Role of a funding valuation
A funding valuation is an assessment of the long-term financial health of a pension plan. The valuation shows whether the plan has a surplus of assets, a shortfall of assets or the right amount of assets needed to pay future pension benefits. A valuation is a good measure of the pension plan's financial health because it looks ahead to the remaining lifetime of each plan member.
Role of the sponsors Role of the sponsors
A plan sponsor is responsible for ensuring that a defined benefit pension plan is fully funded.
The Ontario Teachers' Pension Plan has two sponsors:
- Ontario Teachers' Federation (OTF), representing members
- The Ontario government, representing employers
These co-sponsors must agree to the use of surplus funds and when there is a funding shortfall, both share responsibility for eliminating it.
Filing a funding valuation Filing a funding valuation
The sponsors are required to file a funding valuation with the regulators at least once every three years although they also have the option to file more frequently.
A filed valuation must show that the plan has enough assets to meet the projected cost of future pension benefits. The valuation cannot be in a deficit position when filed.
If a preliminary valuation shows a shortfall or a surplus, the sponsors jointly decide on how they will balance the plan before the valuation is filed with the regulators.
Handling a surplus or shortfall Handling a surplus or shortfall
The sponsors have a Funding Management Policy that guides their decisions on how to use any surplus funds or resolve any shortfall.
To address a funding surplus or shortfall, they can:
- Change contribution rates
- Change the level of inflation protection for benefits earned after 2009
- Change other pension benefits members will earn in future years
- Adopt a combination of these options
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, 2022 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.
We continue to live in an uncertain and unpredictable investment and geopolitical environment with inflation levels the highest we’ve seen in Canada since the 1990s. Notwithstanding current challenges, the long-term outlook remains table. As a result, the board decided to hold the real discount rate steady at 2.45% after having lowered it from 2.60% for the January 1, 2021 valuation.
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.
Discount rates used in recent funding valuations
|Filed funding valuation1||Discount rate/inflation rate|
|January 1, 2022||4.50% (2.45% real, 2.0% inflation)|
|January 1, 2021||4.50% (2.45% real, 2.0% inflation)|
|January 1, 2020||4.65% (2.60% real, 2.0% inflation)|
|January 1, 2018||4.80% (2.75% real, 2.0% inflation)|
|January 1, 2017||4.80% (2.75% real, 2.0% inflation)|
|January 1, 2016||4.80% (2.75% real, 2.0% inflation)|
|January 1, 2015||4.85% (2.85% real, 2.0% inflation)|
|January 1, 2014||4.95% (2.85% real, 2.1% inflation)|
|January 1, 2012||5.30% (3.1% real, 2.2% inflation)|
|January 1, 2011||5.40% (3.25% real, 2.15% inflation)|
Effective January 1, 2016, the real rate shown is the geometric difference between the discount rate and the inflation rate. Previously, the real rate shown was based on the arithmetic difference between the discount rate and the inflation rate.
1 Valuation filling dates are determined by the plan sponsors.