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||2017*|
|Average retirement age||58||59|
|Average starting pension||$29,000||$46,300|
|Average contributory years at retirement||29||26|
|Expected years on pension||25||32|
|Number of pensioners aged 100 or more||13||131|
|Ratio of active teachers to pensioners||4 to 1||1.3 to 1|
|Average contribution rate1||8.0%||12.0%|
*as of December 31, 2017
1Average contribution rate decreased to 11% effective January 1, 2018.
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 for many years. The 20-year average of long-term real-return bond yields at the end of 2017 was 1.9%. The spot rate, which is the settlement price at a specific point in time, at the end of 2017 was 0.6% – a notable decline over the last two decades. Interest rates affect both assets and liabilities. An increase in rates could reduce the value of plan assets. Long-term interest rates are also an important input to the discount rate decision. The discount rate reflects what the plan's assets can reasonably be expected to earn over the long term, minus a provision for risk. Plan liabilities are sensitive to changes in the discount rate. Assuming a higher discount rate in funding valuations would reduce plan liabilities. The investment program maintains an allocation to a Liability Driven Investment (LDI) program to mitigate the risk of changes in the discount rate as a result of long-term interest rates.
The plan seeks to provide retired members with annual pension increases to offset the impact of inflation. Inflation that is higher than assumed in the valuation increases the plan's liabilities, given the plan's inflation protection feature, while inflation that is lower than assumed reduces the plan's liabilities. The annual increase received by retirees on the portion of their pensions earned after 2009 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. During 2017, the annual change in the Consumer Price Index ranged from 1.0% to 2.1%.
Strong stock market performance in recent years has helped produce positive investment returns for the plan. After many years of gains, there is a risk that equities may be fully priced and a material drop in prices would negatively impact asset values. In 2017, as part of its OneTeachers' investment strategy, management took steps to further improve the plan's asset diversification and risk profile in order to mitigate this risk.
Currency volatility also has an impact on plan assets. Economic trends, commodity prices, market sentiment and other factors affect the value of the Canadian dollar against other currencies. The plan derives income from assets around the world, so global currency movements can affect investment returns positively or negatively. Volatile asset markets can present opportunities for long-term investors such as Ontario Teachers', but they can also lead to investment losses that affect the plan's funded status.
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%||5.1%||5.4%|
|Decrease in level of CIP required for 10% loss in assets||n/a||34%||23%|
|Asset loss capable of being absorbed by fully invoked CIP||n/a||$34B||$72B|
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 2027 could be absorbed by lowering inflation protection increases for benefits earned after 2009 from 100% to 77%. As another example, 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 2027 asset loss of $72 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.