Chief Actuary Position Paper – Subsection 113(2) of the Canada Pension Plan

Office of the Chief Actuary
Office of the Superintendent of Financial Institutions Canada
255 Albert Street
Ottawa, Ontario
K1A 0H2

E-mail address: oca-bac@osfi-bsif.gc.ca

1. Context

Under the Canada Pension Plan (the Act), a province can withdraw from the Canada Pension Plan (CPP) if certain legislative requirements are met. Alberta is looking into the possibility of exiting the CPP and establishing a provincial pension plan. If this were to occur, pursuant to subsection 113(1) of the Act, all accrued and accruing obligations and liabilities in Alberta would be assumed by Alberta, and the Minister of Finance would pay out a prescribed amount to the Government of Alberta. Subsection 113(2) of the Act outlines the calculation that the Minister of Finance shall apply in determining the amount that would be transferred to the Government of Alberta.

In September 2023, the Government of Alberta released a report providing an actuarial analysis of a potential Alberta pension plan prepared by LifeWorks (currently known as Telus Health). Following the release of this report there has been much public debate related to potential positions on subsection 113(2) of the Act.

The Chair of the CPP Committee of Officials representing the federal, provincial and territorial Ministers of Finance asked the Chief Actuary of the Office of the Superintendent of Financial Institutions to develop her own position on subsection 113(2) of the Act, in consultation with relevant experts, as appropriate.

In response to this request, the Chief Actuary has formulated her position based on a close reading of the legislation. Her position is also informed by expert views gathered via the creation of an Independent Advisory Panel of actuaries (IAP) and the review of other publicly available information.

The purpose of this paper is to present the Chief Actuary's position on subsection 113(2) of the Act.

2. Chief Actuary's position on subsection 113(2) of the Canada Pension Plan

This section outlines the Chief Actuary's position on subsection 113(2) of the Act, which sets out the amount to be paid to the government of a province that is establishing its own pension plan. In developing her position, the Chief Actuary primarily relied on a close reading of the Act (subsection 113(2) is presented in Appendix A). The position therefore reflects the Chief Actuary's opinion and best judgement of the meaning of the legislation's wording and textual indications. The following items were also considered in formulating her position:

• The findings of the IAP (summarized in Appendix B)
• Publicly available positions on subsection 113(2) of the Act, namely the "Literal" and "Alternate and Reasonable" positions presented in the LifeWorks report as well as positions presented in papers published by Dr. Trevor Tombe, professor of economics at the University of Calgary (summarized in Appendix C).
• Other publicly available information such as the opinions of professionals from various fields, historical parliamentary debates and publications as well as the original legislation.

The Chief Actuary's position is intended to respond to the request made by the Chair of the CPP Committee of Officials representing the federal, provincial and territorial Ministers of Finance and to provide support to the Minister of Finance in determining the amount that shall be paid to the government of a province establishing a provincial pension plan. Given that the legislative responsibility to calculate and pay the amount resides with the Minister of Finance, the final position on subsection 113(2) of the Act is that of the Minister's.

2.1 Chief Actuary's position

The following are the Chief Actuary's conclusions based on the wording and textual indications of subsection 113(2) of the legislation. Further rationale and comments on the components included in the transfer amount are presented in the next section. The actual text of subsection 113(2) of the Act is presented in Appendix A.

The Chief Actuary's position, although independently developed, is consistent with the findings of the IAP and the method presented in Dr. Tombe's paper.

2.2 Rationale and comments

2.2.1 General comments on subsection 113(2)

Subsection 113(2) sets out the amount to be paid to the government of a province that is establishing its own pension plan. This amount is to be calculated by the Minister of Finance and is determined in accordance with an established formula that is comprised of four separate components. Each component is described in a separate paragraph, such that the total amount transferred is:

$\mathrm{Total\; amount\; transferred}=\left(a\right)+\left(b\right)-\left(c\right)-\left(d\right)$

Each component is determined over the reference period which is defined as the period from the inception of the CPP to the date that the provincial plan becomes effective. The calculation assigns to a province establishing its own pension plan a share of historical contributions, historical net investment returns and interest credits (net investment income), historical benefits and historical administration costs over the reference period.

Although paragraphs (a), (c) and (d) set out methods for calculating the amounts of historical contributions, benefits, and administrative costs to be included in the transfer amount, paragraph (b) does not set out a method for calculating the historical net investment income to be included. The Chief Actuary therefore relied on textual indications in paragraph (b) to develop her position on a calculation method for apportioning net investment income.

More rationale and comments on each paragraph can be found below. It is also important to note that while the Chief Actuary's position is described in general terms, a detailed analysis will be required to calculate each component of the transfer amount, and certain assumptions may be necessary to address data limitations.

2.2.2 Paragraph 113(2)(a)

This paragraph sets out the contributions to be included in the calculation of the transfer amount of an exiting province. The language is clear and unambiguous. It refers to the total amount of all contributions credited to the Canada Pension Plan Account (CPP Account) and the Additional Canada Pension Plan Account (ACPP Account) in respect of employment or self-employment in that province over the reference period.

As such, whatever amounts were contributed and attributable to employment in the province since the inception of the CPP are to be included for the purposes of this paragraph. This amount can be calculated from historical data.

The Chief Actuary's position on this paragraph is consistent with the findings of the IAP.

2.2.3 Paragraph 113(2)(b)

This paragraph describes the net investment income to be included in the calculation of the transfer amount of an exiting province. Although the paragraph does not clearly set out the calculation method, there are textual indications that must be respected when performing a calculation pursuant to this paragraph. The key textual indications in the paragraph are listed below. Using these textual indications, the Chief Actuary presents her position on the paragraph which includes a calculation method.

Fixed amount to be apportioned

Through the use of the words "the part of", it is clear that the amount that follows is to be apportioned. From the remaining wording, it is clear that the amount to be apportioned is a fixed amount comprised of all net investment return and interest earned by the Canada Pension Plan Investment Board (CPPIB) as well as the CPP and ACPP Accounts during the reference period. This fixed amount can also be referred to as the net investment income of the CPP.

Furthermore, the direct references to "the net investment return" and "all interest credited to or accrued to the credit of the Canada Pension Plan..." indicate that the fixed amount is a known amount that can be determined for the CPP as a whole using historical data. There is no indication that net investment income should be re-calculated using historical annual cash flows and rates of return.

Therefore, it follows that the fixed amount to be apportioned, that is, the net investment income, is to be determined as a whole by taking the difference between the total value of CPP assets at the end of the reference period and the total amount of net CPP contributions (total CPP contributions minus total CPP expenditures) over the reference period.

Meaning of taking a "part of"

The use of the words "part of" indicates that the net investment income can be divided into parts and that those parts must add up to the whole amount of net investment income. Furthermore, when read plainly, the word "part" indicates a positive amount. Finally, since the right to exit the CPP is available to all provinces, the division into parts must be possible in any type of scenario faced by the CPP, whether there is one departing province or several, or all provinces departing at the same time.

It therefore follows that a theoretical apportionment to all provinces at once would result in:

• each province being assigned a part of the net investment income, with the sum of all parts being equal to 100% of the net investment income; and
• each province being assigned a positive part. This means that no province would be assigned a negative part under paragraph 113(2)(b).

A calculation method that results in negative parts, or in a hypothetical allocation to all provinces that is higher than the total net investment income does not respect the textual indications of the legislation.

Meaning of "derived from the contributions referred to in paragraph (a)"

The paragraph ends with a description of what is to be considered in determining the part of the net investment income that is to be assigned to the province exiting the CPP. The wording specifies that the part is "derived from the contributions in (a)".

The term "derived from contributions" is not a technical term and does not impose a calculation method. However, the wording is clear that no factor other than contributions in paragraph (a) should be considered when identifying a part. It therefore follows that benefit payments referred to in paragraph (c) and administration costs referred to in paragraph (d) are not to be considered while apportioning the net investment income.

Furthermore, the direct reference to paragraph (a) makes use of the word "total" to specify what contributions to include.

Calculation method respecting textual indications

Relying on the textual indications in paragraph (b) that are described above, the legislation supports apportioning the total net investment income of the CPP based on the proportion of the province's total contributions determined in paragraph (a) relative to total CPP contributions over the reference period.

This calculation method respects the textual indications as follows:

• since all contributions are positive amounts, the resulting parts of the net investment income can never be negative such that, the "part" "derived" from contributions would always be a positive amount;
• if all provinces were to exit at the same time, the parts would add up to the total net investment income;
• no factors other than contributions are used to apportion the total net investment income; and
• total contributions form the basis to determine a proportion of contributions, which is then used to apportion the net investment income.

The resulting calculation method is also in line with how loans were granted to provinces and interest was credited to the CPP account when the legislation was first enacted.

The Chief Actuary's position on this paragraph is consistent with the findings of the IAP.

Furthermore, in the Chief Actuary's opinion, neither of the positions presented in the LifeWorks report respect the textual indications of the legislation. The 'Literal' interpretation presented in the LifeWorks report would result in a hypothetical allocation to all provinces that is higher than the total net investment income. The 'Alternate and Reasonable' interpretation could result in negative allocations for certain provinces and considers factors other than contributions (benefit payments and administration costs) to apportion the total net investment income.

2.2.4 Paragraph 113(2)(c)

This paragraph sets out the benefits to be included in the calculation of the transfer amount of an exiting province. The language is clear and unambiguous. It refers to benefits paid under the Act that would not have been payable if the province had established its own pension plan at the inception of the CPP and had never participated in the CPP.

This amount can be calculated from historical data. Since the benefits need to be established based on province of employment (i.e. where the contributions were made), careful analysis is required to properly reflect individuals with contributions in a province or territory other than where they reside.

The Chief Actuary's position on this paragraph is consistent with the findings of the IAP.

2.2.5 Paragraph 113(2)(d)

This paragraph sets out the part of the administration costs to be included in the calculation of the transfer amount of an exiting province. The language is clear and unambiguous, and sets out the method for determining the part. It specifies that the part is determined as the proportion of the province's total contributions relative to total CPP contributions over the reference period. This amount can be calculated from historical data.

The Chief Actuary's position on this paragraph is consistent with the findings of the IAP.

2.3 Additional notes regarding actuarial principles

The Chief Actuary's position presented in this document is based on a close reading of subsection 113(2) as it is written in the Act. It does not represent the Chief Actuary's opinion on an actuarially sound method of determining a transfer amount to the government of a province exiting the CPP.

Generally, there are principles underlying the distribution of assets when one or many participating entities exit a defined benefit pension plan (DBPP). In Canada, there are pension legislations and policies in place that govern the distribution of DBPP assets in accordance with these principles. Given that the CPP is a social insurance program with plan provisions and a funding mechanism that are significantly different from that of Canadian DBPP, a one-for-one relationship between policies and rules governing Canadian DBPP and the CPP is not always appropriate. However, considering the defined benefit nature of the CPP, principles and objectives governing asset transfer in Canadian DBPP can still be used as a reference to assess the actuarial soundness of subsection 113(2) of the Act. Those principles and objectives are as follows:

• Maintaining risk pooling principles up to the date of the distribution of assets.
• Maintaining the security of accrued benefits for both the portion of the plan paying the transfer and the portion of the plan receiving the transfer.
• Ensuring that the distribution of assets does not have a material negative impact on the funding status of the remaining portion of the plan.

Subsection 113(2) of the Act does not fully reflect the principles outlined above and, in the opinion of the Chief Actuary, would not be considered in line with sound actuarial principles.

The Chief Actuary's opinion on this is consistent with the findings of the IAP.

Appendix A – Legislation

113(2) For the purposes of subsection (1), the amount to be calculated as provided in this subsection in the case of any province shall be calculated by the Minister of Finance as the amount obtained by adding:

• (a) the total amount of all contributions credited to the Canada Pension Plan Account and the Additional Canada Pension Plan Account, to the day on which the regulation referred to in subsection (1) became effective, in respect of employment in that province or in respect of self-employed earnings of persons resident in that province, and
• (b) the part of the net investment return of the Investment Board and all interest credited to or accrued to the credit of the Canada Pension Plan Account and the Additional Canada Pension Plan Account, to the day on which the regulation referred to in subsection (1) became effective, that is derived from the contributions referred to in paragraph (a),

and subtracting from the total so obtained

• (c) such part of all amounts paid as or on account of benefits under this Act as would not have been payable under this Act if that province had been a province described in paragraph (a) of the definition province providing a comprehensive pension plan in subsection 3(1), and
• (d) the part of the costs of administration of this Act, to the day on which the regulation referred to in subsection (1) became effective, that is equal to the proportion of those costs that the total amount of the contributions referred to in paragraph (a) is of the total amount of all contributions credited to the Canada Pension Plan Account and the Additional Canada Pension Plan Account to that day.

Appendix B – Summary of views of the Independent Advisory Panel

In the process of developing her position, the Chief Actuary gathered views of relevant experts via the creation of an Independent Advisory Panel (IAP) and review of publicly available sources. The IAP was comprised of five actuaries who have extensive experience in social security and/or pensions. Panel members had varied backgrounds that allowed for a range of views to be discussed.

The IAP was asked to provide the Chief Actuary with a joint report providing their views and positions on subsection 113(2) of the Act. A summary of the IAP's views is presented in this appendix.

The IAP found broad agreement on how to calculate paragraphs (a), (c) and (d) (contributions, benefits, and expenses). The IAP identified the issue as how to allocate investment earnings (paragraph (b)) to a withdrawing province and, more specifically, how to interpret "derived from the contributions referred to in paragraph (a)".

The IAP's interpretation of paragraph (b) of subsection 113(2) is that:

• Its original purpose was to allocate the net investment return (NIR) accumulated in the reserve. This implies that the total of the amount allocated to every participating province must be equal to the total NIR credited to the reserve; no more, no less.
• It follows from this interpretation that should all provinces withdraw from CPP, the sum of the amounts calculated under paragraph (a) and (b) would be a positive number for every participating province. It is conceivable though, that the net amount for certain provinces, once the amounts under paragraphs (c) and (d) have been deducted, could be a negative amount.
• With regards to how NIR should be allocated by province, the IAP believes that the words "derived from the contributions referred to in paragraph (a)" should be interpreted to mean: the allocation should be based on the amount of contribution as recorded: i.e. the contributions made without regards to the benefits paid.
• Given these observations, four of the panel members prefer the approach espoused by Tombe over the approach espoused by LifeWorks.^{Footnote 1} One member of the panel was not prepared to opine on a preferred method of allocation of NIR based on their actuarial expertise and available information.

The Chief Actuary's position, although independently developed, is in line with the IAP findings.

Appendix C – Summary of publicly available positions

This appendix provides high level and simplified summaries of three positions that have been publicly debated. Readers are expected to refer to the appropriate source documents to fully understand the nuances in the positions.

C.1 Literal reading based on the LifeWorks Report

Based on the LifeWorks Report, Alberta Pension Plan – Analysis of Costs, Benefits Risks and Considerations, a literal reading of the legislation implies that investment returns should only be applied to CPP contributions, and not to benefit payments and administration costs. A detailed discussion can be found in Appendix B of the LifeWorks Report.

Based on the literal reading approach of the LifeWorks report, the amount of the transfer amount can be expressed as the following formula:

$\mathrm{Transfer\; Amount}=A+B-C-D$

where,

• A: CPP contributions paid in Alberta since 1966
• B: Compounded annual investment returns on contributions referred to in item A, based on the historical yields and net investment rates of return of the CPPIB as the case may be
• C: Benefits that would not have been paid from the CPP if an Alberta Pension Plan had been set up in 1966
• D: Share of total costs of administration of the Act, based on proportion of contributions paid in Alberta since 1966 relative to total CPP contributions since 1966

C.2 Alternate and reasonable approach based on the LifeWorks Report

The main findings in the LifeWorks report are based on an approach that is qualified in the report as alternate and reasonable. Under this approach, investment returns are applied to the net cash flows of contributions less benefit payments and administration costs (rather than only to contributions as presented in the literal reading approach above).

Based on the LifeWorks report alternate and reasonable approach, the amount of the transfer amount can be expressed as follows:

$\mathrm{Transfer\; Amount}=A+B-C-D$

where,

• A: CPP contributions paid in Alberta since 1966
• B: Compounded annual investment returns on Alberta's net cash flows (contributions (A) less benefit payments (C) less costs of administration of the Act (D)), based on the historical yields and net investment rates of return of the CPPIB as the case may be
• C: Benefits that would not have been paid from the CPP if an Alberta Pension Plan had been set up in 1966
• D: Share of total costs of administration of the Act, based on proportion of contributions paid in Alberta since 1966 relative to total CPP contributions since 1966

C.3 Dr. Trevor Tombe – Allocation of investment returns by historical contribution shares

Dr. Trevor Tombe, professor of economics at the University of Calgary, published a paper The Alberta Pension Advantage? A Quantitative Analysis of a Separate Provincial Plan (PDF) in October 2023. In section 4.2 Dividing the Canada Pension Plan Investment Funds, an interpretation of the legislation is presented wherein the allocation of net investment returns is based on the aggregate share of Alberta's contributions to the CPP.

$\mathrm{Transfer\; Amount}=A+B-C-D$

where,

• A: CPP contributions paid in Alberta since 1966
• B: Share of total CPP net investment income and interest apportioned to Alberta based on the ratio of Alberta's aggregate historical contributions to the aggregate historical total CPP contributions since 1966^{Footnote 2}
• C: Benefits that would not have been paid from the CPP if an Alberta Pension Plan had been set up in 1966
• D: Share of total costs of administration of the Act, based on proportion of contributions paid in Alberta relative to total CPP contributions