Public pension reform and the 49th parallel: Lessons from Canada for the U.S.

• Author: Clive Lipshitz,Ingo Walter
• Published date: 01 November 2020
• Date: 01 November 2020
• DOI: http://doi.org/10.1111/fmii.12133

DOI: 10.1111/fmii.12133

ORIGINAL ARTICLE

Public pension reform and the 49th parallel:

Lessons from Canada for the U.S.

Clive Lipshitz1Ingo Walter2

1TradewindInterstate Advisors & Stern School of Business, New York University

2Stern School of Business, New YorkUniversity

Correspondence

CliveLipshitz.

Email:clive@ti-advisors.com,

IngoWalter, Department of Finance, Stern

Schoolof Business, New York University,44

West4th Street, New York, NY 10012, USA.

Email:iwalter@stern.nyu.edu

Abstract

Public employee pension systems around the world show

remarkable diversity in design and execution. Among these,

the U.S. defined benefit public pension system has drawn

increased attention because of questions about the long-

term sustainability of many of the underlying pension funds

– as well as concerns of equity between pension plan mem-

bers, retirees, taxpayers, bondholders, and users of public

services. The Covid-19 pandemic introduced new fissures in

state and local government finances, heightening the need

to bolster long-term public pension fund robustness. As an

alternative model, the Canadian public pension system is

widely respected. This was not foreordained. The authors

trace difficult decisions undertaken in Canada in the 1980s

and 1990s along with essential descriptive features of the

Canadian Model. Using a novel primary dataset, the authors

benchmark the 25 largest U.S. plans against their ten largest

Canadian peers, exploring key issues in a paired analysis.

The authors extract fundamental lessons from the Cana-

dian experience, proposing a roadmap for reform of the U.S.

public pension system. They argue that long-term pension

sustainability, once politically prioritized, must be built on

equity and discipline in plan design, funding, and amorti-

zation of existing deficits. They emphasize the importance

© 2020 New YorkUniversity Salomon Center and Wiley Periodicals, Inc.

Financial Markets,Inst. & Inst. 2020;29:121–162. wileyonlinelibrary.com/journal/fmii 121

122 LIPSHITZ AND WALTER

of legal framework, particularly joint sponsorship, along-

side enhanced governance and unified legislation. They also

draw lessons from the Canadian experience with respect

to enhanced investment organizations and investment

strategies.

KEYWORDS

Public pension funds, Public finance, Municipal finance, State and

local government debt, Retirement security, Comparative govern-

ment retirement systems, Pension reform, Canadian pension sys-

tem, Canadian Model, Institutional investors, Pairedanalysis

JEL CLASSIFICATION

G230, H7, J38, J45

1INTRODUCTION

In the late 1970s, a Presidential Commission during the Carter administrationconducted a two-year study of U.S. pen-

sion systems (private and public). In its subsequent report to President Reagan and the U.S.Congress, the Commission

madeparticularreferencetostateandlocalgovernmentpensionplans,notingthat“...concerns relatingtotheown-

ership and control of pension fund assets are among the most important social and economic public policy issues fac-

ing the Nation in the upcoming decades.. . [the] Commission recommends that Congress and the President continue

research and policy development; and to encourage public debate.. . recommends the establishment of a Presidential

Commission.”1

That second commission to study public pension plans was never established. However, a great deal has been

learned in the intervening years about the sustainability of public pension systems and the causes and consequences

of errors in employee and employercontributions, promises to beneficiaries, and estimated rates of return.

In a previous study2we provided a structural overview of the U.S. publicpension system based on a quantitative

analysis – using a new primary dataset covering the 25 largest U.S.pension plans. These account for more than half of

all public pension assets in the country.

Public pension systems are complex structures. Their impact on the economy is not fully understood – particularly

in terms of market structure. There are approximately5,3003distinct U.S. public pension funds, covered by relatively

limited analytics at the national level.

U.S. public pension funds control $4 trillion in assets.4The system is financially massive, and its underfunding –

which we detail herein – may well be approaching a tipping point, albeit to a different degree in different states. The

Covid-19 pandemic of 2020 may well transforma public finance challenge into a crisis at the center of policy debates.

Public pension funds have four sets of stakeholders that can be defined as “principals” – beneficiaries, taxpayers,

bondholders, and users of public services. Pension fund governance has primarily focused on interests of the first of

these stakeholders, with risks to the others much more opaque. Given competing public finance needs, pressure on

state and local government fiscal resources is a virtual constant. That pressure has been exacerbatedby the Covid-19

pandemic and its dramatic erosion of tax revenues even as governments are encouraged to increase public expen-

ditures. Meanwhile, pension plan assets have been eroded by financial market shocks. All the while, most states are

required to balance their budgets. And if challenges become insurmountable, the option for states to restructure pub-

lic debt through a bankruptcy process does not exist.5

LIPSHITZ AND WALTER 123

Consequently,there have been repeated calls for reform of the pension system over the years. The 2020 pandemic

and its waterfall of impacts have made these calls more urgent. What are the options?

Wewill argue that Canada provides valuable lessons for the United States. While not perfect, the Canadian defined

benefit public pension system is generallywell regarded. That was not always the case. Through the 1980s and into the

early 1990s, the country’s public pension system was a cause for concern among informed policymakers at both the

provincial and federal levels. One by one, the individual pension funds and their regulators restructured the system,

introducing a series of changes that have provenboth effective and sustainable.6

We analyze the structural design and executionundertaken in Canada – its historical antecedents and subsequent

evolution. Wesurvey key aspects of the Canadian public-sector pension model. Using primary datasets for the largest

Canadian and U.S. plans, we provide a cross-sectional comparison between the two systems. This paired analysis pro-

vides a useful lens to evaluatethe p ositiveimpact of transformative changes undertaken in Canada. It brings into focus

the necessity and potential value of public pension reform in the U.S. and providesa roadmap for such reform.

Our objective is to providesensible and practical ideas for U.S. policymakers at the state and local levels, for federal

officials concerned with the solvency of state and local governments,7and for stakeholders with a direct interest in

strong public pension finance.8Indirect stakeholdersthat service public pension funds – actuaries, investment consul-

tants, asset managers, and legal advisors – will also find value in this study.

The first section of this article profiles the developmentand attributes of the Canadian public pension system at the

national and provinciallevels, using the Canada Pension Plan as well as Ontario and Alberta as examples. It proceeds to

draw Canadian-U.S. comparisons in plan design, discount rates, funded status, investmentorganization and strategy,

and investment performance. The final section lays out the important lessons of the paired analysis for U.S. public

sector pension systems, along with keypolicy recommendations.

2 WHY CANADA?

It is widely accepted that the Canadian public pension system functions well, with enviable funding levels.9Indeed,

the so-called “Canadian Model” of pension management is often seen as a global gold standard in the realm of public

finance.10

This was not always the case. In the early 1990s, the Canada Pension Plan (CPP) and the various provincial pub-

lic pension plans were financially challenged. Their subsequent successes were hardly inevitable or predictable at the

time. CPP was structured as a pay-as-you-gosystem and many of the provincial plans were funded through superannu-

ation accounts.11 Theywere not independent of government and invested largely in Canadian sovereign and provincial

debt.

Here we review a series of key changes undertakenin Canada in the late 1980s and during the 1990s, allowing us

to compare key plan features in both countries. Using a side-by-side analysis of primary data sources, we illustrate

the positive impact of reforms on Canadian public pension funds relative to those in the U.S. Inevitably,difficult policy

decisions had to be taken. Public officials in Canada took manyof these decisions over three decades ago. The U.S. has

the benefit of learning from that experience as a roadmap for the future solvency of its public pension funds – with

lessons for public finance across the country.

In order to compare the public pension systems of Canada and the U.S., we rely on a primary dataset sourced

directly from the public filings of the largest public pension systems in each country.For Canada, the sample includes

nine of the largest public pension plans12 and the Canada Pension Plan.13 Forthe United States, the sample comprises

the twenty-five largest public pension plans.14 Our dataset is sourced from elevenyears of annual reports for these 35

pensionplans ending in 2018, and in aggregate includes more than 25,000 distinct observations. Exhibit 1and Exhibit 2

detail the Canadian and U.S. pension systems included in our study,while Exhibit 3ranks the thirty-five pension sys-

tems by net plan assets. Exhibit 4provides comparativenational statistics for the two countries. Our entire dataset is

as of fiscal year end, 2018.