Plan Funding

• 1. Why does the pension plan have another funding shortfall when the fund made money in 2009?

Funding shortfalls can occur when the plan is earning money if plan liabilities (the cost of future pensions) grow faster than plan assets. Despite strong investment returns in 2009, the pension plan reported a preliminary $17.1 billion shortfall as at January 1, 2010.

The latest shortfall has two chief causes: low real interest rates (interest rates after inflation) and the impact of absorbing the 2008 investment loss. Approximately $15 billion of the $17.1 billion shortfall was due to declining long-term real interest rates (interest rates after inflation). When interest rates drop, pension costs rise because more money must be set aside today to cover the projected cost of future pensions. Real interest rates declined to 1.5% at the end of 2009 from 2.1% at the start of the year.

Recognizing part of the 2008 investment loss also contributed to the shortfall. We absorb gains and losses over five years to smooth out the impact of market fluctuations on the plan’s bottom line.

• 2. Is my pension going to change?

The value of pension benefits already earned by working and retired members is protected under current Ontario law. Only contribution rates and pension benefits to be earned in the future can be adjusted in response to funding shortfalls.

If a funding shortfall persists when the next funding valuation is required by the pension regulator in 2012, the OTF and the Ontario government – the plan sponsors – must eliminate it. To address a funding shortfall, the OTF and the government can:

• increase contribution rates;
• invoke conditional inflation protection for pension credit earned after 2009;
• reduce pension benefits members will earn in the future; or
• adopt a combination of these options.

• These and other questions are answered in the plan funding section of our website.

Investments

• 3. How did the fund perform overall?

The fund earned a 13.0% rate of return as global stock markets rebounded. Investment income totalled $10.9 billion in 2009. We earned back approximately half of the 2008 loss ($19.0 billion). Much of the investment income came from public equities that were hardest hit in the 2008 market slide and benefited most from the market rebound last year. A breakdown of investment income by asset class follows:

Asset Class	Income by asset class	Performance vs. Benchmark	Percentage of Asset Mix
Equities	$7.2 billion	Return: 21.4% Benchmark: 17.2%	44%
Fixed income	$1.8 billion	Return: 23.6% Benchmark: -4.8%	7%
Inflation-sensitive investments	$1.9 billion	Return: 4.0% Benchmark: 5.4%	49%
Total	$10.9 billion	Return: 13.0% Benchmark: 8.8%	100%

Our 13.0% rate of return exceeded our 8.8% fund benchmark by a wide margin. This translated into $3.4 billion more than the markets returned. Credit products and hedge funds (held in our fixed income asset class) performed well, as did public equities due to decisions several years ago to invest in Brazil.

• 4. How do you set your benchmark?

The fund benchmark is neither a target nor a random number – it is an aggregate measure of the performance of key markets in which we invest.

We compare our performance against the performance of the relevant market index, such as the S&P/TSX Total Return Index for Canadian stocks or the S&P 500 Total Return Index for U.S. stocks. Our goal is to perform better than the indices. The fund benchmark is a composite of the asset class benchmarks weighted according to our asset-mix policy (45% inflation-sensitive investments, 40% equities, 15% fixed income in 2009).

See rates of return compared to benchmarks for a list of the benchmarks used for each asset class.

• 5. Why is your benchmark lower than that of other pension plans?

Different pension funds have different benchmarks depending on their asset mix (allocations to stocks, bonds and other investments). Every pension plan has different member demographics and benefit structures, and this influences investment decisions.

Our asset-mix policy in 2009 called for 40% equities, less than some other pension plans. Equity markets performed well last year, so investors with higher allocations to stocks would be expected to have higher benchmarks and returns.

• 6. Why are so many of your top holdings in Brazil? Isn't that risky?

A reasonable amount of investment in emerging markets makes sense for this pension plan because emerging markets are growing more quickly than developed markets. Emerging markets (including Brazil) account for 13% of our direct equity holdings and Brazil is the largest exposure in this category. (By comparison, Canada and Europe account for 18% and 25% of our direct stock holdings respectively.)

We began acquiring resource equities, real estate and bonds in Brazil after significant research and due diligence. These investments were not extraordinarily large when we made them but have grown significantly since our original investment. We’re comfortable investing in Brazil because it has good economic fundamentals. It is not only resource-rich but the government’s fiscal affairs are in order. Brazil’s debt was rated investment grade in 2008, earlier than many investors expected.

• 7. How did your fixed income investments earn a 23% return last year?

Our fixed income asset class includes more than just bonds and T-bills. It holds a wide variety of assets (corporate bonds, credit products, externally managed hedge funds) and strategies that aim to increase returns. Credit products, hedge funds and active currency management pushed performance well ahead of the fixed income benchmark, which primarily tracks the performance of long-term government bonds.

Compensation

• 8. Why are bonuses being paid when there's a big shortfall?

Incentive compensation is not based on the plan’s funding status (surplus or shortfall). It is based on whether investment staff outperform relevant market benchmarks. A funding shortfall arises from an imbalance between projected assets and liabilities (the cost of future pensions). Many important factors in a funding valuation, such as interest rates, contribution rates and benefit levels, are outside of our control. The Ontario Teachers’ Federation (OTF) and the Ontario government decide contribution and benefit levels for the pension plan.

See question 5 for more information on benchmarks.

• 9. What are bonuses based on?

Incentive compensation for executives and investment staff is based on performance relative to market benchmarks over four-year periods. For example, if markets go up 10% and we generate a 12% return, our staff is rewarded for performing better than the markets.

This year’s payments result from three very strong years of market outperformance (2006, 2007 and 2009) and one bad year (2008). Incentive compensation for investment staff dropped by 40% ($27 million) for 2008, and payments to the most highly paid executives were down even more. Incentive payments for 2009 are somewhat higher than they were in 2008 due to good performance last year – but they are still much lower than they were prior to 2008. The 2008 performance continues to have a large negative impact on incentive payments and will significantly reduce compensation levels through 2011.

See Executive Compensation and read the Compensation Discussion and Analysis
(pages 61 to 67) in our annual report for more information.