• 1. Why does the pension plan have persistent funding problems?

Plan liabilities (the projected cost of future pensions) are growing faster than plan assets. Key reasons include:

• low real (after inflation) interest rates;
• longer lifespans; and
• lengthy retirements.

• 2. Why do low interest rates affect pension costs?

Low real interest rates increase pension costs because they substantially affect the estimated amount of money required now to fund pensions in the future. When interest rates drop, estimated pension costs rise; when interest rates rise, estimated pension costs drop.

To understand this concept, imagine you are saving for a down payment on a house or car by a specific date. If your savings earn less each year because interest rates are low, you will have to put aside more money to reach your goal on time.

It’s the same with pensions. When real interest rates drop, the plan needs to set aside more money to earn the amount required for future pensions.

Real interest rates declined to 1.1% at the end of 2010, from 1.5% at the start of the year, adding about $13 billion to the projected cost of future pensions.

The “real” interest rate is the interest rate after inflation. If the stated interest rate is 3%, at a time when inflation is 2%, the “real” rate is 1%.

• 3. The Ontario Teachers’ Federation (OTF) and the Ontario government addressed the 2011 funding shortfall. Is it likely there will be another funding shortfall soon?

The 2011 shortfall has been addressed.

However, future shortfalls are projected to recur because plan liabilities (the cost of future pensions) continue to grow faster than plan assets. A shift in member demographics has resulted in systemic funding problems and contributed to recurring shortfalls since 2003.

Further changes to the plan may be necessary to address long-term funding problems caused by longevity and rising pension costs if funding shortfalls persist.

• 4. What demographic trends are causing systemic funding challenges?

Member demographics have changed dramatically during the past 20 years and pension costs are growing as pensioners live longer. A number of demographic challenges are stressing the plan’s funding stability, including:

• the growing number of retirees;
• the declining ratio of working to retired teachers; and
• the long period teachers are collecting a pension vs. the shorter period they
  contribute to the plan.

Growing number of pensioners – Like most mature pension plans, the Teachers’ plan pays more in benefits than it collects in contributions each year. In 2010, for example, benefit payments exceeded contributions collected by $1.8 billion.

Declining ratio of working to retired teachers – There are now fewer than two working teachers to every pensioner in the plan. Since pensioners don’t share the cost of resolving funding shortfalls, a declining proportion of the membership carries increased responsibility for meeting the plan’s funding requirements. The declining ratio of working to retired members makes it difficult to overcome funding shortfalls with contribution rate increases alone if markets drop or the plan’s investments underperform.

For example, a 10% decline in plan assets would require a contribution rate increase of about 4.0 percentage points to close the gap. In 1970 when there were 10 members to every pensioner, the same decline would have required an increase of only 0.5 percentage points.

The mature nature of the Teachers’ pension plan requires investment managers to carefully weigh the amount of risk taken to generate returns. Investment managers must be as concerned about the potential loss from an investment as they are about how much could be earned. This is a challenge because risk and return are related. Lower risk usually results in lower returns. Since the plan has to take less risk, future long-term returns are projected to be modest.

Teachers are collecting pensions for longer periods – Teachers are living and collecting pensions for longer periods. A typical teacher retiring today is expected to collect a pension for 30 years, plus a benefit may be paid to a survivor after the teacher dies. This means a typical teacher collects a pension about four years longer than the average contribution period.

• 5. Why are 2008 investment losses still affecting the pension plan?

The plan’s 2008 investment losses will be recognized until the end of 2012 due a practice called smoothing. Smoothing evens out short-term fluctuations in investment returns by amortizing annual investment gains or losses over a period of years. Smoothing doesn’t make gains or losses disappear. It just stretches them out so they can be managed better. Without smoothing, the Teachers’ pension plan would have to change contribution rates, benefit levels or both much more frequently to keep the pension plan balanced.