Good morning, and thank you for the opportunity to present today. On behalf of eBay Canada, I appreciate the committee's focus on ways to improve Canada Post, something in which we also have a keen interest. Indeed, eBay participated in phase one of the task force hearings, and I've also written and spoken on this topic in various forums.
We care about Canada Post for the same reason that this committee and all Canadians should; there are more than one million small and medium-sized businesses, or SMBs, in Canada that rely on Canada Post as an essential part of doing business. It's not overstating the case to say that Canada Post provides critical enabling infrastructure to the Canadian economy.
Let me begin with some background on eBay. Launched more than 20 years ago, eBay has become one of the world's largest online marketplaces, with approximately one billion listings and 165 million active buyers globally. Here in Canada, eBay is a top e-commerce destination, with more than eight million unique visitors each month who trade more than $1 billion each year.
In addition to changing how consumers buy, e-commerce has changed the way we sell. eBay has created a platform where anyone can become an entrepreneur, starting with a single listing, and e-commerce is levelling the playing field for rural versus urban retailers. You no longer need to live in a city to access enough buyers to make your business viable.
Canadian entrepreneurs have been able to make impressive gains through e-commerce, and we should be very clear that Canada Post is a critical partner in driving that success. At present, there's much talk about the innovation agenda, but the reality is that SMB innovation is facilitated by a 200-year-old corporation.
Canada Post allows small and medium-sized Canadian businesses to participate in the global economy by offering relatively cost-effective access to the world in what could be described as a 21st-century trading route. In terms of significance, this is meaningful trade. Canadian commercial sellers on eBay export at a rate of 99.9%, reaching 20 markets annually, much stronger results than those of traditional SMBs. As a result of their ability to effectively serve foreign markets, these companies find that, on average, more than half of their sales come from international customers.
Canada Post has more than a 90% share of eBay Canada transactions. There can be no doubt that the micro-multinationals I've just described depend on Canada Post to drive their businesses both domestically and internationally.
Canada Post is an enabler of small and medium-sized businesses, but it also creates significant challenges for them. For example, this summer's uncertainty around a possible disruption created major business obstacles for Canadian SMBs. While a work stoppage didn't occur, Canadian businesses were forced to prepare for the possibility of a strike or lockout. They had to invest time and effort in adopting alternative, and in many cases, more expensive shipping arrangements. Given what we heard from our sellers, we were not surprised when, on July 8, Canada Post announced that its parcel volume had declined by more than 80%.
Unlike their larger competitors, smaller businesses were not able to leverage their scale to negotiate favourable rates with private couriers, and as a result, many SMBs were forced to create patchwork solutions to ensure they could meet buyer expectations. As Winnipeg-based small business owner Maureen Lyons described to this committee, she had to “offer local pickup for regional sales, courier service for domestic orders, and day trips south to utilize USPS for international sales.” Maureen was one of thousands of sellers dealing with this uncertainty.
As the risk of a work stoppage extended into August, eBay drafted a letter to the asking for a return to consistent postal services. Within 24 hours, more than 2,000 concerned eBay sellers had signed the letter. Everyone was gratified to see that a negotiated settlement was reached shortly thereafter, but given that it's a two-year agreement, SMBs worry that they'll be facing a return to uncertainty in a matter of months.
Going forward, we believe that Canada Post should focus on accelerating the growth in its parcel division by expanding its e-commerce services, including affordable tracking and aggressive rate tiering. Further, Canada Post should invest in improved marketing of the e-commerce services it has already created, such as flex delivery, to drive wider awareness and adoption.
Modernization of customs rules would also drive volume for Canada Post. As the task force noted, Canada's de minimis threshold, the value of goods that can be shipped into Canada before duty and taxes are assessed, is out of line with international standards. Increasing it could accelerate parcel volume growth. eBay Canada concurs and asks that the committee recommend increasing Canada's de minimis threshold.
As a platform for small and medium-sized Canadian businesses, eBay appreciates the time to appear before you today, and I look forward to your questions.
Good morning, Mr. Chair and members of the committee. Thank you very much for the invitation to testify today. Here with me are partners Uros Karadzic and Pierre Lanctôt. Pierre is here to conduct the financial assessment, and Uros is here to review all of the pension issues.
The mandate that we received from the task force was to review four streams of work.
Our analysis focused on four areas. First, to review and validate Canada Post's financial performance in the last five years. Second, to evaluate the financial impact of the resumption of payments on the pension plan solvency deficit. Third, to provide an independent assessment of Canada Post's projections to 2026, including the measures in the five-point action plan. And finally, to validate the annual savings target of $400 million to $500 million from the move to community mailboxes and to assess the possibility of keeping door-to-door delivery.
If I may make this point to the committee, the major findings that we would like to bring to your attention will be dealing with three issues. First is the financial position of the corporation; second is the cost savings associated with the CMB, or community mailbox program; and the final one is the pension situation.
Starting with the financial position of the corporation, as we recall, the one-time strategic price increase of April 2014 and the growth in partial volumes have briefly curtailed the ongoing weakening of Canada Post's financial position. Looking ahead, the financial position projection to 2026 paints an unsustainable future, with over $700 million per year of run rate loss. Drivers for these negative results are multiple, but include the continuing mail erosion driven by electronic communications; inflationary cost pressures; the network growth linked to the Canadian population increase; competition, including new service providers, lower-cost service providers, and disruptive technologies; and the funding requirements of the pension plan. Our analysis leads us to believe that Canada Post's projected loss is at the optimistic end of the acceptable range of estimates. It could be higher.
A major element of the negative financial results is the labour cost structure. When we looked at the productive hours for Canada Post's inside employees, it's approximately 68% more expensive than that of competitors. The cost of delivery agents is approximately 26% higher. Labour accounts for 70% of the cost of Canada Post. Making up such differences is very challenging, especially at a time when the future of the corporation is dependent on its ability to compete in the parcel delivery business.
Maybe I'll say a few words on the
community mailbox program.
The initial proposal was to find savings in the order of $450 million per year. We reviewed the hypotheses and tested them. We also reviewed the partial implementation of the program up until it was suspended in the fall of 2015. We believe that the figure of $450 million makes sense.
Making those savings is essential to temporarily stabilizing Canada Post's financial situation. If the program were not relaunched in a form more or less in conformity with the initial proposal, Canada Post would quickly run out of funds, requiring it to borrow an estimated $2.9 billion by 2026.
Now, I would like to say a few words about the pension.
The pension liability of Canada Post is large in relation to its revenue. A number of factors have led to this. Some are challenges common to all pension plans in Canada, and some are unique to Canada Post. All plans in Canada have been negatively impacted by a low and declining interest rate environment, by an improvement in the longevity of Canadians, and by a volatile asset return.
In addition, Canada Post's exemption to make solvency payments in recent years has released some funding pressure in the corporation, but has resulted in fewer assets in the plan and, hence, a larger pension liability.
Most employers in Canada with pension plans have moved to defined contribution plans. While Canada Post has moved in a similar direction in recent years for some of its management and all of its executive employees, the vast majority of employees are covered under a defined benefit plan with indexation. Changing the plan for future employees will only contain the growth of the challenge. It will not yield any meaningful relief to the corporation's financial position in the short or medium term. The current deficit is a problem that will not go away by itself.
Finally, we propose a number of ways to deal with the solvency deficit. They all have pros and cons. Some are easier to implement than others. None are without consequences. The decision to choose one or another solution is an issue of equity between pensioners, employees, taxpayers, and future generations. It's clearly a policy issue.
On this note, we thank you, Mr. Chair, as well as on behalf of our colleagues.
Good afternoon, Mr. Chairman and committee members. Thank you for inviting us to appear before you today.
Oliver Wyman is a leading global management consulting firm. We're part of Marsh & McLennan, which is a $13-billion global risk management and advisory services firm. We combine deep industry knowledge and specialized expertise in strategy, operations, risk management, and organizational transformation. We help companies optimize and improve their business performance and accelerate organizational effectiveness in the most attractive areas of opportunity. Our firm's credibility is established by more than 40 years of experience serving “Global 1000” clients. We have a staff of more than 4,000 and offices and operations in more than 50 cities in 26 countries.
Specifically, we're organized by industry vertical, which means we bring domain expertise to each project. I'm representing a team of two other partners who were involved. I'm part of our transportation practice. We had a lead from commercial banking, as well as our European global transportation practice leader and three full-time consultants on the project.
Oliver Wyman was engaged by the task force to assess the planned and potential business operations in both traditional and new lines of business. Simply put, my colleagues from EY were focused on the core business and baseline performance, while we were focused on the potential new areas of opportunity for Canada Post.
Based on our international experience, we identified almost 40 initiatives that had potential for CPC, which were included in detail in the report. These included new lines of business, changes to existing services, as well as changes that were leveraged to an existing asset model. We created a filtering methodology for evaluating the long list of ideas and focusing on the highest value areas of opportunity. This iterative assessment of the long list, according to the filtering methodology, resulted in a short list of opportunities with the highest potential. Development of more detailed business cases and analyses of key elements of each of the short list are included in the task force report.
Here are a few key findings in terms of the value drivers, in terms of where we would see these areas of opportunity. The key value drivers are as follows. The first is shifting demand; mail volume continues to decline, while parcel volume is increasing primarily in response to the growth of e-commerce. Next is growing competition; the competition for parcel delivery, as well as adjacent services that replace paper communication is growing fiercely. There's a split business model. Although letter and parcel delivery share assets, they are fundamentally different business models. Further, one has the government exclusivity guarantee, and the other is highly competitive, which is further complicated by the split between Canada Post and the Purolator parcel businesses. Last is the high-cost workforce; labour agreements establish labour cost rates at roughly 20% over private sector rates, which adds further constraints to business flexibility and limits the ability to adapt or change current operations.
The overall findings were that there are no silver bullets. Some of the options have value and have been deemed worth pursuing. There are no credible game-changing initiatives that would stem the demand trends that we're seeing. Of the highest potential initiatives evaluated, the best opportunities focused on improving or optimizing the current CPC operations in response to declining volumes. Most of these opportunities, however, would require flexibility on the part of the government, policy, and labour.
There are a few opportunities to increase profitable revenue. Most are insufficient, even in combination, to compensate for the reduction in volumes. Some of those opportunities are advertising and consolidation with Service Canada centres. Many opportunities also fall short based on their fit with CPC capabilities or its cost to serve, and also due to competitive concerns, such as the government putting a subsidized entity in against what is already established private market competition.
A consistent challenge across many of the areas identified are the labour constraints, especially for initiatives where adjustments to the current labour agreement would be required. Implementation could be as long as five to 10 years in order to match with the schedules for contract negotiations.
Finally, a number of potential initiatives aimed at reducing cost or increasing revenue could actually undermine CPC by driving away customer volume, while strengthening the competition, potentially accelerating CPC's declining financial position despite the relatively positive benefits. Those might include alternate-day delivery or last-mile delivery for third parties, sometimes referred to as “interliner”.
The results of the detailed options analysis are as follows. These are proposed opportunities, not specific recommendations, and they need to be balanced against the other priorities. The first is changing mail delivery service to alternate-day delivery, which would save $74 million per year. Another is easing the 1994 moratorium and the CUPW agreement, which would allow CPC to convert more post offices to franchises. That would save $177 million per year. Then there is rationalizing depots and sort centres to adapt the network to changes in volume and product mix, which would save roughly $66 million per year and would likely require capital expenditures.
Next, providing services on behalf of the government, enabling consolidation of some Service Canada centres may save roughly $11.5 million per year. Expanding CPC's interliner offering, providing last-mile delivery service for third parties, is worth roughly $10 million per year. Further pursuing synergies with Purolator beyond the ongoing efforts that have already been identified would generate roughly $16.5 million per year. Finally, selling advertising space in the retail locations and on the delivery fleet would generate almost $20 million per year.
We did do a study of postal banking options and it appears that postal banking is just a marginal opportunity for Canada Post, and when compared to other higher-yielding, lower-risk initiatives explored in the main report, such as adjusting the retail footprint, we did not come down supportive of postal banking as a particularly good opportunity for Canada Post.
Please note that this report and the related review of CPC's strategic business options contain a substantial amount of information deemed commercially sensitive by Canada Post.
I'll be more than happy to answer whatever questions I can now, and further in the in camera session.
Thank you all again.
I'll make some statements, and then you'll all have chance to respond.
We hear from the ground, and we have been consulting widely, that for 19 of the past 20 years Canada Post has been making profit, giving dividends, and paying taxes, and it's billions of dollars. The assumptions you've made are probably a little skewed because you had to take data, which was sometimes consistent and sometimes was not consistent. You have answered that in your previous questions, but what I also understood from the ground was that Canada Post management is not thinking outside the box, and it does not have an integrated approach to thinking. Now that's not your mandate, because your mandate was totally different. We have to find a fine balance. When you say to stick to your knitting, if you stick to your knitting and the wool is going, what the hell do you do then? You have to think creatively and outside the box. My question is, what other strategic areas would you look at?
You're suggesting that Canada Post in its current format might just about disintegrate. Should it?
Mr. Spear, the question I have for you specifically is about Australia. I looked at Australia, and it is in the same ballpark figure as us with a large land mass and a high rural population, but it has very successful postal banking. With a population of 24 million, it seems to be making $6.6 billion in revenue. What can we learn, and have you had the opportunity for lessons learned? We cannot just pooh-pooh it because maybe in 1968 the postal bank was successful, and then the banking lobby came. We need to be balanced. Give me your analysis of it, and then I'll ask the other question.
Thank you very much, Mr. Chair.
Good afternoon. My name is Lynn Hemmings. I'm the senior chief of the pensions team in the financial sector policy branch at the Department of Finance.
I'm here today to answer your questions about the Canada Post pension plan, but let me first provide you with a bit of context on the funding requirements under federal pension legislation, the Pension Benefits Standards Act, or PBSA.
Under the PBSA, the federal government regulates the plans of crown corporations and private sector plans covering areas of employment under federal jurisdiction, such as telecommunications, banking, and interprovincial transportation. At this time, there are over 1,200 federally regulated pension plans, and over 300 of those are defined benefit plans. Canada Post's is the largest defined benefit plan under federal jurisdiction, with almost $22 billion in plan assets as of December 31, 2015.
Under the PBSA, defined benefit pension plans are required to be funded on both a going concern and a solvency basis. “Going concern” assumes the plan operates indefinitely, whereas solvency assumes the plan is terminated and all the promised pension benefits must be paid immediately.
The intent of the solvency funding requirement is to protect the pension benefits of plan members and retirees by ensuring that plan assets are sufficient to meet the plan's full obligation. In cases where a plan does not have a solvency funding deficit, the PBSA provides the flexibility to fund that deficit over a period of five years.
Today, some plan sponsors continue to face funding challenges for their defined benefit plans as a result of a combination of factors, including the ongoing low interest rate environment, volatile market returns, and increasing life expectancy of retirees. Over the last 10 years, the government has implemented a number of reforms to provide funding relief to plans to address these challenges.
In 2006, a sharp decline in long-term interest rates combined with poor investment returns and increasing life expectancies resulted in solvency deficits in many plans. To help alleviate these pressures, the government passed temporary solvency funding relief measures that allowed solvency deficits to be paid over a longer period. Following the implementation of these measures, funding levels in plans began to improve.
In 2009, following the financial crisis, plan funding levels began deteriorating again as a result of the significant decline in global markets and even further reductions in interest rates. To help plans address these challenges, the government once again passed temporary funding relief measures. As it became apparent that low interest rates and uncertain market returns were becoming the new normal, the government moved to put in place permanent relief measures. These measures included allowing the use of letters of credit to cover solvency special payments up to a limit of 15% of the market value of plan assets and moving to a three-year average for the calculation of solvency ratios in order to reduce the volatility of a plan's deficit.
For pension plans facing unique financial challenges, the Minister of Finance has the authority to grant funding relief through the use of special regulations. In the case of Air Canada, for example, in order to provide the company with the time needed to restructure its operations, its pension plan was exempted from solvency funding requirements from 2014 to 2020 in exchange for making payments of at least $150 million per year into the plan. As a result of improving its business operations, changes in plan design, and new investment strategy, Air Canada has been able to eliminate its solvency deficit and announced in May 2015 that it was opting out of the special regulations, with the pension plan now in surplus.
The Minister of Finance has also exempted Canada Post from solvency funding requirements from 2014 to 2018. This funding relief was provided within the context of a continued decline in mail volume and little to no net income generated by the corporation. As with Air Canada, the purpose of the relief was to provide Canada Post with the time to make itself financially sustainable. As this funding relief is set to expire at the end of 2017, we are continuing to monitor the developments in Canada Post's pension plan.
We look forward to hearing the recommendations of this committee on the business operations of Canada Post, which will help to inform our advice to the on the pension plan going forward.
Thank you for inviting us to speak with the committee today regarding the Canada Post pension plan.
I would like to make a few observations about the plan, during which I will make reference to the supplementary document that has been circulated, and then we look forward to taking your questions.
I'm an actuary with Mercer, which has been the plan's actuarial firm since its inception in 2000. In my role as an actuary, I work on the annual valuations of the plan prepared for funding and accounting purposes. Our valuations are performed according to the applicable legislation and regulatory guidance under the federal jurisdiction, and according to the professional standards of the Canadian Institute of Actuaries. The results of the valuation are presented each year to Canada Post's management, the pension committee of the board, and the pension advisory council, which includes representatives from management and the various unions.
Joining me is my colleague Michel St-Germain. Michel brings a broader perspective on trends in the pension landscape across the country and over time. Michel plays or has played various roles within the Canadian Institute of Actuaries and the Association of Canadian Pension Management.
I have a few comments on plan size. The Canada Post pension plan has been growing steadily since plan inception. As shown in figure 1 of the supplementary document, the plan's assets have almost tripled in size between 2001 and 2015. Over that same period, the solvency liability more than quadrupled.
The solvency deficit at the end of 2015 was about $6 billion, which has grown to about $8 billion so far in 2016. The biggest driver of the increased solvency liabilities and deficits has been the decline in interest rates in recent years. Figure 2 shows that the interest rate net of inflation used to value the solvency liability had fallen to 1.2% at the end of 2015 versus 2.25% 10 years earlier. By June 30, 2016, that rate had declined to 0.08%.
As it has grown, the plan has become very large compared to the size of Canada Post itself. We've illustrated this in two ways in figures 3 and 4. Figure 3 shows the size of the pension obligation on a corporate accounting basis as a percentage of corporate revenue. This excludes, by the way, the obligation for other non-pension employee benefits which are worth about another $4 billion. This ratio has grown almost every year in the last 10 from 226% to 390% of revenue. To put these numbers in context, the graph also shows the distribution of the same sort of results for organizations in the TSX Composite with DB, defined benefit, pension plans.
Clearly, the growth of Canada Post's pension plan has far outstripped that of its revenue, which has been consistently around $6 billion per year excluding the subsidiaries over the period shown.
Besides the fairly flat revenue, another reason for these large ratios is the relative generosity of the Canada Post plan benefits, for example, full guaranteed indexation. Given the current size of the active membership, and given that many of Canada Post's new hires continue to join the DB component, the plan is expected to continue to grow for many years to come.
Another way to look at relative size is given in figure 4, which shows the employer pension contributions over time also as a percentage of corporate revenue. Canada Post's contribution requirements in the absence of the CPC special relief measures, which Ms. Hemmings described, varied widely between 1% and over 15% during this period.
In figure 5 we show the historical contributions to the Canada Post plan. The solid blue and red bars show how the employee and employer current service contributions have changed over time to reflect a more balanced sharing of these costs. In addition to current service contributions, Canada Post is responsible for funding any deficits. Going concern deficits must be paid off over 15 years. Solvency payment requirements are more complicated since we are required under federal funding rules to determine the special payments based on a three-year average solvency ratio. There are details on these calculations in figure 8 of my supplementary document, but we won't go through those in detail unless they come up in questions.
The striped red bars show Canada Post's deficit contributions, which are over $1.6 billion in total, mostly for solvency deficits. There are two items worth pointing out on this graph. Since 2011, agent crown corporations like Canada Post have been permitted to reduce their solvency special payments up to a cumulative total reduction of 15% of plan assets. Canada Post used this to reduce its special payment requirements from 2011 through 2013 with a cumulative special payment reduction of $2.4 billion. That cumulative reduction limit of 15% of assets would have been reached in 2014 with the chance that the remaining required payments could exceed Canada Post's ability to pay.
In response to this issue, special regulations were enacted in early 2014—that's the CPC special relief—exempting Canada Post from special payment requirements for 2014 through to the end of 2017. The yellow bars in figure 5 show the special payments that would have been made to the plan if the CPC special relief had not happened.
In figure 6, we show the expected range of projected future employer contributions over the next five years, based on market conditions and valuation results as at year-end 2015. As shown by the small blue squares, the median projected contribution over this period ranges from about $260 million to $540 million. However, the graph shows that there's at least a 25% probability of required contributions exceeding $1 billion in 2019 and 2020, as shown by the top of the light green bar. Since year-end, market interest rates have declined significantly, so our current estimates of future contributions would tend to be higher than the ones shown on this graph.
The task force has proposed some options to modify or eliminate solvency funding requirements for Canada Post. The elimination of mandatory solvency funding would relieve much of the short-term funding pressure the plan places on Canada Post; however, significant risks would still remain in the longer term. Even in the absence of solvency special payments, the size of the plan relative to that of Canada Post would remain at least as large. For instance, the relative size of the accounting obligation in figure 3 is not affected at all by contribution requirements.
Currently, the going concern basis is much less expensive than the solvency basis; however, this is largely due to an assumption that the plan's asset mix—specifically, its allocation to riskier asset classes such as public equities—will yield higher returns than the conservative asset mix required for solvency purposes. While we expect that to be the case on average over the long term, it's not guaranteed to occur over any particular period. It's also worth noting that if members live longer than we have assumed, plan costs could increase.
Canada Post can reduce the risk of volatility in the net position of the plan by decreasing its allocations to risky assets; however, this will decrease the expected return and increase the cost. It's not hard to imagine the current going concern surplus turning into a deficit due to a bad experience. One year of asset returns like we saw in the market crisis of 2008 could result in as much as $2 billion of special payments being made to the plan over a 10-year period, even in the absence of solvency funding requirements. In addition, assumptions may change over time as the asset mix or the actuary's outlook for the future changes.
These types of risks are expected with traditional DB plans. It is the size of this plan relative to the size of Canada Post that makes this of special concern.
It's interesting to note that two of the most well-regarded public sector pension plans, Ontario Teachers' and the Healthcare of Ontario pension plan—HOOPP—are exempt from solvency funding, yet these plans have both taken steps to modify their benefits, particularly the level of guaranteed indexation, to control costs and volatility.
If Canada Post were to become exempt from having to fund on a solvency basis, we would also encourage consideration of additional changes to address the remaining risks.
On changes to investment policy, Canada Post plans to gradually reduce their allocation to riskier assets as the plan's position improves over time. This will make the plan less sensitive to changes in market interest rates, although it does not address the current deficit.
On defined contribution, a defined contribution, or DC, plan like the one offered by Canada Post represents the lowest cost volatility possible for the portion of the plan covered by it. DC designs are increasingly common, particularly in the private sector. Recently, Unifor agreed to a DC plan for new hires at General Motors when it became clear that GM would not be able to afford the DB plan. While extending DC to more members would slow the growth of the DB component of the plan, the problem of funding the existing DB component would remain.
On risk-shared plans, there are some middle-ground options, which aim to retain much of the predictable benefit stream of a traditional DB plan while significantly lowering cost volatility. Such plans share risks between the employer and members or across the members as a group, which is preferable to individual risk-bearing. One such planned design would reduce or eliminate guaranteed pension indexation, indexing pensions only when the plan's financial position permits, according to rules laid out in advance. Canada Post has been looking into designs like this.
Another option is a target benefit plan, or TBP. In a TBP, employer contributions would be predictable and clear rules would be set out in advance regarding the handling of surpluses and deficits, with some benefits at risk of reduction in bad times. The federal government tabled a bill earlier this month to permit the establishment of TBPs in the federal jurisdiction. We have discussed the TBP concept with Canada Post.
While risk-shared plans can work well for the future, benefits already accrued remain in the traditional DB plan, unless members or their unions consent to a conversion to the new plan.
One final option for consideration is joint governance. Some of the most successful large Canadian pension plans are governed on a joint basis with representatives from employers and members making decisions together. Ontario Teachers' and HOOPP are examples of such plans. Under the right conditions, this can work very well, but we believe that joint governance is best accomplished in conjunction with shared responsibility for the funding of any past service benefits.
This concludes our prepared remarks. We thank you and look forward to your questions.
I'm also an actuary by profession, and I've been asked to speak to some of the key features of the Ontario Teachers' pension plan that contribute to the sustainability of the arrangement.
The Ontario Teachers' Pension Plan, or OTTP, Board was established as an independent, arm's-length organization in 1990. We are a jointly sponsored pension plan, or JSPP, designed and governed to ensure a balance of stakeholder interest. We have a robust governance structure with clearly articulated roles and responsibilities consisting of an independent, professional, 11-member board. The plan sponsors are the Province of Ontario, more specifically the Minister of Education, and the Ontario Teachers' Federation, which represents the plan members.
The board's responsibilities include managing the investments of the pension fund, setting key accrual assumptions, including the valuation discount rate, and administering the pension benefits for our 385,000 active and former teachers. Plan sponsor responsibilities include determining benefit and contribution levels by determining how deficits are funded and how surpluses are utilized. The JSPP structure ensures that both plan members, through OTF representation and the province have a voice at the table in these critical decisions and are aware of the associated risks. We are a contributory defined benefit pension plan with full inflation protection provided on benefits earned prior to 2010 and with conditional inflation protection for benefits earned after 2009. I'll speak more to how CIP works in a moment.
Our teachers currently contribute 12% of their pay, on average, which is matched by the Province of Ontario. Our strategic destination is to have a fully funded plan with the contribution rate of 11% of pay, on average, which is matched by the province, and 100% inflation protection on all benefits. As of the end of 2015, our market value of assets was $171 billion. We recently filed the January 1, 2016, valuation report disclosing a surplus on a going concern basis of $4.5 billion. Note that our valuations must be balanced, as we cannot file an evaluation with a deficit.
Going back historically to the early 2000s, the plan's funding position and demographic realities have a direct impact on how our assets are managed. We set an asset mix policy by taking into account what the plan needs to deliver its pension obligations. Sustaining benefit levels for future teachers without contribution increases requires consistently meeting our return targets. Today, for a new entrant to the plan, providing a pension fully indexed at an average contribution rate of 11% matched by the province would require a real return of 4% per annum. The plan's demographic circumstances moderate our ability to take risks. The return target and the plan's ability to take risk by managing the impact from potential losses must remain aligned to meet our sustainability objective.
An important factor over the long term that impacts our return target is the expected lifespans of our members. This ultimately led to the adoption, in 2008, of a custom OTPP mortality table and mortality improvement scales. These tables were most recently updated in 2014, including the adoption of a two-dimensional mortality improvement scale.
In 2001, discussions began between OTPP and the plan sponsors related to reserving some gains in the fund to create a cushion to protect against the loss in difficult times and to keep contribution rates stable.
Back in 2003, the sponsors adopted a funding management policy, or FMP, with the objective to provide a guidance framework for decision-making when there is a funding surplus or shortfall. A key component of the creation of the FMP was the concept of funding zones, each defined by a range. The funding zones provide a point of reference for whether action is required by the sponsors, and if so, guidance is provided on how to use any surplus funds or resolve any shortfall, specifically answering the question of when it is prudent to increase or decrease benefits, raise or lower contribution rates, or simply conserve assets for an uncertain time.
While the FMP outlines preferred mechanisms associated with its various funding zones, it is ultimately the sponsors' responsibility to decide what actions to take.
In March 2015, a zone for temporary plan improvements was added to the FMP to allow for temporary contribution decreases, surplus distribution, or benefit improvements, so long as they do not increase the long-term costs of the plan.
Uses of surplus in this zone are paced, and a provision is included such that temporary improvements cease if a significant market event occurs.
Commencing roughly a decade ago, we began experiencing recurring deficits in preliminary funding valuations resulting from a combination of low returns, a low interest rate environment and increasing longevity. It is necessary to take on risk from an investment perspective to achieve the returns necessary to ensure the sustainability of the plan, particularly in a low interest rate environment.
Knowing that we will have losses from time to time, we needed to introduce a mechanism for addressing downturns, which would share losses with our plan members, including retirees.
Our current ratio of active to retired members is 1.4:1, which is expected to continue to decrease and will likely be 1:1 at some point in the future. We have negative net cash outflows of $2.2 billion. We received $3.3 billion in contributions in 2015 and paid $5.5 billion in pensions, which means that strong liquidity management is crucial.
On average, Ontario teachers retire at age 59 after having worked and contributed to the pension plan for 26 years, and they receive benefits for 31 years on average. Additional benefits may be provided to a surviving spouse for a further period of time.
We need to ensure that our asset mix and risk management take the aging of the plan into consideration. As mentioned above, the board has responsibility for managing the pension fund and therefore we are constantly focused on risk management and asset allocation.
It is clear that contribution increases alone will not be sufficient to protect the plan against major investment losses. Along with that is the reality that with an 11% contribution rate, a 4% real return is necessary, a return that is difficult to achieve, particularly in today's environment.
Therefore, in 2008 the concept of conditional inflation protection was introduced. CIP is not only a powerful lever for managing funding volatility, it also promotes intergenerational equity.
Benefits earned after 2009 are conditionally indexed in accordance with the plan's ability to pay. There are three service breaks, with different levels of protection as follows: All benefits earned before 2010 are still fully indexed to inflation. Benefits earned after 2009 but before 2014 are conditionally indexed with a minimum adjustment guarantee of 50% of consumer price index. Benefits earned after 2013 are conditionally indexed with no minimum guarantee.
Consistent with the spirit of a shared risk plan, any inflation payments forgone by plan members are matched by the government via additional contributions to the fund up to the first 50% of inflation protection forgone.
CIP is an extremely powerful funding lever, and the expectation is that by 2025, fully invoked CIP will be powerful enough to absorb an asset loss of $62 billion.
As mentioned by my colleague, OTPP is subject to going concern funding requirements and is exempt from solvency funding on a named plan basis under the regulations of the Pension Benefits Act of Ontario.
In 2010 Bill 120 was passed in response to recommendations by the Arthurs commission to strengthen pension funding rules and to clarify rules for surpluses, contribution holidays, and other funding-related issues. The rationale for the exemption from solvency funding includes that both the province and OTF have a role in selecting the board members that oversee the pension plan, thus promoting good governance.
The JSPP governance model means that both plan sponsors are involved in and responsible for decisions related to benefit design.
Funding on a going concern basis is appropriate for our plan, given the size, maturity, and robust governance structure. Because of this, we can use the aggregate cost method, which allows us to factor in the expected impact of future contributions and benefit accruals, whereas resolution of any solvency deficits could be done only via contribution increases, a mechanism at odds with those proposed by the funding management policy and particularly with the ability to share the risk with retirees through conditional inflation protection.
Solvency-based tests are not a suitable measure for OTPP given our long-term perspective and our joint governance capacity to change future contribution and benefit levels to address funding shortfalls or surpluses.
In the unlikely event of plan windup, given the size of the plan, it would be impossible to settle benefits via annuity purchases given the limited market in Canada. Thus, there would need to be legislative intervention to allow the plan to continue in some capacity.
Finally, we are not subject to, nor a risk to, the pension benefits guarantee fund of Ontario.
In closing, the plan's sustainability is defined as its ability to meet the needs of the present without compromising the ability of future generations to meet their own needs. The strong governance framework of the plan is key to ensuring its long-term sustainability.
Thank you, Mr. Chair and committee members.
My name is Tony Irwin, and I'm president of the Canadian Consumer Finance Association, formerly known as the Canadian Payday Loan Association. We appreciate the opportunity to speak to the House of Commons Standing Committee on Government Operations and Estimates regarding the discussion paper “Canada Post in the digital age”.
Our association represents financial service businesses that provide payday loans to Canadians, as well as a range of other financial products including installment loans, cheque cashing, wire transfer services, bill payment services, and currency exchange. The CCFA has 18 member companies that hold the lender licences for approximately 960 stores and online lending platforms. This represents 69% of the payday loan industry across Canada.
A payday loan is typically a loan in an amount of $400 to $500 that is repayable on the borrower's next payday. The legal definition of a payday loan is a loan not to exceed $1,500 for a term of not more than 62 days. In 2008, the federal government transferred jurisdiction to the provinces to regulate this product. The provinces of British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, Nova Scotia, and Prince Edward Island have now licensed the product, and the Province of New Brunswick is currently finalizing its regulations.
To operate in these provinces, a payday lender must apply for and obtain a lending licence, which requires payday paying annual licensing fees, and often filing transaction data, or financial statements, on an annual basis. Each province sets maximum fees that can be charged for loans, and all aspects of the operation of the business are strictly regulated, including disclosure of information, standard contract terms, right to rescind by borrowers, limits on default fees, advertising, sale of ancillary products, and collection practices, among other things.
There are many misconceptions and much misinformation about the industry. Some opponents have labelled our industry as predatory, but the industry grew in response to consumer demand. Many Canadians have a need for a small loan for a short period that they can obtain quickly, and for those who do not have good credit or an established banking relationship, the need was not being served by banks or credit unions. A survey of payday loan borrowers that was just published by the Financial Consumer Agency of Canada on October 25, 2016, found that 45% of respondents typically used payday loans for unexpected necessary expenses, and 41% typically used payday loans for expected necessary expenses. Borrowers will tell you our members provide a needed and valuable service, and provincial governments understood this when they chose to regulate the industry in a manner that protects consumers but allows for a viable industry.
There is a perception that payday lending is a rapidly growing industry, and lenders are making excessive profits. This is not correct. At the time regulation came into effect in most provinces, in 2009, there were approximately 1,452 payday loan outlets across the country. Today, there are approximately 1,426 licensed online or store outlets. The return on investment of payday lenders is far lower than that of the banks. If the industry were highly profitable, the industry would have grown in the last five years, rather than contracted.
As the Canada Post discussion paper states, despite the high rates, the payday loan industry has low margins. The cost of credit is expensive because it's costly to provide. Costs are high not just because of higher default rates, as the consultation document notes, but also a high cost of operation. Unlike banks and credit unions, payday lenders do not hold deposits or offer large secured loans to help cover the cost of operations. In addition, our industry serves a large sector of borrowers with thin credit files, and lenders have to employ complex and expensive technology and systems to manage their product offerings, risk assessments, and regulatory compliance.
Many payday lenders offer the service of cheque cashing, which is referred to in the discussion paper. Cheque cashing is a competitive business, and a typical fee for cashing a cheque is 2.9% of the face amount, plus an item fee of $3 on average. On a $300 cheque, that would equate to $11.70. While the government indemnifies banks, credit unions, and trust companies for loss due to fraud resulting from cashing cheques up to $1,500, no such indemnity is provided to financial service businesses. They must bear the risk.
It is important to note that over the past decade, the use of cheques has dropped dramatically, and this trend is continuing as more and more businesses are making payments electronically. As a result, cheque cashing is becoming an ancillary and increasingly more marginal business.
The Canada Post discussion paper increasingly notes payday loan-type businesses are moving online. This is very true. Five years ago, getting an online loan was not common. Today there are any number of apps you can download on your phone to provide you with a loan. A survey of our members who are primarily bricks-and-mortar operators found that the amount lent by their online divisions from 2010 to 2014 increased over 520%.
In the past there was typically a delay of up to 24 hours between the time a customer applied online for a loan from the lender and the time funds were deposited into the borrower's bank account. With recent updates in technology, lenders can now deposit funds into a borrower's bank account instantly. Removal of this time delay will result in greater and more rapid growth of the online business in Canada.
A recent study commissioned by the Consumers Council of Canada noted that in the United Kingdom more than 80% of transactions are done online. In the U.S. and Australia online lending comprises one-third of all payday loan transactions. We expect this will be the Canadian experience as well. In the future as most customers are reached electronically, the need for physical premises to transact and advance a loan are less important.
Access to credit for all Canadians is important. The Canadian Consumer Finance Association believes that the more options consumers have to meet their credit needs, the better. However, anyone considering entering the marketplace should be aware that this is a highly regulated and competitive market. Margins are small and even at the maximum fees permitted in each province, only the most efficient operators will succeed.
Thank you for inviting me to be here with you this afternoon to contribute to your review of Canada Post.
My name is Darren Hannah, and I am the vice-president of finance, risk and prudential policy, at the Canadian Bankers Association.
The CBA represents 59 domestic banks, foreign bank subsidiaries, and foreign bank branches operating in Canada.
As the committee is likely aware, the CBA was an active participant in the first phase of the review process led by the Canada Post review task force. The banking industry's interest in the review is limited, and it relates specifically to the proposals that Canada Post engage in the business of banking across the country. Our concern is that such proposals are not guided by a clear public policy need. They overlook that Canada benefits from a highly competitive and accessible financial services sector, and that banking is one of the most heavily regulated and supervised sectors across the country.
Canada has a highly competitive financial services sector. There are currently 80 banks operating in Canada, with more than 40 offering financial products and services to Canadian consumers. Canada has more large banks actively competing against each other for customers than practically any country in Europe, including the U.K., which has almost double the population of Canada. There are also non-bank providers of financial services that actively compete with the banking industry, including over 1,000 credit unions and caisses populaires.
With so many financial service providers available to consumers, Canadians are actively taking advantage of the choices available and shopping around for the options that are best suited to their needs. Nearly 60% of Canadians have switched accounts to reduce their service fees, and 32% have switched banks entirely. Additionally, 65% of Canadians deal with more than one financial institution, and of those, 34% deal with three or more. With so many bank and non-bank providers of financial products and services actively competing across the country, consumers continue to be well served by Canada's competitive financial marketplace.
Some proponents of postal banking have asserted that banking services have become inaccessible in Canada. Contrary to these claims, banking is more accessible than ever. According to the World Bank, 99% of Canadian adults have an account with a financial institution, and Canadians can now bank virtually any time from anywhere using a number of different options that reflect the growing expectations of Canadians for greater ease and convenience when banking.
Online is emerging as the preferred means of banking for the majority of Canadians of all age groups. Banking has continually evolved, and customers value innovation and convenience as they access their banking outside of traditional business hours. Now 55% of Canadians use online as their preferred means of banking, which is up from only 8% in 2000. Additionally, 48% of Canadians use online as their primary method of bill payment. Furthermore, the number of transactions taking place online keeps growing, with nearly 615 million Internet banking transactions being completed in 2015.
With more and more Canadians carrying mobile devices, banks offer mobile banking services and apps that allow customers to carry out a variety of day-to-day transactions through their mobile devices. Over a few short years, the number of Canadians who use these applications has grown dramatically, with 31% of Canadians using mobile banking last year, which is up from 5% in 2010.
Branches remain an integral part of banking in Canada. While only 13% of Canadians visit branches for their daily banking, banks have maintained their extensive branch network for those clients who choose to access financial services and advice they need in person when making important life decisions like purchasing a home, making investments, or planning for retirement.
To argue that postal banking is needed so that Canadians can have access to banking services does not reflect the continuing innovations and growing convenience of banking across the country.
A healthy financial sector is a key component to a well-functioning economy. Canada's banking system is widely recognized as being one of the strongest and soundest in the world. This strength was clearly demonstrated through the global financial crisis, as the Canadian banking sector continued to perform and did not require government-funded bailouts, which stands in sharp contrast to the challenges faced in other countries. Canada's prudent banks, combined with effective regulation and supervision, form a model of stability in the global financial system.
Given the strength of Canada's financial system and its critical importance to the health and stability of the broader national economy, proposals for Canada Post to become involved in retail financial services should not be taken lightly. The cost of regulatory compliance is high, and it's critically important for all financial service providers to have appropriate expertise, processes, systems, and robust risk management practices in place to protect Canada's financial system. Canada Post is a crown corporation, and taxpayers ultimately bear the risk of its operations.
Canadians benefit from more choice, convenience, and access in banking services than ever before. Canadians are well served by Canada’s competitive, prudently regulated, and effectively managed banking system. We agree with the task force members, who concluded that Canada already benefits from a well-established market for financial services. We believe there is no public policy objective or existing gap in the marketplace that would necessitate the Government of Canada entering into the business of retail banking through Canada Post.
Thank you, again, for the opportunity to present our views. I look forward to your questions.
Good afternoon. My name is Rob Martin, and I'm a senior policy adviser at the Canadian Credit Union Association. Looking around the table, I think that some of you know who we are.
The Canadian Credit Union Association is the national trade association for credit unions outside of Quebec. Desjardins is our co-operative partner, but it's mostly within Quebec. CCUA represents 293 credit unions including the first federal credit union, which is called the UNI Financial Cooperation, which came out of New Brunswick.
Credit unions are banking institutions owned by their members and their customers. This means we're 100% Canadian-owned competitors to the big banks. Currently 5.6 million Canadians trust the local credit union for their day-to-day banking needs. Collectively we employ more than 27,000 people and manage over $196 billion in assets. This makes us bigger collectively than National Bank.
In terms of market share, credit unions have about 6.3% of the assets held by deposit-taking institutions in Canada, but we have large market shares in two key segments, small business and agriculture, with 11.5% of the market and 10.4% of the market respectively. As co-operatives, credit unions are different. We are not motivated by profit maximization but rather focus on the benefit of our members and our community. This translates into our having preferential rates, providing patronage dividends for credit union members, and keeping branches and service outlets in underserved areas.
In fact, credit unions are the only banking service provider in 380 communities across Canada. In other instances we see credit unions like Vancity providing alternatives to payday loans, such as Vancity's fair and fast loan or First Calgary Financial's cash crunch loan, to help individuals get out of a payday loan debt. Servus Credit Union in northern Alberta is working on a similar offering as is the Ontario system.
While credit unions are users of the mail and parcel services offered by Canada Post, the reason we are presenting today is to address the debate concerning Canada Post's potential entry into the financial services industry. We know that CUPW is promoting the entry of Canada Post into banking as a means of increasing revenues, offsetting losses, and maintaining jobs. Other advocates emphasize delivering financial services to under-banked rural remote regions and indigenous communities. Of course, given our history and our orientation, concerns about the financially excluded have considerable resonance with credit unions, and we are always open to dialogue with the government on these issues. That being said, CCUA is not supportive of establishing a stand-alone postal bank in Canada. Our reasoning behind this position aligns well with the report of the task force for the Canada Post review.
Specifically we believe that the business case for such an enterprise is weak, and the entry of Canada Post into the banking field could result in negative unintended consequences in the market. Regarding our first point, given the rapidly evolving financial services sector, we are certain a postal bank would face a challenging time establishing itself in a crowded and well-served market. On the supply side, the market is served by nearly 80 chartered banks—ATB in Alberta, Desjardins, and 293 credit unions across Canada. These institutions offer remote cheque capture, eliminating the need to access an ATM or branch, and most allow customers or members to conduct all their transactions—everything from applying for a loan to transferring funds—from the convenience of their home. Not surprisingly then, credit unions are seeing a steady decline in traffic in their branches.
On top of this, Canadians also have offerings from the Business Development Bank of Canada, Farm Credit Canada, and Export Development Canada. On the demand side, as my colleague here mentioned, World Bank research suggests that unmet demand for financial services is limited. The World Bank research indicates that 99% of adult Canadians age 15 or over have some form of bank account. Other research from the Canadian Centre for Policy Alternatives indicates that only 3% of all Canadian adults have no bank account at all. Admittedly this number rises to 8% for low-income Canadians. This is a fact that merits attention from policy-makers. CCUA is open to a dialogue with government on how these issues might be addressed. We do not, however, believe that this situation justifies the establishment of a stand-alone postal bank in Canada.
Now to our second point. A concerted push to establish a postal bank in Canada could produce unintended consequences and crowding-out effects in the financial services market. Banks and credit unions could find themselves in competition with a postal bank that benefits from difficult-to-match state-granted privileges and advantages. One of these advantages would be a lower cost of funds. C.D. Howe Institute research has noted that crown financial institutions enjoy a comparatively low cost of capital because they can issue debt that is backed by the federal government and can borrow directly from the government itself at preferential rates.
The institute estimated that crown borrowing costs are 30 to 50 basis points lower than those available to private sector competitors like credit unions. This can rise to 300 basis points in times of stress. This funding advantage can tilt the playing field in favour of the crown by granting it pricing advantages. If a postal bank were to lean on these advantages, it might produce perverse outcomes with banks and credit unions possibly pulling back from markets where margins are thin.
Also, a postal bank would enjoy a pre-established outlet network. A postal bank could also enjoy an advantage over competitors as a result of its outlet network, which I think is approximately 6,400 locations across Canada. This outlet network was developed with Government of Canada investment over many decades in the service of its mail mandate. From the get-go, a postal bank would face fewer costs associated with establishing and administering a financial network as do other financial institutions.
The scope of that network will be difficult to match and could undermine the economic rationale for some bank and credit union branches in regions with a limited economic base or thin operating margins. I can elaborate on that further in questions.
My final point is there would be a lighter regulatory touch. If history is any guide, it's possible that a postal bank would face fewer regulatory pressures in comparison to those faced by banks and credit unions. For example, Farm Credit Canada, the BDC, and EDC are not answerable to a prudential regulator. Furthermore, they often face fewer statutory restrictions on their business powers and activities than crowns do. This is in contrast to credit unions and banks that face significant restrictions on their business practices and are therefore subject to ongoing prudential onsite guidance.
Before I conclude, I would like to flag the fact that at the moment, there are two concurrent federal ongoing efforts to research competition and financial inclusion in the Canadian banking sector. The first announced in the 2016 budget consists of the decision to push off the five-year 2017 financial services review by two years to 2019 and to provide $4.2 million in funding for that effort. It's to look at competition and service in the market. The second, as recently announced by the Competition Bureau, is looking at how technology-led innovation in the Canadian financial services sector is affecting the way consumers use financial services and products.
From a policy perspective, it would be ill advised for the Government of Canada to move toward establishing a postal bank in advance of these studies being completed and their recommendations known by the Canadian public.
To conclude, the Canadian Credit Union Association thanks the committee for this opportunity to contribute. While the CCUA is not supportive of the establishment of a postal bank in Canada, we appreciate the need to expand the availability of banking services in some targeted areas. CCUA is open to engaging with the government on how that might best be achieved through collaborative approaches involving both public and private sectors.
We'd be happy to respond to any questions you have.
I thank the representatives of the Canadian Bankers Association and of the Canadian Credit Union Association for being with us today.
We are at the end of our consultation process. We have heard a lot about postal banking. We were told that it could be a viable solution in certain cases. This was the opinion of the members of the union, among others.
I listened to you. I would have been surprised had you said the opposite of what you said to us. I have never heard any person or industry speak in favour of the arrival of a new competitor on the market. I did not expect you to say anything else. This does not detract from you in any way; it is nothing personal.
However, I heard Mr. Martin say some interesting things. The cooperatives have a greater interest in the needs of members. They have a concern that has been raised on many occasions throughout Canada. In remote areas, there are fewer services. In certain cases, even the cooperatives are closing. That is unfortunate given that in certain cases, they are the last financial institutions in the regions.
That said, there is still worse. Often, the people who live in these regions do not have access to quality Internet services. When you leave large urban centres, you are caught in a vice.
As you confirmed, Mr. Martin, 1% of the population does not have a bank account, and these are mostly low-income people, people who have particular needs and cannot get access to credit easily.
As people say, banks are interested in the bottom line. Mr. Hannah, you said that there was a rigorous process that precedes the decision to close a branch. Nevertheless, if you are making money, you will never close it. If you are not making money, you will close it rather quickly. To my mind, it is that simple.
Can things be seen in a different way, and could we take advantage of this opportunity? In fact, it is an opportunity. We were talking initially about Canada Post, but we came to talk about a postal banking service. This has highlighted a gap in the Canadian banking and credit union system. There are improvements that could be made. There may be an opportunity with Canada Post, or perhaps not.
I would like to hear how we could cooperate—Mr. Martin will be happy—in order to offer new services that may not be offered currently to Canadians who need them, so that we may become a world leader in banking and credit union services, in cooperation with Canada Post.
I used three minutes of my speaking time for this long introduction.
Mr. Martin, could you answer me first?