Funding Status and Solutions

•  1. What is the pension plan’s funding status?

The Ontario Teachers' Pension Plan reported a preliminary $9.6 billion funding shortfall as of Jan. 1, 2012. That means the pension plan is projected to have 94% of the estimated funds required to meet its future long-term pension obligations. The shortfall exists despite an 11.2% return on investments in 2011 and plan changes that eliminated a shortfall
reported last year.

• 2. How will this latest shortfall be resolved?

To address a projected shortfall, the Ontario Teachers’ Federation (OTF) and the Ontario government can:

• increase contribution rates;
• further reduce inflation protection for pension credit earned after 2009;
• reduce other pension benefits members will earn in future years; or,
• adopt a combination of these options.

• 3. What solutions are being considered to address our funding problems?

It’s too soon to talk about a shopping list of pension plan changes. The plan sponsors – the Ontario Teachers’ Federation and the Ontario government – are still exploring ways to resolve the funding shortfall.

• 4. When will the shortfall be resolved?

OTF and the government must eliminate any shortfall before they file the next funding valuation with the provincial pension regulator. A funding valuation is an assessment of the pension plan’s long-term financial status. The next valuation is due in 2014, but OTF and the government could decide to file earlier.

• 5. Will the shortfall disappear if long-term interest rates rise?

A 1% increase in long-term rates will decrease estimated future pension costs by about $25 billion. However, the pension plan uses a three-year average interest rate as the starting point to estimate pension costs, so any positive impact from rising rates will be moderated (due to averaging) for at least the next two years.

• 6. Would higher contribution rates resolve the funding shortfall?

Raising contribution rates isn’t as effective in resolving shortfalls as it was in the past. Today, there are only 1.5 working teachers for each retiree. In 1970, there were 10. The smaller proportion of working members makes it more difficult to overcome funding shortfalls with contribution rate increases alone when markets fall or the plan’s
investments underperform.

For example, a 10% decline in plan assets would require a contribution rate increase of 4.4%. In 1970, when there were 10 working teachers to every retiree, the same decline would have required an increase of only 0.6%.

The low ratio of teachers to pensioners puts increased pressure on the pension plan fund to generate higher investment returns – but higher returns are difficult to achieve because the pension fund has a lower tolerance for investment risk as it gets increasingly mature.

• 7. What changes were made to eliminate the shortfall reported in 2011?

OTF and the Ontario government made three changes to address the 2011 shortfall:

1. A 1.1% contribution rate increase, phased in over 2012, 2013 and 2014
2. Slightly smaller annual cost-of-living increases for teachers who retired after 2009
3. Recognizing the 2011 contribution rate as the permanent base rate

In addition, the pension plan board adjusted a key assumption used to value projected pension assets and liabilities, which reduced the size of the shortfall.

 Pension Security

• 8. Is the pension plan running out of money?

No, the pension plan has $117.1 billion in assets, enough to pay pensions for many years. But we must prevent shortfalls that are projected to arise when we look ahead 70 years or more. That’s when today’s newest teachers will still be collecting their pensions.

• 9. Is my pension secure?

Yes, as mentioned in the previous Q&A, the pension plan is not in immediate financial distress. However, plan changes will be needed in future to address any shortfall and to keep the pension plan viable and affordable for all generations of teachers.

• 10. Can my benefits be reduced?

Current Ontario legislation protects the value of pension benefits already earned by working and retired members. Only pension benefits not yet earned can be adjusted during a teacher’s career.

• 11. Could the government change the legislation that protects the benefits I’ve already earned?

We cannot speculate on that. Only the government can change legislation. Keep in mind that the Ontario Teachers’ Federation (OTF) and the Ontario government have several options for dealing with funding shortfalls. They could:

• increase contribution rates;
• further reduce inflation protection for pension credit earned after 2009;
• reduce other pension benefits members will earn in future years; or,
• adopt a combination of these options.

• 12. Should I change my retirement plans?

It's unnecessary to delay or advance retirement plans because of the shortfall or concerns about possible future benefit changes. Teachers’ base pensions are defined by a formula based on years of credited service and average earnings, not on the funding status of the plan when you retire.

 Causes of Shortfall

• 13. Why do we have another funding shortfall?

As anticipated, plan liabilities (the cost of future pensions) are growing faster than plan assets. This trend continues despite strong investment returns and recent plan changes that addressed a funding shortfall in 2011. The changes included contribution rate increases and slightly smaller inflation increases for pension credit earned after 2009.

Increased life expectancy, longer retirements and low long-term interest rates are increasing future pension costs faster than the expected growth in plan assets, resulting in recurring funding shortfalls.

• 14. Why are low interest rates affecting pension costs?

Interest rates are used as a starting point to estimate the cost of future pensions because they predict future economic growth. When long-term interest rates fall, as they have in recent years, pension costs rise because more money needs to be set aside now to earn the value of pensions that will be paid in the future.

Low interest rates are great for borrowing, but not for saving. Imagine you are saving for a down payment for a house or car by a specific date. If your savings earn less each year because interest rates are low, you will have to put aside more money to reach your goal on time. It’s the same with pensions. When long-term interest rates drop, the plan needs to set aside more money to reach its goal.

“Real” interest rates (which are interest rates minus inflation) declined to 0.45% at the end of 2011 from 1.1% at the start of the year.

• 15. How are demographics contributing to recurring shortfalls?

Longer life spans and longer retirements are pushing up pension costs. In 1970, a typical teacher could expect to collect a pension for about 20 years. A typical teacher retiring today can expect to collect a pension for about 30 years, four years longer than she contributes to the pension plan. Plus, a pension may be paid to a survivor.

• 16. Why are 2008 investment losses still affecting the pension plan?

The plan’s 2008 investment losses will be recognized until the end of 2012 due to a practice called smoothing. Smoothing evens out short-term fluctuations in investment returns by amortizing annual investment gains or losses over a period of years. Smoothing doesn’t make gains or losses disappear. It just stretches them out so they can be managed better. Without smoothing, the Teachers’ pension plan would have to change contribution rates, benefit levels or both much more frequently to keep the pension balanced.

• 17. Do other pension plans have funding challenges?

Aging populations and low interest rates have put unprecedented demands on pension plans all over the world. Many organizations have closed their defined benefit plans, shifting the risk of retirement security to their employees. To survive, defined benefit plans will need to adapt to new economic and demographic realities. OTF and the government, which sponsor the Teachers' pension plan, have taken action in the past to preserve the pension plan and are committed to doing so in future.

 Miscellaneous

• 18. What is a financial statement valuation and what is a funding valuation?

A financial statement valuation determines whether there is enough money to cover all pension benefits accumulated by members to the end of the reporting year. It is required to meet accounting standards.

A funding valuation determines whether the assets in the plan, as it exists today with current contribution and benefit levels, can fully cover the cost of accrued and future benefits for all existing plan members and their survivors over the next 70 years or so. It is required under Ontario’s Pension Benefits Act.

The Teachers’ pension plan uses the funding valuation to determine whether the plan has a surplus of assets, a shortfall of assets or enough assets to meet its long-term benefit obligations.

• 19. Why is there such a large difference between the numbers in the two valuations?

The financial statement valuation reported in the pension plan’s 2011 annual report shows a $45.5 billion deficit, while the funding valuation shows a preliminary $9.6 billion shortfall.

The valuations are difficult to compare because they reflect different assumptions and methods and are used for different purposes (see previous Q&A).

Three key differences are shown in the Summary of Actuarial Methods and Assumptions Chart.

Summary of Actuarial Methods and Assumptions

• 20. What is the pension plan doing to help address funding challenges?

The pension plan is managing factors within its control. For example, it is:

• Managing the investment program so it has the best chance of reducing the gap
  between pension assets and liabilities
• Operating as efficiently as possible and managing costs
• Attracting and retaining quality staff
• Providing OTF and the government with the advice they need to make
  informed decisions