July 31, 2020

This Blog will review the Actuarial Report for the Canada Pension Plan as at December 31, 2018.  That Report was released to the public at the end of 2019.  I will guide you through the process, emphasizing the critical assumptions made in the Report’s analysis.   Also, I will highlight a few key areas of concern that need to be addressed.

First, I should emphasize that this Report is thorough and has been prepared by highly trained and experienced actuarial professionals.  Furthermore, to ensure that high standards are met, an external peer review has been undertaken.  In addition, the Chief Actuary has sought input from a wide range of outside experts in a variety of disciplines.  Therefore, I believe that Canadians can have confidence in the integrity of this Report.


The purpose of the Actuarial Report is to determine if there are enough contributions and investment returns forecast to be generated over the next seventy-five years to equal (or exceed) all of the contractual pension and other benefit payments.  To accomplish that task, detailed forecasts were developed for all of the relevant factors.  These forecasts used what is called the “best estimate assumption”.  All such forecasts have uncertainties and a reasonable range of possible outcomes.  The “best estimate assumption” is the mathematical mid-point of the range of possible outcomes.  This approach was applied to each relevant factor to develop detailed cash flow forecasts over the 75 year period.  These forecasts were then displayed in detailed charts and tables.  Importantly, the actuaries also did a “sensitivity analysis” which told us how a forecasting error in any of these factors would affect contribution levels.  In their Report, the actuaries concluded that (based upon their “best estimate assumptions”) the Canada Pension Plan could meet all of its obligations for the next seventy-five years.


I am going to review each of the key factors for which “best estimate assumptions” were made.   The first factor is “Mortality”, which deals with how long pension beneficiaries will live.  If people live longer, they will be a greater burden on the Plan.  The assumption is made that “mortality will continue to improve but at a slower pace than over the past decade”.  This seems like a very reasonable assumption as it is consistent with both history and world-wide trends.  However, the next actuarial report (for December 31, 2021) will have to address the impact of both COVID-19 and possible future pandemics.

 The next factor to consider is the “Fertility Rate” (1.62), which is the rate at which women have children.  The assumption here seems soundly based reflecting the historical trends.  The “Disability Rate” is also reasonably based on the historical data available to the Plan.   Similarly, the assumptions for the “Rate of Increase in Prices”, “Labour Participation Rates”, “Net Migration Rate” and “Retirement Rates” have good data support and are realistic for the future.  For more detailed information on how these factors were analyzed, please consult the 2018 Actuarial Report.

The Actuarial Report’s forecasts were also based upon the assumption of “moderate and sustainable growth” in the economy.   The future realization of this growth assumption supports the “Real Growth in Employment Earnings” assumption (1%) as well as the forecast “Immigration Levels”.  In a recent publication, the Conference Board of Canada is not supportive of this assumption.  They state that “Beyond 2020, economic growth will be constrained by declining labour force growth and weak business investment.” They go on to conclude that “From 2020 to 2040 GDP growth is projected to average just 1.7%”.  This compares to a GDP growth rate of 3.1% from 1962 to 2019. 

Forecasts of economic growth are affected by expectations of declining investment in the oil industry due to dramatically lower prices and environmental concerns.  At the same time, resource development is being affected by environmental issues.   The United States and China are home to the biggest technology companies, which are investing heavily in artificial intelligence and all its related applications.  We need to find ways to participate in this new technology and in every other growth opportunity.  If economic growth is not maintained, then workers and employers will see their pension contributions go up at a higher than forecast rate.


When speaking about investment returns, it is important to understand the particular meaning of the key terms.    “Investment returns” mean the actual returns, while “real returns” mean the actual returns minus the rate of Inflation.  The “Assumed Investment Return” on the Pension Plan assets is a critical factor affecting its viability.   The Actuarial Report assumes a 5.95% annual return for the Basic pension plan and a 5.58% annual return on the Enhanced plan.  These return targets are partly based upon the assumption that long-term interest rates gradually rise to provide a real return of 2.3% per year.

 Unfortunately, The Bank of Canada has reported that since October 2018 long-term interest rates have steadily fallen so that the real return in Canada is now a significant negative number.  Around the world, there are now trillions of dollars of debt securities trading at actual negative interest rates.  This means that bond buyers have to pay interest instead of receiving interest.  In June, 2019, economists with the Bank for International Settlements concluded that “Our empirical estimates suggest that the world real rate of interest is likely to remain low or negative for an extended period of time.”  Also, the Governor of the Bank of Canada recently stated that “he expects interest rates to remain low for years to come due to the effects of structural changes such as sluggish productivity and population growth”.   This forecast is further supported by the expansive monetary policies being pursued in response to the Covid-19 pandemic.

All of this information and analysis suggests that the target returns on long-term debt securities will be difficult to achieve.  This is particularly relevant to the Enhanced Benefit Plan which has a debt component approaching 50%.  Of course, the actuaries for the Canada Pension Plan did not have the knowledge of the recent market activity when their estimates were made.  The CPP Investment Board is addressing this problem of low returns on debt securities by investing more into private debt, where the lesser liquidity is offset by higher yields.   We will await further possible action by the Board.


  Given the strong evidence of a long-term secular decline in interest rates, the assumption regarding the forecast of a 2.3% real return on long-term debt securities as a “best estimate assumption” seems high. Recent forecasts also indicate that the economic growth assumptions may be too optimistic.  Therefore, I would expect to see further increases in the contribution rates for both the Basic Plan and the Enhanced Plan.  These comments do not take account of the long term implications of the COVID-19 pandemic which will require a later assessment.

Elliot M Rodin
Bachelor of Commerce Degree   – University of Manitoba
MBA                                                 – Harvard Business School