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||2018||1990|
|Average retirement age||59||58|
|Average starting pension||$47,300||$29,000|
|Average contributory years at retirement||26||29|
|Expected years on pension||32||25|
|Number of pensioners aged 100 or more||133||13|
|Ratio of active teachers to pensioners||1.3 to 1||4 to 1|
|Average contribution rate||11.0%||8.0%|
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. Given the longevity of the plan members, Ontario Teachers' uses plan-specific mortality tables and custom two-dimensional mortality improvement scales which are regularly reviewed and updated as warranted.
As the Canadian economy has recovered from the downturn following the Global Financial Crisis, interest rates have edged gradually higher in recent years, driven in part by the normalization in the Bank of Canada's policy rate. Even so, rates remain well below their historic levels.
Interest rates affect both assets and liabilities. An increase in rates could reduce the value of the plan's 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, reduced for a provision for risk. Plan liabilities are very sensitive to changes in the discount rate. Assuming a lower discount rate in funding valuations would increase plan liabilities. The investment program maintains an allocation to a Liability Driven Investment (LDI) program to help 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 an increased cost of living (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 relatively stable since 1991, generally remaining within one percentage point of the Bank of Canada's 2% target.
After witnessing generally positive markets over the past 10 years, there are some indications that asset valuations may be fully priced. A material drop in asset prices would negatively impact asset values. In 2018, management took further steps to diversify the plan's assets in a manner that optimizes its risk profile for the current environment.
Currency volatility also has an impact on the plan's 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 materially 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 design and implementation of an innovative funding risk mitigant, conditional inflation protection (CIP), adds flexibility to the plan and promotes intergenerational equity. It recognizes and virtually neutralizes the impact of the changing ratio of active to retired plan members on the plan's funded status.
The plan sponsors prudently and proactively introduced CIP in 2008, recognizing that if significant investment losses or a funding shortfall occurred, an increase in contribution rates alone was unlikely to be sufficient, and increases would be borne solely by active plan members.
CIP allows ﬂexibility in the amount of inﬂation increase provided to pensioners for beneﬁts earned after 2009. The level of increase is a sponsor decision and is conditional based on the funded status of the plan. Pension credit that members earned before 2010 remains fully indexed to inflation. There are three levels of inflation protection for members, which are based on when pension credit was earned: before 2010, during 2010 to 2013, and after 2013.
When pension credit
What this means
This portion of a member's pension will keep pace
with annual increases in the Consumer Price Index (CPI).
|During 2010–2013||50% to 100%||
This portion of a member's pension will receive at least 50%
and up to 100% of the annual increase in the CPI, depending on the plan's funded status.
|After 2013||0% to 100%||
This portion of a member's pension will receive from 0%
to 100% of the annual increase in the CPI, depending on the plan's funded status.
CIP is an effective lever for mitigating funding risks while also promoting intergenerational equity because, over time, as more active members retire, the risk of significant investment losses or a funding shortfall is distributed more broadly among the membership – that is, risk is shared by more retired members.
CIP is becoming more powerful over time. The proportion of service that members have earned after 2009 continues to grow, while the proportion of service earned before 2010 (which is fully indexed to inﬂation) is in decline. These trends mean that, eventually, all pension beneﬁts will be subject to CIP and active and retired plan members will both share the risk of a loss.
In effect, this has the impact of reversing the plan's demographic profile by improving the ratio of members who share in the plan's risk to those who don't share in risk. When CIP became a feature of the plan in 2008, there were 1.5 active members sharing in the plan's risk for every retiree, who at the time did not share in the plan's risk. By 2058, as the impact of CIP grows, there will be 14 members (both active and retired) sharing in the plan's risk for each retiree who does not.
As CIP applies to more pension beneﬁciaries, it will be able to absorb a greater loss, making it a more effective risk management tool.
|Increase in contributions required for 10% loss in assets||1.9%||5.0%||5.4%|
|Decrease in level of CIP required for 10% loss in assets||n/a||32%||23%|
|Asset loss capable of being absorbed by fully invoked CIP||n/a||$37B||$75B|
As an example, a 10% asset loss in 2028 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 to 0% on benefits earned after 2013, this funding lever would be powerful enough to absorb a 2028 asset loss of $75 billion.