Canadian Government Debt 1999 - Unfunded liabilities of government programs

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Many programs in Canada--retirement income support plans (CPP/QPP and OAS), workers' compensation boards, the health-care system, and pension plans for civil-service employees--have unfunded liabilities. These programs are government obligations or promises to provide benefits in the future.

Funding structure

These programs are designed like insurance plans: individuals contribute to a program for a specified period of time, accumulating benefits that are to be received at a later date. Unfortunately, only the workers' compensation boards and pension plans for civil-service employees operate on an accumulated-benefit formula. The remaining programs are funded on a pay-as-you-go system. Rather than accumulate funds in individual personal accounts for future payment, current contributions are used to pay the benefits of current recipients.

The source of funds also varies among programs. The Canada and Quebec Pension Plans, the pension plans for civil-service employees, and the workers' compensation boards derive their funding from direct payroll deductions. Old Age Security and the health-care system are financed through general government tax revenues.

Analysis of unfunded liabilities

The essence of an analysis of unfunded liabilities is the actuarial valuation. This valuation assesses the ability of a program to finance the stated benefits for a specific time given the contribution rates, expected investment returns, and specific economic and demographic assumptions. For instance, the Ontario government currently has a large unfunded liability for its Teachers' Pension Plan. Actuarial calculations show that the Ontario government would have to add $5.4 billion to the fund today to cover all of its stated future pension obligations (see the box in table 4).

Actuarial valuations are extremely sensitive to their underlying assumptions. For this report, the assumptions underlying the valuations of Old Age Security (OAS) and the health-care system are: inflation 3.5 percent, wage growth 4.5 percent, and interest rate 6.0 percent. The OAS and health-care estimates are unfunded liabilities of future costs, meaning that there is no revenue stream applied in determining the values in table 5. These estimates are the best available from the federal government. The 1998 values for OAS and health care were estimated by the authors based on information from the previous seven years. The assumptions underlying the valuations of the Canada Pension Plan and the Quebec Pension Plan are: inflation 3.0 percent, wage growth 4.0 percent, and nominal interest rate 7.0 percent.

Changes in the underlying assumptions can cause significant deviations in the results. The purpose of the valuation is to determine the current long-term deficit or surplus. Actuaries normally conduct valuations every three years to modify assumptions based on new economic conditions. All past and current unfunded liability figures in this report make use of consistent assumptions.

Pension plans for government employees

The federal and provincial governments have benefit funds for their pension plans for government employees. Most provincial governments have committed themselves to the elimination of the actuarial deficits by a set deadline. The federal government currently maintains a surplus of about $27 billion in its plans. Table 4 summarizes the most recently available actuarial valuations for the provincial and federal governments' pension plans. Unfunded liabilities of public-sector employee pensions are now included in the direct debt figures to maintain consistency with the FMS data. Unlike previous editions of this report, surplus amounts for the provinces are not included in this study, again to maintain consistency with the FMS data. The surpluses in the federal government's employee pension plans are still included because it is likely that the federal government will absorb them. Bill C-78, which will allow the Government of Canada to deal with the accumulated surpluses in these funds, had not been adopted at the time this study was compiled. If the bill is adopted as it is, the federal government will have a maximum of 15 years to deal with the surpluses, as recommended by a previous report from the Auditor General.

Workers' compensation boards

There is a wide disparity in the liability status of workers' compensation boards within Canada. Seven of the 12 boards currently possess a surplus. Ontario, Quebec, Prince Edward Island, and Newfoundland saw the unfunded liability for their workers' compensation boards shrink between 1996/1997 and 1997/1998; Nova Scotia saw a small increase.

Retirement-income support programs and the health-care system

The unfunded liabilities of most pressing concern are the retirement programs and the health-care system. At their inception, both programs were based upon similar assumptions and philosophies. It was assumed that the mix of ages in the population, the rate of economic growth, and the wage increases of the 1960s would continue indefinitely. It was considered favourable social and economic policy to transfer a small amount of money from a large group of younger workers to benefit a small group of relatively poor retirees.

These assumptions were wrong. Birth rates have declined, income growth has stagnated, and mortality rates have decreased. In 1966, the ratio of Canadians under 20 to Canadians over 65 was 5.5 to 1. This ratio decreased to 2.3 by 1995 and is expected to decline further to 1.1 by the year 2030 (Canadian Institute of Actuaries 1995: 2). A more alarming trend is the relationship between workers and retirees. In 1995, the number of seniors in the population was 19.8 percent of the working-age population (ages 18 to 64). This figure is expected to increase dramatically to 38.9 percent by 2030 (Canadian Institute of Actuaries 1995: 2). These demographic changes have undermined the ability of the retirement programs and the health-care system to provide the intended level of benefits; and will continue do so.

Because of these demographic changes, the policy of transferring a small amount of money from a large group of younger workers to benefit a small group of relatively poor retirees has become, in fact, a policy of using large deductions from a small group of workers with stagnant incomes to sustain a large group of relatively wealthy retirees. The Fraser Institute's study on inter-generational accounts (Good 1995) shows that the tax rates implied by all of the different transfers that we expect to extract from our working population by the time the last of the "baby boomers" retires in 2030 is simply unsustainable.

Table 5 shows a summary of the unfunded liabilities from 1991 to 1998 of the various retirement-income support programs and the health-care system. This section considers health care along with retirement-income support programs since seniors currently consume approximately 50 percent of all health-care expenditures. This rate is expected to increase to almost 67 percent by 2030 (Good 1995: 16).

These unfunded liabilities are enormous obligations. Current estimates of the unfunded liabilities of the federal retirement-income support programs and the health-care system exceed 276 percent of the total direct debt of all governments in Canada and 274 percent of GDP. The actuarial valuations for some of these programs may be overstated because taxes used to finance expenditures are not fully incorporated into the valuation process. For example, income taxes collected from seniors in 1992 covered about 25 percent of the cost of their OAS and health-care benefits. If we use an assumption from Troubled Tomorrows (Canadian Institute of Actuaries 1995: C2), namely, that other taxes paid by seniors cover the cost of the other benefits they receive, we could reduce the estimated accrued OAS and health-care liabilities by 25 percent. This would reflect more accurately the unfunded OAS and health-care liabilities that must be borne by future generations. The adjustment is not reflected in this years' calculations as further research is necessary to determine precisely how much of the cost of OAS and health care is covered by taxes paid by seniors.

Even if the unfunded liabilities can legitimately be reduced by 25 percent, they are still an enormous burden. Restructuring retirement-income support programs should be initiated immediately to eliminate the inter-generational wealth transfer and to ensure that needy seniors do not suffer from the policy mistakes of government. Health-care funding is primarily provided through general tax revenue even though it is consumed according to a normal insurance pattern. There continue to be lengthy waiting lists for a wide range of procedures in every province and an aging population will place tremendous pressures on the health-care system. Unless governments make changes soon, these pressures will inevitably lead to higher general tax rates or a further reduction in services.

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Last Modified: Wednesday, November 24, 1999.