Financial statement valuations
We conduct two different actuarial valuations.
- The funding valuation assesses the long-term health of the plan and informs contribution and benefit rates.
- The financial statement valuation is a mark-to-market, current snapshot view of the financial position of the plan. Valuation assumptions and methodology are outlined in Section 4600 of the Chartered Professional Accountants Canada Handbook.
A key reason for the different results between the two valuations is how the discount rate is set. The lower the discount rate, the higher the liability.
Discount rate for funding valuation
The discount rate is derived from the expected rate of return on investments and takes into consideration the cost of running the plan and provisions for plan maturity as well as major adverse events, such as the 2008 financial crisis and the volatile effects of COVID-19 on the markets.
For the January 1, 2021 funding valuation, the nominal discount rate was 4.5% with an underlying real return of 2.45%.
Discount rate for financial statement evaluation
Our financial statement valuation discount rate (2.0% nominal, 0.5% real) is based on market rates. This is determined as at the valuation date of bonds issued by the province of Ontario. These bonds have characteristics similar to the plan’s liabilities. The discount rate was determined by applying a weighted average discount rate that reflects the estimated timing and amount of benefit payments
A funding valuation uses several actuarial assumptions to project the value of future pension plan liabilities and contributions.
Assumptions using professional judgment are made about:
- Future inﬂation
- Salary increases
- Retirement ages
- Life expectancy
- Other variables.
One of the most important assumptions is the discount rate, which plays a key role in assessing whether the pension plan has enough assets to meet our future pension obligations.
The discount rate is used to calculate the present value of future pension benefits that the plan expects to pay to members as well as contributions it anticipates receiving.
Plan liabilities are sensitive to changes in the discount rate, with a lower rate resulting in increased liabilities. The discount rate is derived from:
- The expected rate of return on investments
- The cost of running the plan
- Provisions for plan maturity
- Provisions for major adverse events, such as the 2008 financial crisis.
The discount rate is approved annually by the Board members. The process to set the discount rate is robust to ensure this assumption is reasonable and appropriate for the plan.
Ontario Teachers’ is facing imposing headwinds and an uncertain and unpredictable investment and geopolitical environment.
In addition, there has been a sustained decline in long-term interest rates, reflecting a continuing “lower for longer” expectation.
With these factors in mind, the Board decided to lower the real discount rate from 2.6% to 2.45%. This is a prudent decision, particularly given the maturing demographics of the plan’s membership.
The discount rate must be realistic to avoid masking plan funding issues that could impact future generations of retirees and plan members.
- If the assumption is too high and investments earn less than expected, a funding shortfall could result, requiring younger and future plan members to contribute more to the pension plan, receive lower benefits, or both.
- If the assumption is too low, current members could pay more than necessary for their pensions or benefits may be reduced more than necessary.