Municipal pensions are not guaranteed – that’s the landmark decision a federal judge made regarding the city of Detroit’s decision to enter bankruptcy. During the summer, Detroit, a once prosperous city, made international headlines when it filed for bankruptcy – the largest city to do so.
The Detroit pension cuts ruling deals a major blow to city workers who were under the impression their pensions were safe under state law. It also sent shockwaves to California, where many cities are struggling to meet promised pension obligations.
While Detroit may be a border away, it has set a dangerous new precedent in North America – could Canadian municipal pensions be at risk as a result?
Similarities with Canadian Cities
Don’t put all your eggs in one basket – that’s the cardinal rule we’re taught when it comes to investing. The same can be said for cities – Detroit relied heavily on the auto industry. Although major cities like Toronto and Vancouver are well diversified in many sectors, smaller cities like Hamilton and Waterloo rely heavily on single industries like steel and high-tech. This could put these cities in a precarious situation if their key industry falls on hard times.
Property taxes are the lifeblood of cities – they account for as much as 40 per cent of municipal revenues. As long as the population is growing in your city, so too should the tax revenue. While cities in western Canada like Calgary and Edmonton are booming, cities like Windsor and Thunder Bay are actually losing residents. This is worrisome, especially with the onslaught of Baby Boomers retiring over the next couple decades. Although cities may be in good shape now, crunch time could be a few years away when property tax revenues are falling and less active employees are contributing to the municipal pensions.
Deficits A Key Difference Between U.S. And Canadian Cities
Although Canadian and U.S. cities may look and feel the same, they’re actually a lot different behind the scenes. How they operate is a key difference – while American cities can carry deficits and use “creative accounting” to push liabilities off over the horizon, Ontario cities are strictly bound by the law to balance their budget and spend tax dollars prudently.
The ability to carry deficits is what led to Detroit’s downfall – as debt continued to snowball, the problem only got worse. As Detroit was unable to cope with its debt, its credit rating worsened, increasing its cost of borrowing. Meanwhile, Canadian cities for the most part have pristine credit ratings – nearly 90 per cent have credit ratings of AA- or above. Canadian cities also operate more closely under the watchful eye of the provincial government, subject to stricter financial and regularity oversight.
Pension Protection in Canada
Legacy costs, including pensions, are one of the key contributing factors that led to the Motor City’s collapse. Canada has often been praised for its well-regulated banking sector, which weathered the storm during the financial crisis. The same can be said about pension legislation, which is a lot stricter in Canada than the U.S. While American cities can choose to take a pension contribution holiday when they’re in trouble, Canadian cities operate under strict rules. Pensions in Canada have to regularly file valuation reports to ensure their assets are sufficient to meet pension liabilities.
Even if a Canadian city were to go bankrupt, you most likely wouldn’t lose your entire pension. For example, if the pension if 70 per cent fund, you would only be at risk of losing 30 per cent of your pension. Furthermore, Ontario workers operate under the safety net of the Pension Benefits Guarantee Fund, which covers pensions up to $1,000 a month in case of insolvency.
The bottom line is although the Detroit-style bankruptcy is possible in Canada, it’s highly unlikely – city workers can rest as ease knowing they’ll most likely have their full pension at retirement.