Balancing plan assets and the cost of future pensions is an ongoing objective for the two sponsors of the Ontario Teachers' Pension Plan: Ontario Teachers' Federation (OTF) and the Ontario government.
When making decisions on behalf of all beneficiaries, the plan's management and sponsors consider the impact of ever-changing demographic and economic factors and risks. The table below shows changes in key funding variables since the pension plan's inception in 1990.
|Funding Variables Comparison||1990||2016*|
|Average retirement age||58||59|
|Average starting pension||$29,000||$45,000|
|Average contributory years at retirement||29||26|
|Expected years on pension||25||31|
|Number of pensioners aged 100 or more||13||142|
|Ratio of active teachers to pensioners||4 to 1||1.3 to 1|
|Average contribution rate||8.0%||12.3%|
*as of December 31, 2016
Key funding considerations:
The plan has identified four main funding risks – longevity, interest rates, inflation and asset volatility – and seeks to manage intergenerational equity given these risks.
Teachers in Ontario live longer than the general Canadian population and their life expectancy continues to increase. It costs more to pay lifetime pensions when members live longer. Members are contributing to the plan for fewer years than in the 1990s, and their retirement periods are longer. The plan regularly updates its mortality assumptions (most recently for the January 1, 2015, valuation) and has adopted more innovative modelling to predict improvements in longevity, consistent with ongoing efforts by the actuarial profession in Canada, the United States and the United Kingdom.
Subdued economic growth and low inflation have kept interest rates at historically low levels. When interest rates are low, pension liabilities rise as more money must be set aside to earn enough to pay future pensions. In Canada, long-term real-return bond yields have declined from 2.07% over the last 20 years, on average, to 0.51% at the end of 2016. Interest rates also affect asset prices, and an increase in rates could reduce the value of our assets.
The plan seeks to provide retired members with annual pension increases to offset the impact of inflation. Higher inflation increases the plan's liabilities given the plan's inflation protection feature, while low inflation reduces the plan's liabilities. The annual increase that members receive is conditional on the plan's funded status. Inflation in Canada has been stable since 1991, generally remaining within one percentage point of the Bank of Canada's 2% target. The annual percentage change in the monthly Consumer Price Index ranged from 1.1% to 2.0% in 2016. In this era of low policy rates, economic uncertainty and volatile commodity and currency markets, it is more likely that inflation could miss the bank's target.
Strong stock market performance in recent years has helped produce positive investment returns for the plan. In an environment of modest global growth, macroeconomic and geopolitical risks and tighter U.S. monetary policy, higher valuations will result in higher market volatility. A number of major currencies moved sharply after unexpected results in the U.K. referendum on E.U. membership and the U.S. election. Further currency volatility can be expected as the implications of these geopolitical developments become clear, and some central banks begin to raise interest rates, while others maintain low policy rates. Volatile markets can present opportunities for long-term investors but they can also lead to investment losses.
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. Intergenerational equity is the principle that members of each generation contribute the right amount to pay for the benefits they receive. It is an important aspect of sustainability.
In the event of significant investment losses or a funding shortfall, there are two primary funding levers that the sponsors can use to bring the plan back into balance: increasing contribution rates and reducing conditional inflation protection (CIP).
Ontario Teachers' is a mature pension plan, with relatively fewer active, contributing members available to fund any major investment losses. It would be unlikely that increases in contribution rates alone would be sufficient to fund major investment losses and, in addition, these increases would be borne solely by active plan members. As noted, CIP provides flexibility in the amount of inflation increase provided for benefits earned after 2009. It is an effective lever for mitigating funding risks while also promoting intergenerational equity as the risk is distributed more broadly. As shown in the table below, CIP will become more effective over time as the amount of service earned after 2009 continues to grow.
|Increase in contributions required for 10% loss in assets||1.9%||4.8%||5.3%|
|Decrease in level of CIP required for 10% loss in assets||n/a||36%||24%|
|Asset loss capable of being absorbed by fully invoked CIP||n/a||$31B||$67B|
The figures above are relative to a fully funded plan, with 100% inflation protection provided for all benefits and average contributions of 11%. As an example, a 10% asset loss in 2025 could be absorbed by lowering inflation protection increases for benefits earned after 2009 from 100% to 75%. In the most extreme case, if CIP levels were lowered to 50% on benefits earned during 2010-2013 and 0% on benefits earned after 2013, this funding lever would be powerful enough to absorb a 2025 asset loss of $62 billion.
The maturity of the pension plan, the desire for intergenerational equity and the effectiveness of CIP as a funding lever are key considerations for constructing and managing the investment portfolio.