Low interest rates, longer life expectancy results in liabilities outstripping assets: OTPP
Changes to the inflation protection provisions of the Ontario Teachers’ Pension Plan (OTPP) for service after 2013 agreed upon by the Ontario Teachers’ Federation (OTF) and the Ontario government in February pave the way for the elimination of a $9.6 billion funding shortfall, projected at the beginning of 2012.
However, removing guaranteed indexing for future service could have a disproportionate impact on new teachers.
The OTPP earned 13 per cent in 2012 and beat all of its benchmarks. CEM Benchmarking has also ranked the plan first among international and North American pension systems for the last three years.
Nevertheless, low interest rates and longer life expectancies have resulted in liabilities outstripping assets, says Jim Leech, president and CEO of the OTPP.
“People are living longer, so we have to rethink the mathematical models that were developed 30 or 40 years ago.”
Today a typical teacher retires at age 59 and can expect to collect a pension for 30 years or more. The combined effect of early retirement and increased longevity means members now typically collect pensions for more years than they contribute to the pension plan.
The changes will have no effect on current retirees and minimal effect on teachers who retire within the next two years because the value of pensions already earned cannot be reduced under Ontario’s Pension Benefits Act.
“Pension credits earned before 2010 will be 100 per cent inflation-protected. Increases for pension credits earned during 2010-13 will range from 50 per cent to 100 per cent of the cost of living, depending on the plan’s funded status,” explains OTF president Terry Hamilton. “However, the portion of the pension accrued after 2013 will range from zero per cent to 100 per cent based on how well the plan is funded.”
Leech acknowledges the potential inter-generational differences created by the new indexing rules, but says the plan must evolve.
“Like any species, unless we adapt to changes in the environment, we risk becoming extinct,” he said.
The chart on page 2 further illustrates how the changes to inflation protection will affect different groups of members. If the plan is in a surplus position in the future, inflation protection could be restored on a go-forward basis to reflect previously unrecognized inflation.
One benefit of removing the guarantee on inflation-protection for future service is the plan will have more flexibility to take on additional investment risk, says Leech.
“If we hit a bump in the road like an investment loss, we can dial back on inflation protection for the period but when things get better, it can be reinstated.”
Hamilton agrees that by increasing conditional indexing, the plan has a bigger lever to bring the plan back into balance if some investments don’t work out. However, he admits this could be at the members’ expense.
“Not all of our members are happy, but part of our job is to help them to understand why the changes are necessary and how they may ultimately be affected.”
Eckler principal and communications leader Paul Harrietha has been advising pension plan sponsors on how to communicate plan changes for more than two decades.
The major challenge for OTPP is to make it clear that the pension plan remains relevant and fair to the members affected and ensure that the overall employment value proposition is compelling enough to offset the pension changes, Harrietha suggests.
“Even without the guarantee, OTPP remains an outstanding plan by any standards,” he says.
In addition to the February 2013 changes to inflation protection that brought the 2012 valuation into balance, in mid-March, the OTF and the Ontario government announced an agreement providing for a temporary four-year valuation cycle for the OTPP (as opposed to the normal three-year cycle).
This agreement will provide contribution stability for the next five years and give the plan sponsors another mechanism to deal with funding levels in the plan, Hamilton says.
“The discount rate for our valuation is based on a three-year smoothed rate for Real Return Bonds (RRB). RRB rates are currently at 0.5 per cent so they have nowhere to go but up,” he says. “A four-year valuation cycle gives us more time to deal with the ‘tail-end’ of the low-interest rate period before the next valuation.”
Sheryl Smolkin is a Toronto journalist and lawyer. She writes about workplace issues.
