• 1. What is 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 to cover the costs of future pension benefits.

The valuation uses a number of assumptions to compare the value of pension plan assets (such as stocks and bonds, as well as future contributions) to the value of pension plan liabilities (the amount required to pay accrued and future pension benefits).

A valuation is a good measure of the pension plan’s financial health because it looks ahead more than 70 years. That’s how long the plan is expected to pay future benefits promised to all current members and their survivors.

• 2. Who is responsible for plan funding?

A plan sponsor – usually the employer – is responsible for ensuring that a defined benefit pension plan is fully funded. The Teachers’ pension plan has two sponsors: the Ontario Teachers’ Federation (OTF), representing plan members, and the Ontario government, representing employers. These co-sponsors negotiate the use of surplus funds and, when there is a funding shortfall, both share responsibility for eliminating it.

• 3. What happens to the funding valuation?

The OTF and the Ontario government are required to file a funding valuation with the pension regulator at least every three years.

A filed valuation must show that the plan has enough assets to meet the projected cost of future pension benefits. If a preliminary valuation shows a shortfall, a solution for bringing the plan back into balance is required before the valuation is filed with the regulator.

• 4. How are future pension costs estimated?

To estimate future pension costs, the pension plan commissions an independent actuary to conduct a funding valuation. The actuary determines how much money is required to pay pensions by making assumptions about the future inflation rate, future return on invested assets, future salary increases, age at retirement, life expectancy and other factors.

To ensure members pay the right amount into the plan for the benefits provided, the assumptions must be reasonable and provide a plausible snapshot of the plan’s future health. Economic assumptions are approved by the pension plan’s board members.

• 5. How are future assets estimated?

The investment rate of return assumption estimates how much the plan’s investments will earn over time. The assumption has a large impact on the funding valuation.

The return assumption is based on a three-year average of the yield on Government of Canada 30-year bonds.

The assumption is higher than the three-year average bond rate because the fund is expected to earn more than bonds do.

As a starting point, a premium of either 0.5% or 1.4% is added to the average bond rate. When the plan has a surplus, the assumption is the average bond rate, plus 0.5%. That means the plan expects to earn half a percentage point more than the bonds. Using 0.5% when the plan is in a strong financial position helps build up an asset cushion in good times.

When the plan has a shortfall, the starting point for the assumption is the average bond rate, plus 1.4%. Using 1.4% helps the plan absorb short-term changes in market returns. This avoids the need for frequent changes to contribution or benefit levels to keep plan assets and costs in balance.

The premium is set out in the plan’s Funding Management Policy, which was adopted by the OTF and the Ontario government. The plan board then applies its professional judgment as to the reasonableness of the premium given the risk profile of the fund.

• 6. How do you define a surplus or a shortfall?

The OTF and the Ontario government adopted a Funding Management Policy in 2003. Under the policy:

• If assets are equal to or up to 10% greater than liabilities, the plan is in balance and no change is required.
• If assets are more than 10% greater than liabilities, the plan has a surplus that can be used to reduce contribution rates or improve benefits.
• If liabilities are greater than assets, the plan has a shortfall.

The Funding Management Policy cannot stop a shortfall from occurring or make it disappear. It does, however, provide guidance on when to use surplus funds and when to change benefit or contribution levels when the plan has a shortfall.

The Teachers’ pension plan is fully funded when plan assets are equal to, or up to 10% greater, than the cost of future pensions.