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1991 Report of the Auditor General of Canada

Main Points

8.1 A substantial portion of the federal annual budgetary deficit is financed through internal borrowing from accounts that the government administers on behalf of third parties. The largest internal borrowing is from federal employee pension accounts. As a result, $71 billion, or about 18 percent of the $399 billion gross public debt, was owed to employee pension accounts at the end of 1989-90. If the Department of Finance's projections that external financing will be reduced to zero by 1994-95 are achieved, it is estimated that the amount owing to employee pension accounts will represent 23 percent of the total public debt (paragraphs 8.8 and 8.9).

8.2 The long-term financial implications of borrowing from pension accounts have not been reviewed since the present pension legislation came into effect in 1954. Certain events that have transpired since then raise questions about the appropriateness of the present arrangements and indicate the need to evaluate them (8.27 to 8.39).

8.3 Interest (notional investment earnings) credited to the pension accounts is based on the government's long-term borrowing rates. It is widely agreed that these rates are between 1 and 2 percent lower, on average over the long term, than the rates of return earned by pension plans with marketable assets. This has resulted in the government assuming greater actuarial deficits (8.40 to 8.45).

8.4 At the same time, internal borrowing from pension accounts receives little attention from the Department of Finance debt managers because the borrowings are non-cash transactions (8.46 to 8.49).

8.5 Over the years, contributions have exceeded pension payments. This has helped to expand internal borrowings and reduce external borrowing requirements. Pension payments now exceed contributions, which means higher cash requirements for the government. This reversal reflects, in part, the decline in the ratio of contributors to beneficiaries. Nevertheless, borrowings from pension accounts continue to grow, mainly because of compounding interest credited to these accounts (8.50 to 8.56).

8.6 We also observed that information on pensions and public debt owing to pension accounts is not clearly presented in the Estimates and the Public Accounts. Consequently, internal borrowings from pension accounts and other specified purpose accounts are not scrutinized by Parliament in the same manner as borrowings from the general public (8.59 to 8.72).

Background

External and Internal Borrowing

8.7 For the past two decades the federal government's annual expenditures have exceeded its revenues. This revenue shortfall has been bridged by borrowing, which has led to an increase in the public debt. Exhibit 8.1 summarizes the growth in federal government liabilities by category of debt over the last decade, with projections to 1995-96 based on the February 1991 Budget.

8.8 The government borrows from two sources:

(a) External: The government borrows externally from the general public by issuing certificates of indebtedness to lenders. The government's overall statement of assets and liabilities that this Office audits annually (see Vol. I, Section 2 of the Public Accounts) discloses the cumulative outstanding balances of external borrowings as unmatured debt. This is, as evident in Exhibit 8.1 , the largest portion of public debt. These external borrowings are undertaken to meet cash requirements. However, not all financing takes place in terms of cash.

(b) Internal: A substantial portion of the government's budgetary deficit is financed through internal non-cash borrowing from specified purpose accounts (SPAs). These accounts are administered by the government for third parties. As defined in the Public Accounts, SPAs represent the recorded value of financial obligations of the Government of Canada in its role as the administrator of certain public moneys received or collected for specified purposes, under or pursuant to legislation, trust, treaties, undertakings, or contracts. In The Budget of 26 February 1991, the government described superannuation (pension) and other SPAs as trust accounts. The bulk of borrowings from SPAs comes from pension accounts. These borrowings do not involve cash but rather result from a deferral of payments of contributions and interest owed by the government to the third parties on whose behalf the SPAs are administered. No debt instrument in recognition of amounts borrowed is issued to the accounts or to the third parties.

Public Debt and Pension Accounts

8.9 The largest internal borrowings are from the pension accounts of federal government employees. At the end of 1989-90, the outstanding public debt arising from borrowing from SPAs was $78 billion, of which $71 billion or 91 percent was owed to pension accounts. As illustrated in Exhibit 8.1 , amounts owing to employee pension plans by the government accounted for about 18 percent of gross public debt outstanding in 1989-90. If the Department of Finance's projections that external financing will be reduced to zero by 1994-95 are achieved, it is estimated that the amount owed to employee pension accounts will represent 23 percent of the total public debt.

8.10 There are separate superannuation (pension) accounts for the three basic employee pension plans established by the federal government - the Public Service Superannuation Account, the Canadian Forces Superannuation Account and the Royal Canadian Mounted Police Superannuation Account. The principles and structures underlying these plans are similar. A fourth superannuation account, the Supplementary Retirement Benefits Account, was established to record receipts and payments associated with provisions to protect the defined benefits of the three basic plans from erosion due to inflation, sometimes referred to as the cost of living indexation plan. Other federal pension plans, including that of Members of Parliament, operate in a manner similar in principle to the employee pension plans; they also have cost of living indexation provisions.

Present Employee Pension Arrangement

8.11 Legislated arrangement. All employee pension plans are governed by legislation. The pension arrangements are legislated, not negotiated. Exhibit 8.2 briefly describes the current pension arrangement. Changes to the arrangement are effected through changes to existing pension legislation. For example, in 1986, the government introduced a Bill to substantially reform the pension arrangements. This Bill died on the order paper. We understand that the government is working on a new legislative proposal. The government can also make changes to the pension arrangements through further legislation. For example, in 1970, the government enacted the Supplementary Retirement Benefits Act. Also, in 1983, when wage and price controls were legislated, the indexing factor of the public service pensions was cut back to 6.5 and 5.5 percent for 1983 and 1984 respectively, even though the increase in the consumer price index - to which indexation was tied by legislation - averaged about 7.7 percent during that period. The full indexing provision was re-instituted in 1985.

8.12 The financial foundation of the pension plans is the government's promise to pay pension benefits to qualified employees on retirement and to their beneficiaries after their death. However, the federal employee pension plans are not funded through investment in marketable securities. Instead, the plans' assets are borrowed by the government.

8.13 Other national governments (e.g., U.K. and other countries in the Organization for Economic Co-operation and Development) finance their employee pension plans in much the same way as Canada does. That is, for defined benefit plans, no external funding is undertaken. In some cases, employer and employee contributions are required to be invested in government securities. Interest may or may not be credited in these cases.

8.14 On the other hand, some Canadian provinces are moving away from the internal funding model for pension plans for their public servants. Alberta, for example, established a Public Pension Fund with marketable assets in 1981. Ontario and British Columbia are heading towards a fiduciary-oriented investment philosophy. In Ontario, the assets of the municipal employee pension plan are now invested almost exclusively in the market, except for a relatively small proportion held as non-marketable provincial bonds, and pension funds for teachers and public servants are going in the same direction. Quebec and Manitoba have what is known as "split funding", in which employee contributions are invested in a fiduciary-oriented fund while employer contributions are credited to the pension account only as internal book entries. In these cases, half the benefits are paid from the employee fund, and the government pays the other half from the Consolidated Revenue Fund.

8.15 Investing of pension notional resources. The other side of the pension borrowing arrangement is the notional investment of the pension resources. The government credits interest on its cumulative borrowings from the pension accounts on two different bases: basic accounts are credited with interest at 20-year Government of Canada bond rates and the indexation account is credited at the 5-year borrowing rate as charged on borrowings by Crown corporations from the Consolidated Revenue Fund. In effect, the current notional investment strategy is to invest account balances in the equivalent of 100 percent fixed-income government securities.

8.16 Benefits and contributions. As an employer, the government agrees to pay its employees, when they qualify at some future date, a defined benefit. The government matches (or contributes more in the case of the Canadian Forces and RCMP superannuation accounts) employees' contributions.

8.17 Actuarial liability adjustment. All employee pension plans are valued on an actuarial basis. The government is fully responsible for any actuarial deficiency (i.e., the difference between the present value of estimated future payments and the notional capital value of pension accounts). Thus, from time to time, to bring the pension accounts into line with actuarially determined obligations, the accounts are credited with an actuarial liability adjustment. Actuarial deficiencies arise primarily because earlier assumptions (about mortality, retirement ages, wage and salary increases, interest rates, inflation rates and other relevant factors) underlying actuarial projections turn out to be either too high or too low and no longer represent the best estimate for the future. On the basis of new assumptions, adjustments are made to bring the liabilities recorded in the pension accounts in line with the revised estimates of pension obligations. The cumulative actuarial evaluation adjustment made between 1959-60 and 1988-89 totalled $11.6 billion. Also, in 1989-90, an actuarial liability allowance of $6.7 billion was established to cover the shortfall in the book values of all federal pension obligations to employees, Members of Parliament, federal judges, etc. This allowance was not credited to the accounts.

8.18 Budgetary coverage of shortfall in Supplementary Retirement Benefits (indexation) account. The government is entirely responsible for any shortfall in the indexation account. The Supplementary Retirement Benefits Act enacted in 1970 extended benefits to pensioners and their surviving dependents, although they had made no contributions to help fund these benefits. As well, once an individual pensioner's contributions for indexing and the employer's matching contribution, plus interest earned on contributions and previous earnings, have been exhausted, his/her benefits are charged to budgetary expenditures rather than pension accounts. Between 1973-74, when indexation came into full effect, and 1989-90, a total of $7.7 billion was charged to budgetary expenditures to cover all unfunded indexation benefits. The annual budgetary expenditure to cover indexation shortfall is now close to $1 billion.

Pension-related Budgetary Expenditures

8.19 Annual budgetary expenditures related to the operation of the pension plans are significant. In 1989-90, total budgetary expenditures related to the plans were $8.2 billion, consisting of:

$ millions

Employer contributions

896

Indexation benefits charged to budgetary expenditures

966

Interest credited to accounts

6,373

8,235

Accounting for Pension Obligations

8.20 Exhibit 8.3 illustrates how the financial transactions are recorded in the Public Accounts. Under this arrangement, the government credits employee and employer contributions to the pension accounts, along with interest due on the account balances. There are no cash flows into the accounts from the Consolidated Revenue Fund and no cash outflows from the accounts to pensioners. The government pays pensioners and beneficiaries from the Fund and debits these payments to the accounts. In effect, the government borrows the difference between annual credits and debits to the pension accounts as follows:

    - employee contributions deducted from pay cheques - credited but not "paid" to the accounts, plus
    - employer contributions due from the government - credited but not "paid" to the accounts, plus
    - interest the government "owes" on pension account balances - credited but not "paid" to the accounts, minus
    - the payment of benefits to the plans' retired employees and their beneficiaries - debited to but not "paid" from the accounts.
8.21 Basically, the pension accounts reflect the government's indebtedness to pensioners and plan members based on the pension promise. Thus, from time to time, actuarial liability adjustments, due from the government as employer and plan sponsor, are made to bring the account balances in line with pension actuarial obligations. These are credited but not "paid" to the accounts.

8.22 In 1989-90, the amount borrowed from pension accounts was $6.4 billion, consisting of:

$ millions

Employer contributions

1,050

Employee contributions

931

Interest on account balances

6,373

Other

46

Sub-total

8,400

Less pension benefit payments

2,016

Total borrowing from pension accounts in 1989-90

6,384


Treasury Board Secretariat's response: The government does not borrow funds directly from the public service pension accounts to finance other spending activities. The government has borrowed from the pension accounts only in the sense that by not raising money to invest required employee and government contributions in marketable securities it has not had to borrow money in the capital markets.

Audit Objective and Scope

8.23 Our audit objective was to assess how the government takes into account the long-term financial implications of the current pension arrangements, particularly borrowing from pension accounts, when reviewing its financial requirements and whether these internal borrowing activities are carried out with adequate disclosure and accountability to Parliament.

8.24 While our audit required an understanding of how the pension arrangements are administered, we did not audit this aspect of the pension plans.

8.25 Our audit work concentrated on the Public Service Superannuation Account, which, as Exhibit 8.4 illustrates, is the largest of all superannuation accounts and by far the largest of all specified purpose accounts.

8.26 Our audit involved the following central agencies: Department of Finance, which is responsible for managing government borrowings and the public debt (including public debt owing to pension accounts); Treasury Board Secretariat, which is responsible for program management and for policy evaluation, development and implementation of public service pensions; and the Office of the Comptroller General, which, along with Finance, is responsible for recommending the form of the Public Accounts (including accounting for pensions).

Observations and Recommendations

Need for Evaluation of Current Financing Arrangements

8.27 Because of the significant impact of borrowings from pension accounts on the management of the government's financial requirements and given the government's policy on program evaluation, we would expect the financial implications to be evaluated periodically.

8.28 The Department of Finance annually assesses the structure of the outstanding unmatured debt owing to the public and formulates recommendations to the government on external borrowing and the debt management program. There have been no studies of the long-term implications for future deficits and financial requirements of borrowing from pension accounts to finance government operations since the present legislation came into effect in 1954.

8.29 In 1977 and 1985, studies of the pension plans were done for the Treasury Board by independent actuarial consultants. While both studies reviewed the financial position and future costs of the plans and the 1985 study looked at the implications for the pension account balances of investing the pension assets, they did not examine the long-term financial implications of borrowing from pension accounts for financing government activities. Moreover, we are not aware of any other central agency review of these issues.

8.30 Since the introduction of the pension legislation in 1954, a number of events that have transpired raise questions about the appropriateness of the existing financial arrangements covering pension plans in today's environment and indicate the need to evaluate them. The Pension Benefits Standards Act (PBSA), which sets out standards for pension plan financing and fund management, was introduced in 1967 and updated in 1987. The present arrangements do not conform fully with the PBSA standards, yet the implications of this inconsistency has not been examined. The average rate of return accruing to the accounts since 1959 has been significantly lower than those earned by other private and public service plans with market assets. Benefit payments for the federal employee pension plans now exceed contributions. As well, amounts owing by the government to employee pension accounts have been a significant percentage of its total obligations, yet borrowing from pension accounts receives little attention from Department of Finance debt managers. In view of this, we believe that a comprehensive analysis of the present financing arrangements is essential to everyone's interest - the government's treasury operations, taxpayers, who ultimately finance the government's operations, and plan members. The consequences of current pension arrangements for future deficits and financial requirements need to be examined by the government on a regular basis.

Fiduciary responsibilities for employee pension plans are not consistent with those prescribed for other federally regulated pension plans
8.31 The PBSA sets out standards for pension plan financing and fund management. The PBSA requirements reflect generally accepted principles of pension fund management. Four key principles or standards contained in the Act are relevant to any evaluation of the long-term financing and borrowing implications of federal pension arrangements.

1. An employer shall ensure, with respect to its pension plan, that pension fund moneys are held in trust for the members and former members of the pension plan.

2. A pension fund shall be administered by a board of trustees/pension committee, one member of which shall be a representative of the employees.

3. The administrator shall have a clear fiduciary responsibility for the fund.

4. The fund shall be prudently invested.

8.32 These standards are intended to protect the interest of plan members by ensuring that meeting pension promises (benefits payments) is not dependent on the good will of employers. The Act applies to pension plans of businesses and other organizations under federal jurisdiction. However, Parliament excepted the federal government from the provisions of the PBSA.

8.33 It would be reasonable, however, to expect that the implications of this exception from PBSA requirements would be fully assessed, particularly as they pertain to fiduciary responsibility for, and prudent investment of, pension funds.

8.34 Through the enabling legislation, the government acts as plan sponsor, custodian, "trustee", administrator, and investment policy maker. This arrangement is not consistent with the standards prescribed in the PBSA.

8.35 In administering the federal employee pension accounts, the government has an obligation to manage the pension plan resources for the benefit of plan members. However, pension moneys are not held at arms length and, as noted before, the government is, de facto, borrowing from the pension "trust" accounts at rates that it sets. This situation would not be permitted in any legal trust arrangement.

8.36 Fiduciary responsibility for the pension plans are not clearly assigned. The decisions of both the Treasury Board and the Minister of Finance can affect the pension accounts balances. Treasury Board Secretariat calculates the rates of interest credited to the accounts in accordance with regulations set by the Treasury Board. The Minister of Finance has the authority to direct that any actuarial deficiency resulting from actuarial reviews be credited to the appropriate account. While the Department of Finance is responsible for managing the government's borrowing requirements, it is not concerned with the fiduciary implications of borrowing from pension accounts. As part of its debt management functions, in computing the public debt charges, Finance applies the rates calculated by Treasury Board Secretariat to the government borrowings from the pension accounts. This would imply that the amount of notional investment earnings credited to the pension "trust" accounts is determined by borrowing conditions and raises questions as to whether the fiduciary interests of plan members, beneficiaries and the employer are adequately served.

8.37 On the one hand, fiduciary management requires prudent investment of resources to optimize returns within specified strategic constraints. On the other hand, Finance's debt management operation has an obligation to minimize borrowing costs. Thus, it would appear that this arrangement cannot simultaneously satisfy the government's role as a fiduciary (investment) manager for the pension accounts and its role as a treasury (deficit and debt financing) manager. The present arrangement may be perceived as having legislated an automatic resolution of this conflict. As well, since the government makes up any deficiencies in the accounts, it may be perceived that this conflict has been mitigated. However, there are still questions as to the extent to which the present legislatively set formula can simultaneously satisfy both interests.

8.38 In 1986, the government introduced Bill C-33 to restructure and strengthen the financial arrangements for federal employee pension plans. By providing for the establishment of a pension management board, the Bill would have brought the present arrangements closer to the PBSA standards, although full fiduciary responsibilities were not to be assigned to the board. The Bill died on the order paper.

8.39 The government should consider establishing clear fiduciary responsibility for federal employee pension plans.

Treasury Board Secretariat's response: As noted in this chapter the pension plans for federal public servants are governed by statute. The benefits provided under the various plans are set out in and guaranteed by legislation. As such they are not determined by the method used to fund or pay for them.

In addition, the accounting methods, including the overall approach of funding the public service plans internally and recording the liabilities as part of public debt, rather than investing the contributions in marketable securities, arises out of legislation.

Therefore, both the benefits and funding and financing of public service pensions reflect policies established by Parliament and only Parliament, through legislative action, could change those policies.

In this context, employment by her Majesty in right of Canada is "excepted employment" for the purposes of the federal Pension Benefits Standards Act (PBSA). The funding and plan management requirements arising out of the PBSA are intended to protect the interests of plan members who are employed with companies or corporations whose continued existence is not guaranteed. It is not necessarily appropriate that all requirements of the PBSA apply to the public service pension plans.

There are objective ways of determining what an appropriate contribution rate should be for the public service pension plans for the purpose of demonstrating that plan members have "earned" their benefits regardless of how the plans are funded or financed. Nevertheless, it has long been recognized that if the public service pensions accounts were to be credited with a rate of investment return equivalent to returns realized by plans invested in marketable securities, comparisons between the cost of the public service plans and private sector plans could be more easily and equitably made. Therefore, the rate of return credited to the pension accounts remains a key issue in the public service pension reform process.

Rates of interest credited to the pension accounts are significantly lower, on average over the long term, than rates of return earned by pension plans with capital market assets
8.40 We engaged actuarial consultants to compare the notional investment performance to the rates of return that the pension plans' notional financial assets could have earned had they been invested through the market. A number of different scenarios were developed for the 31-year period from 1959 to 1990, for which consistent data were available from Treasury Board Secretariat. The annual rates of return are compared in Exhibit 8.5 for various scenarios.

8.41 As can be seen from the exhibit , over the entire 31-year period, a market investment strategy would have resulted in annual rates of return from 1.5 to 2.3 percent higher than the notional bond investment strategy applied to the pension accounts. The reader should note, however, that there have been periods (1970 to 1974 and 1985 to 1990) when such market strategies may not have produced better returns. Nevertheless, the intrinsic strength of a market-based investment fund is founded on the long-term growth of the economy, even recognizing downturns in the business cycle from time to time.

8.42 Financial managers, actuaries and government officials generally agree that, over the long term, a diversified portfolio of market investments will yield rates of return higher than interest rates credited to the pension accounts. Thus, the government's Chief Actuary indicated in his 1986 actuarial report on the Public Service Superannuation Accounts that the present notional investment strategy might result, over an extended period of time, in approximately a one percent per year lower rate of return on the total accounts balance than one might reasonably expect from private sector pension funds. Also, data maintained by Treasury Board Secretariat's Pension Division show that, over the previous 30 years, the average rate of return credited to the notional accounts was more than one percent lower than the average annual median return earned by pension funds with marketable securities.

8.43 The lower the interest rate credited to the pension accounts balances, the higher the actuarial deficits (the difference between the actuarial present value of all future benefits that have been earned for services provided and the pension accounts balances). The higher rates of return that the pension accounts could have earned had a market investment strategy been followed over the long term could have substantially reduced or totally eliminated these actuarial deficits. Likewise, budgetary expenditures to cover shortfalls in the indexation account might have been reduced in whole or in part. Consequently, the deficit and debt accumulation could have been lower if a market investment strategy for the pension accounts had been followed from the start.

8.44 In a notional sense, the lower the interest rate credited to pension accounts balances is, the lower the recorded interest on the public debt will be. However, as indicated above, any shortfall in the balances in the pension accounts compared to actuarially determined obligations must be made up by the government alone. The lower the interest rate attributed to the pension accounts is, the higher these supplemental contributions that are charged to budgetary expenditures will be. In the end, the long-term implications for the deficit and the public debt of a notional investment strategy for the pension accounts are not known and need to be evaluated.

8.45 If Bill C-33 (1986) had been passed, it would have established a new basis for determining interest credited to the pension accounts. In the arrangement envisaged, interest credits on future contributions were to be based on the average returns achieved by 10 plans chosen in advance from a sample of 50 large private sector plans invested in balanced portfolios. This arrangement proposed in the Bill might have resulted in higher interest credits to the accounts (and higher interest on the public debt), lower actuarial deficits and lower shortfalls in the indexation account. However, interest on pension debt would still not have been paid in cash; the long-term impact of this deferral of payment on fiscal management will remain obscure until fully examined.

Internal borrowing from pension accounts is largely outside the influence of debt management operations and has received little attention from debt managers
8.46 We would expect borrowing strategies to be based on the overall objective of borrowing appropriate amounts at appropriate times and at least cost over the long term, given constraints.

8.47 The present legislative arrangement for the pension accounts provides the government with a captive source of financing. However, borrowing from pension accounts is largely outside the influence of the Department of Finance's debt management operations, since they have no discretion as to the amount borrowed, the interest rate applied or the term to maturity. In effect, Finance, as the public debt manager, is required by law to borrow from the pension accounts at the current market rate regardless of the need to borrow. Once established, the notional rates of interest accruing to the basic pension accounts are locked in for 20 years. These borrowing costs change only with a long time lag following changes in market conditions. Furthermore, no debt instruments are issued or traded and no cash is involved when borrowing from or crediting interest to the pension accounts, and internal borrowing has no direct impact on market interest rates.

8.48 The objective of Finance's debt management operation is to meet the government's borrowing requirements while minimizing total long-run debt costs and the impact of changes in interest rates on debt charges. A necessary condition for the attainment of this objective is the flexibility to establish and change the total debt structure (mainly through incremental borrowings - new and roll-over - but also through swap arrangements and other debt management techniques) in light of changing market conditions. However, this flexibility is not available with respect to debt incurred under the present legislated pension plan arrangements. As well, cost-minimization strategies that are appropriate for the management of external borrowing, debt servicing and debt refinancing - all of which are cash transactions - may not be applicable to borrowing from pension accounts. Therefore, the integration of internal with external borrowings should be kept under regular examination to ensure that it does not impinge on the overall debt strategy.

8.49 In its most recent annual debt strategy review, Finance illustrated how borrowing from the pension accounts affects the term structure of new debt to be issued over the five-year fiscal planning horizon. The Department has also indicated to us its intention, in its next debt strategy review, to review borrowings from the pension accounts over a longer term, taking into account the impact of the expected drop in financial requirements and increased flows from pension accounts. This review should include an analysis of the long-term implications for the deficit and the public debt of alternative pension plan funding and financing arrangements.

Annual pension payments now exceed contributions, which means higher cash requirements for the government
8.50 For many years, the annual combined (employer and employee) contributions to the pension accounts exceeded the benefits (paid to pensioners and their beneficiaries) charged against these accounts. The surplus of contributions, plus interest credited to account balances, less pension benefits, has meant that the government could cover a large portion of budgetary expenditures related to pension accounts without having to borrow in the market. That is, the excess of contributions over payments has helped to expand internal borrowing and reduce external borrowing requirements. However, in 1989-90, as illustrated by Exhibit 8.6 , combined benefit payments from all pension accounts (excluding indexation benefits charged to budgetary expenditures) exceeded annual contributions. Total pension payments, including benefits charged to the Consolidated Revenue Fund to cover indexation account shortfall, exceeded contributions as early as 1980-81.

8.51 The following points are evident from Exhibit 8.6 :

  • Up to 1989-90, contributions exceeded pension payments, which meant lower cash requirements for the government.
  • The rate of growth of payments has been significantly greater than that of contributions, leading to the disappearance of the "favourable" cash requirement gap last year and to the prospect of an expanding "unfavourable" cash requirement gap in the future.
  • Pension account balances are increasing mainly because of the compounding interest credited to the accounts. If the above trends continue into the future, pension payments may well continue to climb sharply. This will mean higher cash requirements for the government. Given the defined benefits, this will have to be met through one or more of the following: a higher contribution rate; higher external borrowing; higher taxes; or lower expenditures on other things.
8.52 The fact that payments now exceed contributions reflects, in part, the decline in the ratio of contributors to pensioners. Exhibit 8.7 below illustrates the decline in this ratio for the superannuation accounts of the Public Service, the RCMP and the Canadian Forces, between 1978 and 1990.

8.53 The decline in the number of contributors per pensioner is projected to continue, which means that the gap between pension payments and contributions will tend to open further as time passes.

8.54 The trend in contributions, payments and the ratio of contributors to pensioners raises concerns that the present method of funding pension benefits may be shifting the debt burden forward to future taxpayers. As a result, there is a need to examine the financial implication of these trends. Two points are worth noting in this connection.

8.55 First, unless the rate of return on investments (notional or real) reflects a market rate of investment earnings, there is no objective basis for evaluating the correctness of contribution rates vis-à-vis the defined level of benefits.

8.56 Second, under the present arrangement, cash for the payment of benefits comes solely from current revenues - taxes in the main - or from borrowing from the public; there is no additional source of income from an invested pension fund to help with the overall financing. In the case of pension plans with marketable securities, investment earnings provide the main source of funding benefit payments once the funds are well established. In other words, a market-oriented pension fund could, over the long run, put less of a burden on taxpayers by reducing reliance on government revenues for financing pension benefits.

8.57 The lower, long-term, average investment return of the present notional investment policy and the implications of indexation shortfalls for the budgetary deficit and the public debt, along with the trend in contributions and payments, strongly suggest that all aspects of the financing arrangements for the pension plan should be reviewed. Obviously, the financial, economic and political complexities of any change in the status quo would require careful consideration. Furthermore, the experience of other jurisdictions, such as that of provincial governments, that have embarked on funded pension plans would be useful in such a review.

8.58 The government should undertake a study of the costs/benefits and long-term implications of alternative financing arrangements of its employee pension plans. This should include an evaluation of the implications of the current notional investment policy on the deficit, financial requirements and the public debt.

Department of Finance's response: An internal study of the long-term implications for the deficit and debt management of the existing financing arrangements for the pension plans will be jointly undertaken by Finance and the Treasury Board Secretariat.

Treasury Board Secretariat's response: The number of contributors to the public service plans has actually decreased in recent years, both in absolute numbers and in relation to Canada's population. Therefore, the cash requirements for paying the future pension benefits of federal public servants are not expected in the long term to become a burden on the taxing or borrowing capacity of the federal government.

The Treasury Board Secretariat and the Department of Finance do intend to review the implications of the current financing and funding system for public service pensions.

It should be noted, however, that there are many considerations beyond simply debt management or comparative rates of return in assessing the desirability or feasibility of investing federal pension plan moneys in marketable securities. Such issues would include the capacity of the markets to absorb large amounts of new money, control of the funds, potential concentrations of financial power and the ability to maintain arm's length relationships.

Information for Parliament

Information to Parliament on pensions is not clearly presented
8.59 We would expect Parliament to be provided with sufficient information to fully scrutinize all the government's borrowing activities, including those involving captive funds, such as pension accounts.

8.60 We would also expect borrowings from pension accounts to be identified and reported in the Estimates and the Public Accounts as internal borrowings and the cumulative obligations to be clearly reported as public debt in the Public Accounts.

8.61 Parliamentarians rely on a number of sources of information to facilitate their review of government operations. For financial information, they use Part III of the Estimates and the Public Accounts. Information on employee pension plans in these documents is inadequate and inconsistent.

8.62 Program costs and liabilities for employee pensions are significant, and Parliamentarians should be provided with both an overview and details of these costs and liabilities in both forecast (Estimates) and actual (Public Accounts) accountability documents. In 1989-90, pension-related expenditures amounted to over $8 billion, and outstanding employee pension liabilities amounted to $71 billion.

8.63 Public Accounts. In the government's summary financial statements in Section 2 of Volume I of the Public Accounts, the balances in the federal employee pension accounts are included under the general classification of specified purpose accounts and are not clearly presented as public debt. The nomenclature of SPAs may be useful for general ledger control purposes, but the accounting treatment in the financial statement is inconsistent. In the National Accounts presentation, which is used for economic analysis, pension accounts are included as a component of public debt.

8.64 The Public Accounts also provide details of pension costs, but the link between public debt and interest on public debt is far from clear. Interest on the public debt includes interest credited to pension accounts and other SPAs, as well as interest paid on unmatured debt held by the general public. Although interest credited to employee pension accounts is included in public debt cost in the government's statement of revenue and expenditure, the balances in the accounts themselves are not included as unmatured debt in the statement of assets and liabilities. If we compare interest expenses for 1989-90 to unmatured debt, the average rate of interest appears to be over 13 percent. In fact, for all public debt, including that held by SPAs, the actual average rate is under 11 percent. This potential for confusion could be removed by showing charges on public debt arising from external and internal borrowings, separately and collectively, in a note to the financial statements.

8.65 Estimates. The three major employee pension plans are administered under separate departments. The Department of National Defence administers the military plan, and the RCMP administers the plan for members of the force. The Public Service Superannuation Plan is the host plan for all other employees of the federal government and certain other entities (primarily Crown corporations) and operates under the umbrella of Treasury Board. Costs are allocated to each department, except for interest, which is charged to interest on the public debt and thus comes under the Department of Finance.

8.66 Neither National Defence nor the RCMP Part IIIs provide details on the costs of their pension plans (excluding the interest component), even though they account for approximately 6 and 10 percent, respectively, of each department's budget. Public Service Superannuation Plan information is even more dispersed. Because pension costs, other than interest, are allocated to departments, there is no disclosure of aggregate pension costs for the plan in Estimates documents, although (excluding interest) they exceed $1 billion annually. As a minimum, we would expect Part IIIs to contain narrative details of each pension plan, disclosure of plan costs, and (with appropriate cross-reference to the Part IIIs of Finance) the liabilities that have accumulated to the end of the period. Nowhere is this information provided.

8.67 The situation is more confusing in the case of the interest expense relating to pension accounts, which is charged to the Department of Finance as part of total public debt charges. Finance's Part IIIs do not describe the financing structure of the pension accounts or the long-term nature of this type of financing vehicle. The Department currently provides details of interest costs on external borrowings, by types, for a period of years. This disclosure should be extended to internal borrowings from pension accounts, with appropriate cross-referencing to the Part IIIs of Treasury Board Secretariat, Defence and the RCMP.

Department of Finance's response: The Public Accounts, Part II, Volume II, already provides a breakdown of public debt charges incurred on behalf of the pension accounts. Nevertheless, the Department will examine the merits of providing the suggested further disclosure in the Part IIIs.

Inadequate information limits parliamentary scrutiny of borrowings from pension accounts
8.68 The accumulation of debt owing to pension accounts is now increasing by over $6 billion annually. The amounts borrowed by the government from the employee pension accounts during the year are not included in the Borrowing Authority Act. We are concerned that, because of the inadequacy of information on pensions, Parliament is not in a position to scrutinize borrowings from federal employee pension accounts to finance the budgetary deficit in the same manner as external borrowings, and that fiscal accountability is therefore diminished.

8.69 The government should clearly present pension obligations as public debt in the Public Accounts. Adequate information should be provided in the Estimates to enable Parliament to review program details, including the present value of long-term obligations arising from government employee pension plans.

Office of the Comptroller General's response: Parliament has been provided with adequate financial information on employee pensions. However, the presentation of the information may not have provided a clear link with borrowing activities of the government. We will take under consideration this recommendation when we review the presentation of the summary financial statements and related note disclosure.

With regards to the Public Accounts, we can see the usefulness of presenting the pension obligations under the specified purpose accounts classification as is current practice but we also recognize these obligations are part of public debt. In future, we will consider this recommendation when we review the presentation of the summary financial statements and related note disclosure.

Over the last several years, the Office of the Auditor General has placed increasing emphasis on the Part III of the Estimates as a key accountability instrument to Parliament. However, it must be noted that Part III is a departmental expenditure plan which provides an understanding of program mandate, objectives, activities, resources used and required in relation to results achieved and expected. In that context, the focus is on annual appropriations for purposes of program delivery, not principally on public debt, cost of government infrastructure or the efficacy of government financing mechanisms.