Evaluating Public-Sector Pensions: Are Federal Public Servants Overpaid?

Abstract

The federal government appears to believe that pay in the federal public sector should be comparable to pay in the private sector on a total compensation basis. Two recent government reports are generally consistent with this view. To implement this principle, pensions must be valued appropriately. Fair values are the best measure of a pension plan’s worth in a transaction where employees provide their labour in exchange for compensation that includes a valuable pension. However, governments appear not to apply fair value principles, preferring instead to use cost estimates developed for the funding of pension plans or for financial reporting in accordance with public-sector accounting standards. While the differences between fair values and funding estimates were not significant in the 1980s and 1990s when interest rates were high, the differences today are exceedingly large. It is undeniably more convenient for the federal government to continue to use the numbers it has been using. But it is also wrong, for to do so is to collectively guarantee federal employees a 4.1 percent real rate of return on their retirement savings at a time when other Canadians must accept a 1 percent guarantee if they seek one or, alternatively, must bear significant investment risks in pursuit of a 4.1 percent real rate of return. These guarantees are very advantageous yet public-sector accounting standards attach no value to them and the federal government appears to ignore them when assessing the reasonableness of employee compensation. The payroll for members of the federal Public Service Pension Plan was about $20 billion in 2012, with pension contributions totaling about $4 billion. At fair market value, pension contributions would have been about $8 billion. As a consequence, the federal government underestimated the 2012 compensation of these members by $4 billion and reached a long list of erroneous conclusions about the cost of its pension plans and the compensation of its employees. How can this be? The culprits appear to be actuarial and accounting standards that are incompatible with market prices and designed for purposes other than compensation management. Actuarial and accounting standards do not explicitly advocate or endorse the use of funding or accounting numbers in compensation studies but the standards-setting bodies and the professionals involved know, or ought to know, that numbers prepared for one purpose are being used for other purposes to which they are ill-suited. In this sense, actuarial and accounting standards have become the enablers of bad financial practice even though the standard-setting bodies do not advocate or condone bad practice. Given the amounts involved something should be done about this – and done soon.

Keywords: Governance and Public Institutions, Pension Papers

JEL Classification: H55, J32, H83