Bill C-2: The Canada Pension Plan Investment Board Act (LS290e)

HOUSE OF COMMONS		SENATE
Bill Stage	Date	Bill Stage	Date
First Reading:	25 September 1997	First Reading:	4 December 1997
Second Reading:	8 October 1997	Second Reading:	16 December 1997
Committee Report:	21 November 1997	Committee Report:	17 December 1997
Report Stage:	1 December 1997	Report Stage:
Third Reading:	4 December 1997	Third Reading:	18 December 1997

Bill C-2 proposes amendments to the Canada Pension Plan and would establish the Canada Pension Plan Investment Board. Tabled in the House of Commons on 25 September 1997, Bill C-2 is the updated version of previous draft legislation that died when an election was called in April 1997. Compared to the original bill, Bill C-2 would strengthen the fiduciary obligations of the Board and the conflict-of-interest provisions, and clarify the process for appointing directors.

The legislation intends to: 1. preserve the CPP and strengthen its financing by accelerating increases in the contribution rate; 2. improve CPP investment practices; and 3. reduce costs through tighter administrative policy. This legislation would follow the agreement reached by the federal government and all provinces except British Columbia and Saskatchewan. (Any change must be agreed to by two-thirds of the provinces representing two-thirds of the population of Canada.)

Contributions finance benefits for individuals receiving retirement, disability or survivor benefits. When contributions for a given year are not sufficient to cover that year’s benefits, money is drawn out of the CPP Investment Fund. In 1996, $1.2 billion had to be drawn from the CPP Investment Fund. As of 31 March 1996, the Fund held approximately $39 billion. Without changes, demands resulting from current economic and demographic trends would exhaust the fund in less than 20 years.

Every five years the federal and provincial finance ministers set the contribution rates for the next 25 years. The 1991 review called for steady increases to 10.1% by 2016. The contribution rate for 1997 is currently set at 5.85%. The Chief Actuary concluded that the current arrangement, under which the CPP Investment Fund would be depleted by year 2015 and the contribution rate would reach 14.2% by the year 2030, was unsustainable.

With Bill C-2, the CPP would move from an almost purely pay-as-you-go system to one that had fuller funding, but was still far from being fully funded. The CPP Investment Fund is currently at $39 billion, equal to about two years of benefits. It should reach $135 billion by year 2007, four to five years' worth of benefits. By contrast, a fully funded CPP would have accumulated $600 billion in assets by 1995.

The changes proposed in the bill would combine higher contribution rates in the short run, applied to a larger base, with improved management of assets and plan administration. The reserve fund would be prudently invested in a diversified portfolio of securities at arm’s length from governments. Future borrowings by governments would be at market rates with the expected average annual real return being 3.8%.

The new benefit and investment measures are planned to come into effect on 1 January 1998 and the increased contribution rate would be retroactive to 1 January 1997. A number of key benefit provisions would remain unchanged: retirement benefits of all retired CPP pensioners or anyone over 65 as of 31 December 1997 would not be affected by the proposed changes and all benefits under the CPP would remain fully indexed to inflation. The ages of retirement (early: 60, normal: 65 and late: 70) would remain unchanged.

Clause 3 would establish the Canada Pension Plan Investment Board. This would not be an agent of her Majesty, thereby ensuring that the CPP Investment Fund was managed at arm’s length from governments.

Clause 5 defines the objects of the Board as being (a) to manage any amounts transferred to it from the CPP in the best interests of the contributors and beneficiaries under the Plan, and (b) to invest Board assets with a view to achieving a maximum rate of return, without undue risk of loss. In managing the fund, the Board would have to have regard to the factors that might affect the funding of the CPP and the ability of the CPP to meets its financial obligations.

According to clause 7, the Board would be managed by 12 directors (including the Chairperson), whose specific duties are defined in clause 8(1). The board of directors would be required to establish written investment policies, standards and procedures. It would also be required to establish a code of conduct for officers and employees of the Board and procedures to identify and resolve potential conflict-of-interest problems. A committee would be created to monitor these procedures and the code of conduct.

Clause 10(9) lists the persons who would be disqualified from being directors (e.g. an agent or employee of the federal or a provincial government, a Member of Parliament or provincial legislature). Under clause 10(1), each director would be appointed by the Governor in Council, following the recommendations of the Minister of Finance. Each director could hold office for up to three years, and could be reappointed. Under clause 10(4), the Minister would take into account the desirability of having directors representative of the various regions of Canada and of having a sufficient number of directors with proven financial ability.

The Minister of Finance would recommend to the Governor in Council, after consulting with the board of directors and the appropriate provincial Ministers, the director to be appointed as Chairperson. The Chairperson would be eligible for reappointment for one or more additional terms of office and removable for cause (clause 12).

Under clause 13 of Bill C-2, the board of directors could appoint officers and define their duties. A director would not be eligible to be appointed an officer of the Board. A person would be allowed to hold two or more offices on the Board.

The duty of care that should govern every director and officer of the Board when exercising their powers is defined in clause 14. They would have to act honestly and in good faith, exercising the same care, diligence and skill as a reasonably prudent person would exercise in comparable circumstances.

Clause 16 would allow the indemnification of a director or an officer of the Board facing a civil, criminal or administrative action, provided that person had acted honestly and in good faith with a view to the best interests of the Board. Clause 17 would allow the Board to purchase and maintain directors' and officers' insurance.

With respect to conflicts of interest, clause 22(1) states that a director or officer of the Board would have to disclose the nature and extent of any interest, if that person was a party to a transaction (including a contract, a guarantee or an investment) or a proposed transaction with the Board, or if that person was a director or an officer of an entity that was a party to a transaction or a proposed transaction, or if that person held a material interest in any such entity.

Under clause 22(5) a director who was in a conflict-of-interest situation with respect to a transaction would be required to abstain from voting on resolutions, or participating in discussions to approve the transactions in question.

Under clause 30, the board of directors would establish an Audit Committee (whose role is defined in clauses 31-33) and an Investment Committee. The Audit Committee, among other things, would require the Board to implement and maintain internal control procedures which would have to be reviewed, evaluated and approved by the Committee. It also would approve the annual financial statements, and meet with the Board’s auditor to discuss them and the auditor’s report. The Committee would also be responsible for reviewing all investments and transactions that could adversely affect the rate of return of the fund.

The Investment Committee, (whose role is defined in clause 34), among other functions, would approve the engagement of investment managers empowered to invest the assets of the Board and would meet with the officers and employees of the Board to discuss the effectiveness of investment policies.

Clause 35 stipulates that directors would have to establish such investment policies, standards and procedures as would be exercised by a person of ordinary prudence in dealing with the property of others and that the Board and its subsidiaries would have to adhere to these. Under clause 53, the Governor in Council could make regulations subjecting the Board to all or some of the same investment rules set out in the federal Pension Benefits Standards Act and its regulations which govern other pension funds in Canada.

The government has indicated that the Board would not be permitted to hold more than 30% of the voting shares of a single company, nor could it to invest more than 10% of its assets in the securities of an individual issuer, or more than 15% in Canadian resource properties. The 20% foreign property limit for pension funds would also apply. In order to ensure that the fund’s entry would not disrupt financial markets, regulations would also require all of the Board’s domestic equity investments to be selected passively, mirroring broad market indexes. This passive approach would be re-evaluated at the next CPP review in 1999 (as defined in clause 94(1)).

New provisions would guarantee that the Board was accountable to the public as well as governments. In addition, it would report its investment results regularly to Canadians. Clause 39(1) would require the Board and its subsidiaries to keep books of account and records, to maintain financial and management control, and to keep a record of the investments held (including the book value and the market value of each investment). Under clause 39(4), the Board would have to publish annual financial statements (including a balance sheet, a statement of income, a statement of change in net assets and a statement of investment portfolio). The Board would have 90 days after the end of each financial year to provide the Minister of Finance and the Minister of each province with that report (see clause 51(1)). The Board would be required to have a quarterly financial statement prepared and provided within 45 days after the end of the three-month period (see clause 50), as well as having an annual auditor’s report prepared (clause 51). The auditor of the Board would be appointed annually by the directors (clause 42(1)). Clauses 47 to 48 would allow the Minister of Finance to demand a special examination to determine if the systems and practices defined under clause 39(1)(b) were maintained in a manner that provided reasonable assurance that the assets were safeguarded and controlled, that the financial, human and physical resources were managed economically and efficiently, and that the operations were carried out effectively. Once the report was completed, the auditor would have to submit it to the Minister of Finance and the appropriate provincial Ministers.

Under clause 54, every director, officer, employee, agent or auditor that prepared, signed, approved or concurred in any statement or report that contained any false or deceptive information would be guilty of an offence. In the case of a natural person the fine could not exceed $100,000 or 12 months' imprisonment. In any other case, the fine could not exceed $500,000.

Under clause 52, the Board would have to hold a public meeting once every two years in each participating province to discuss the Board’s most recent annual report and allow interested persons an opportunity to comment.

The total CPP contribution rate (employer and employee) for 1997 is currently 5.85%, scheduled to grow to 10.10% in 2016. The Chief Actuary has reported that under the present system contributions would have to increase to 14.2% by the year 2030 to pay for that year’s benefits.

Bill C-2 would increase the 1997 contribution rate to 6% (clause 58). The increased contribution would have to be paid at the time of tax filing, and interest would be charged where sufficient contributions had not been made by the balance-due day. Future rates would also be increased, as set out in the Schedule attached to the bill. They would reach a high of 9.9% in 2003, at which point they would be frozen for subsequent years (clause 59). Under the current schedule, contribution rates would be 7.35% in 2003.

The CPP contribution rate would be applied to earnings, up to the Year’s Maximum Pensionable Earnings (YMPE); however, the first 10% of these earnings, the Year’s Basic Exemption (YBE), would be exempt from contributions, even though pension income would still be based on an amount including this exemption. This is in contrast to most private sector plans, where any income that earns pension credits is subject to a contribution. Under existing legislation, the YMPE and the YBE both grow as average wages increase. This bill would freeze the YBE at its current level of $3,500 (clause 61) while the YMPE would continue to grow in future years. Thus Bill C-2 would increase the base upon which the contribution rate is applied.

The purpose of these proposed changes is to increase the size of the CPP reserve fund, which currently stands at about $39 billion, or two years of benefits. The changes in this bill would cause the fund to grow to an amount representing between four and five years of benefits by the year 2007. While the changes would move the CPP closer to being fully funded, it will still be far from having that status.

Benefits would generally be left unchanged, although some adjustments would be made to the method by which they are calculated, as well as to their administration, to reduce costs by about 9% by 2030.

Retirement Benefits: Under existing legislation, the method of calculating these benefits is based on the last three years of contributions prior to retirement, which under clause 68 would be changed to the last five years prior to retirement. This would be more consistent with the way other pensions are calculated. If wages grow every year, this new calculation would have the effect of reducing future pension benefits. This new method of calculation would also apply to the earnings-related portion of the disability and survivors benefits. The changes would be phased in over two years and would not affect individuals aged 65 years in 1997 or those currently receiving disability or survivor benefits.

Death Benefit: The death benefit is paid to the estate of a deceased beneficiary. It is currently set at six months of benefits, to a maximum of $3,580. Bill C-2 would reduce the maximum benefit to $2,500, at which level it would be frozen for all future years (clause 75(2)).

Disability Benefits: Bill C-2 would tighten the eligibility rules for disability benefits by linking these to a stronger attachment to the labour force. The rule proposed in clause 69 is that individuals would have to have made CPP contributions in four of the last six years in order to be eligible for disability benefits. Currently, an individual must have contributed to the CPP in two of the last three years, or five of the last ten years.

Retirement Pensions for Disability Recipients: Individuals receiving CPP disability benefits have those benefits converted into retirement benefits at age 65. Benefits are currently based on the Year’s Maximum Pensionable Earnings in the year when the individual turns 65, not when the individual became disabled. Clause 71 would base the retirement pension on the YMPE at the time of disablement, indexed for prices, This is consistent with the manner in which other CPP benefits are established. The change would only apply to individuals currently under 65 years of age. If wages grew over time at a faster rate than prices, the provisions in the bill would tend to reduce the retirement benefits of contributors who had received disability benefits prior to age 65.

Combined Pensions: It is possible for individuals to receive two types of CPP benefits concurrently, a survivor benefit coupled with either a retirement benefit or a disability benefit. Bill C-2 would affect the way in which these benefits are combined. It would essentially return to the less generous pre-1987 rules.

Persons aged 65 and over who are eligible for both a retirement and a survivor benefit now receive the full amount of both benefits up to the amount of the maximum retirement pension, currently $736.81 per month. Under clause 76(1), the combined benefit would be calculated as the sum of the larger of the two benefits plus 60% of the smaller benefit, subject to the same maximum.

The benefit system is more complicated for those eligible for both the survivors benefit and a disability benefit. Both benefits contain a flat rate component and an earnings-based component. Currently, beneficiaries receive the larger of the two flat rate components plus the two income-related benefits. The total benefit is subject to a ceiling, calculated as the maximum retirement benefit plus the larger of the two flat rate components. Clause 76(2) of the bill would change the combination of the two benefits so that it would consist of the larger flat rate portion, plus the larger earnings-related portion, plus 60% of the smaller earnings-related portion. The ceiling would be equal to the maximum disability benefit, currently $883.10 per month.

These changes would not apply to current beneficiaries; but only to those who received benefits in the future. In addition, the changes would not apply to the calculation of disability benefits or survivor benefits, but only to the way in which the benefits were combined when an individual was entitled to more than one benefit.

Provisions contained in Bill C-2 could have a significant intergenerational impact, and affect job creation, as well as bond and equity markets.

Many experts and witnesses will claim that intergenerational inequity would be generated by the proposed provisions, arguing that, under the new regime, younger generations would be transferring additional money to seniors. Some, like Malcolm Hamilton, from William M. Mercer, have said that the CPP reform would be a bad deal for the young. Others, like William Robson of the C.D. Howe Institute, argue that younger workers would be forced to pour money into a plan that would provide lower returns than they could get from any private retirement savings plan. Others argue that today’s seniors should not be insulated from the sweeping revisions and should pay some of the cost of repairing the CPP regime; for example, a partial indexation of benefits for the next 20 years would reduce contribution rates.

A self-employed individual earning the maximum pensionable earnings ($35,800) now pays about $1,890 in annual contributions. Once the new CPP regime was fully in place in 2003, that individual would see contributions rise to about $3,270. The employers' contribution for an employee at this income level would go from $945 per year to $1,635. Many see this increase as a "job killer" and are likely to demand that EI premiums be reduced in order to counterbalance the negative impact of the new contribution rates on jobs.

In the past, many business groups and private pension experts, while supportive of an increased contribution rate, urged that CPP benefits be reduced. The Association of Canadian Pension Management has recommended reduced indexation in order to lower the contribution rate.

Others, like the C.D. Howe Institute and the Fraser Institute, propose a new and radical approach: a mandatory personal savings program whereby money would be managed and invested by each individual. Those opposed to the "privatization" of CPP, however, argue that the average Canadian does not have the knowledge to make prudent investment decisions. In addition, the CPP would still be needed to fund promises made to current recipients or those near retirement age; hence, workers would have to pay twice: once to fund their own private pension and a second time to finance the unfunded liability.

It is expected that the new CPP Investment Fund would accumulate $135 billion by the year 2007 and more than $560 billion in the year 2020, and would be subject to the 20% foreign content limit. Such a large fund could affect Canadian stock and bond markets. Some analysts argue that the federal government should increase that limit in order to reduce the effect on Canadian financial markets and maximize the rate of return.

The government and its supporters argue that these proposed changes would rectify the immediate cash-flow problem facing the CPP and that, by acting quickly and decisively to implement the changes, the government would avoid large future premium increases. (It should be remembered that without any reform premiums would likely have to grow to over 14% by the year 2030, according to the Chief Actuary.)

While Bill C-2 would appear to resolve the immediate cash-flow problem and would move the system further away from strict pay-as-you-go financing, it leaves unresolved the ultimate solvency problem of the CPP. According to the Chief Actuary, in 1995 the unfunded liability of the CPP was $556 billion, an amount that is growing by about $50 billion per year. Bill C-2 would cause the CPP fund to grow by an additional $10 billion per year on average over the next ten years. The unfunded liability would still grow significantly, and could reach $1,000 billion by the year 2007.

	CURRENT PROVISIONS	PROPOSED AMENDMENTS
Age of retirement (early)	Starting at age 60	No change
Age of retirement (normal)	Age 65	No change
Age of retirement (late)	Up to age 70	No change
Contribution Rates	Rising to 10.1 per cent by 2016 Projected to increase to 14.2 per cent in 2030	Rising to 9.9 per cent by 2003, then held steady Will not rise above 9.9 per cent
Year's Basic Exemption (YBE)	Currently $3,500 indexed to wages	Frozen at $3,500
Year's Maximum Pensionable Earnings (YMPE)	Indexed to wages	No change
Investment Policy	Invested in non-negotiable provincial bonds	New funds invested in a diversified portfolio of securities
Provincial Borrowing	Provinces borrow at federal rates	Limited provincial borrowings at their own market rates
Retirement Pensions and Earnings-Related Portion of Disability/Survivor Benefits	Based on average of last 3 years' YMPE	Based on average of last 5 years' YMPE
Eligibility for Disability Benefits	Must work and contribute in 2 of last 3, or 5 of last 10 years	Must work and contribute in 4 of last 6 years
Retirement Pensions for Disability Beneficiaries	Based on YMPE when recipient turns 65, then indexed to prices	Based on YMPE at time of disablement, then indexed to prices
Combined Survivor/Disability Benefits	Ceiling equal to maximum retirement pension plus larger of two flat-rate components	Ceiling is one maximum disability pension; limits on flat rates
Combined Survivor/Retirement Benefits	Ceiling equal to maximum retirement pension	No change to ceiling; limited adding up of benefits
All Benefits (except the Death Benefit)	Fully indexed	No change
Death Benefit	Equal to 6-months' retirement benefits up to $3,580; maximum grows with wages	Equal to 6-months' retirement benefits up to $2,500; and maximum frozen