

When it comes to the Canada Pension Plan, a major talking point from the right is that the CPP has "unfunded liabilities", with the implication that is not affordable and financially unsustainable. This is nonsense, a scare tactic based on an accounting fiction that counts only future expenditures but does not count future revenues.

For example, John Robson writes in the Ottawa Sun just the other day:

An even bigger reason for worry [about Canada's debt] is soft unfunded liabilities for things such as the Canada Pension Plan and the Canada Health Act. In 2006 the Chief Actuary of Canada formally estimated the unfunded liabilities of the CPP at $620 billion.
For starters, there is a certain amount of laziness on Robson's part. The most recent report from the Chief Actuary of Canada was released in December 2010. It makes an estimate of "unfunded liabilities" of $748 billion, so Robson could have upped the scare factor just by using Google.

But what's missing from this horror movie is that this is an artifact of CPP being a mostly pay-as-you-go plan. The report calculates all future payouts to beneficiaries, less current holdings of financial assets, but ASSUMES that all CPP contributions from workers present and future ceased. It is as if the CPP closed shop and took in no more premium revenues and simply paid out its legal obligations. On this basis, my telephone connection is an unfunded liability running thousands of dollars because I do not have that money in the bank to pre-fund those future phone bills.

In the real world, we have to consider both income/revenues and expenditures, particularly since the CPP is "intended to be long-term and enduring in nature," according to the Chief Actuary. So the Chief makes a second calculation that does include future contributions from workers, and this basically wipes out the "unfunded liability", though not entirely. By this second estimate there is still a shortfall of $6.9 billion, but this is over the coming 75 years and amounts of 0.3% of the CPP's liabilities.

The gist of the Chief Actuary's report is that the CPP is financially sound for at least the next 75 years. There was a time when this was not the case, and payouts exceeded contributions. In the mid-1990s, fixing the CPP was on the agenda and led to an increase in premium rates. This has meant that since 2000 contributions from workers have exceeded benefits paid, averaging about a $6 billion per year surplus in recent years.

This situation is not expected to last due to retiring boomers, so surpluses are being accumulated and invested in financial markets. A decade from now, those surpluses will be depleted and expenditures will exceed contributions, with the difference made up by income from accumulated assets. Those CPP assets are currently worth $143 billion and are anticipated to continue to rise, even amid negative cash flow from premiums less benefits. That is, only a share of investment income will be needed to keep payments up, and the rate of return on CPP assets would have to drop big time for the plan to start drawing down its capital at all.

So when the right cries "unfunded liabilities" do not panic. They are either mis-informed or deliberately trying to mislead you.

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