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Preliminary valuation shows shortfall
Notwithstanding the fund’s 2007 investment growth, the preliminary funding valuation conducted as of January 1, 2008, shows a $12.7 billion shortfall between the plan’s assets and its liabilities (the cost of future pensions). This valuation is based on the plan’s current Funding Management Policy, adopted by the OTF and Ontario government, and the valuation assumptions approved by the pension plan’s board.
The board, the OTF and the government are discussing the preliminary shortfall in preparation for the next required filing of the funding valuation. A balanced funding valuation must be filed with the provincial regulator by September 30, 2008, showing the plan is likely to have enough money to cover the cost of future pensions for all current members. When there is a shortfall, the OTF and the government can increase contributions, reduce future benefits or use a combination to bring the plan back into balance. (Pensions being paid to retirees and the value of pension benefits already earned by working teachers are protected by law.)
Ongoing funding concerns are largely the result of continuing low real interest rates combined with the challenge of managing a mature plan – a challenge that defined benefit pension plans worldwide are facing. This plan has a low ratio of working-to-retired members (1.6 to 1) and pays out more money annually than it collects (the plan paid $4.0 billion in pension benefits and received $2.1 billion in contributions from teachers and the government in 2007.)
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| | 1970 | 1990 | 2008 |
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| Contributing members per retiree |
10:1 |
4:1 |
1.6:1 |
| Future contributions as a percentage of plan assets1 |
93% |
42% |
26% |
| Increase in contribution rate required if assets decline by 10% |
0.56% |
1.9% |
4.4% |
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| 1Assuming the plan is fully funded
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Due to the declining teacher-to-pensioner ratio, a smaller proportion of the plan’s members bear responsibility for keeping the plan fully funded. The low ratio of contributing teachers to retirees makes it more difficult to overcome any future funding shortfalls with contribution increases alone.
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Plan maturity has two important impacts:
1) it becomes more difficult to use contribution increases alone to offset insufficient investment returns that may cause funding shortfalls (as the table above shows); and therefore,
2) it reduces the amount of investment risk we can take to earn the returns required to pay pensions.
Seeking higher returns means assuming greater risk. However, the low ratio of working teachers to pensioners restricts our ability to increase returns by taking on more risk. If financial markets should fall significantly, it would be difficult, if not impossible, to make up the difference through higher contributions alone. In recent years, we have changed our asset mix to reduce risk, but this approach also reduces the fund’s potential to earn returns over the long term – and for a pension plan, it is the long-term performance that counts most.
We have addressed these competing concerns as much as possible by finding new ways to make the plan’s money work harder. But, the facts remain: this year’s preliminary valuation shows another funding shortfall (despite contribution increases introduced to address the 2005 shortfall) and achieving the investment returns required to match growing pension costs is more difficult with the plan’s lower risk tolerance.
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Real Interest Rate | Amount Required1 |
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| 2.0% |
$855,000 |
| 3.0% |
$745,000 |
| 4.0% |
$660,000 |
| 5.0% |
$585,000 |
1For retirement at age 58
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When real interest rates are low, bonds yields are low. As a result, the cost of future pensions is higher because the pension plan needs more money today to earn the value of pensions to be paid in the future.
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Studies completed in 2007
Keeping the pension promise made to plan members is a goal we share with the plan sponsors – the OTF and the Ontario government. Over the past year, we worked together on two major research projects by:
1) conducting a member survey on contributions and benefits; and
2) commissioning an expert panel to review independently the assumptions used for the plan’s funding valuations.
The survey’s full results are available online. To recap, survey participants said they would be willing to pay an average maximum of 12.3% of their base earnings to preserve their current pension package. Of the three options offered, making cost-of-living increases conditional on the plan’s financial health (with the understanding that inflation protection would resume when the plan could afford it) was their preferred option to address funding shortfalls if contributions were already at their maximum preferred level. More research is being conducted on this option, which has been used by other Canadian pension plans.
The panel completed a thorough analysis of the plan’s valuation assumptions and recommended strengthening the life expectancy assumption to reflect members’ increasing longevity. The plan sponsors may consider the findings of the survey and expert panel as they look at the options to resolve funding concerns. We look forward to working with the plan sponsors on a clear set of measures that will guide their future decisions: when to increase and decrease contributions, and when to address future benefits to keep the plan fully funded over the long term.
In conclusion
Dealing with the shortfall will be a challenge for the plan sponsors. But with the challenge comes the opportunity to work together on changes that will benefit the plan’s members for generations to come.
On behalf of the board and management team, I extend our appreciation to Tom O’Neill and Raymond Koskie who resigned in 2007. Succeeding them are Sharon Sallows, a partner in Ryegate Capital Corp., and Bill Swirsky, a former executive of the Canadian Institute of Chartered Accountants.
I look forward to reporting to you next year on our progress in keeping the pension promise and facing the mature plan challenge.
Jim Leech
President and Chief Executive Officer
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