I am lucky to be a teacher in Ontario because we have one of the most successful pension plans in existence.
As of last week, the Ontario teacher’s pension plan had assets of 190 billion dollars. This is an increase of 10% from the year before.
The plan has about 325,000 active members. Over 100,000 are retired.
Last year they spent 5.7 billion dollars on pension payouts.
My question is, how much is too much? At what point, if any, must the pension board start distributing its assets back to the contributors or at least start lowering pension premiums.
Are there laws that regulate this type of thing?
Thanks in advance.
I don’t know the answer to your question about re-distribution, but yes, there are laws governing pension funds.
The federal Income Tax Act sets ground rules for a pension to be registered under the Act. Registration is required for your contributions to be tax-deductible, and for the assets of the plan to grow without being taxed until you start drawing your pension. One of the requirements under the ITA is that there are maximum contributions employees and employers can make to the plan.
There’s also a provincial statute, the Pension Benefits Act, which regulates the management of a pension plan.
Here’s a link to a web-page about pension benefits in Ontario:
Employees are often more concerned when pensions are underfunded because they worry that the plan won’t be able to pay out all of its promised benefits. You seem to be worrying unnecessarily.
The Ontario Teachers Pension Plan is only about 5% overfunded, which is not a tremendous amount. One bad year in the market could set them back more than that. They became overfunded only by taking some prudent investment risk. A little cushion to absorb future investment risk seems like a good idea.
According to their annual report, the OTPP has reduced premiums effective 1/1/2018 and they restored full inflation protection for beneficiaries. These sound like good benefits to get from their current overfunding.
OTPP 2017 annual report (pdf): https://www.otpp.com/documents/10179/786414/Annual+Report/34a85f19-2ff8-465b-b239-bdb700f69130
A few years ago my wife’s teacher’s pension plan, which is considered to be very healthy by U.S. standards, dipped down to a 1.7% return, against its historical rate of 6.9% A couple more bad years like that would wipe out a 5% overfunding.
Cushions are good.
Back last century, some UK pension funds gave contributors a payment holiday because they were flush with funds. I am not sure why, but eventually the pendulum swung and many pension funds found themselves seriously short of cash. “Black holes” come to mind and it has been a major problem ever since.
The most important factor in how well-funded a pension plan is the discount rate; i.e. the interest rate used to account for the time value of future payouts. As you’re probably aware, the plan’s pension liability consists of all payments to be paid to retirees in the future. This means that the duration of the liability, or average time in the future that the payments will be made, is typically 13-17 years (for active plans in which employees are still accruing benefits). Payments further out in the future, such as for a young employee who is still 40 years from retirement, are discounted far more heavily than that of those that are in closer to retirement or already in retirement.
Since the pension liability has such a long duration, it is extremely sensitive to discount rates. For example for a plan with 15 year duration, in a year where the discount rate falls by 1 percentage point, the liability would increase by about 15%. So if all the assets of the plan were invested in stocks, the stocks would need to provide 15% return just to keep the funding status the same.
Different countries have different rules for which discount rate can be used. In the US for corporate plans, it is the average yield of A or better rated corporate bonds. The implication is that the risk to the pensioner to receive payments until death should be about equal to the ability of a very highly rated company’s ability to make these payments.
I’ve simplified much of this as I’m late for something, but will check back in.
Accounting students as of a few years ago at least here in the US learn some of the rudimentary rules about the funding of pensions and how to account for them. I learned a great deal more than I actually remember, but I’m fairly sure that if the returns on the plan’s assets are greater than expected and this leads to an overfunding of the pension, it will be smoothed out with lesser required pension contributions amortized over the period of average service life. Assuming that people teach for 40 years and there’s an equal amount of each age, that means 1/20 of the overfunding will be applied to reduce the amount the company needs to contribute based on its expected future pension cost. Then next year they’ll figure how much it’s still overfunded and take 1/20 of that again, even though it’ll probably be a smaller amount since it started at 95% the prior year’s. It will very very slowly reduce the overfunding over the long-term, long enough for there to be a time where the asset returns are lower than expected and wipe out the overfunding. The same is true for underfunding. In addition to that, the pension isn’t considered to be over- or under-funded unless it’s more than 10% off from where it needs to be, and the amortization is only on the amount that exceeds that 10% “corridor”.
I was really astonished by how slow this amortization was when learning it, but when you consider market cycles and that the expected average long-run return changes much slower than the current year’s return due to market fluctuations, it makes sense. Pension administrators need to slowly change the expected return based on what happens in the market, but since there can be such wild swings, even in the safe-ish investments pensions invest in, that they really take a long-term approach, which makes sense given their very long-term obligations.
I’ve always felt that for pension plans (and other things, like government bodies reserve fund) should meet the same criteria that sound financial planning sets for individuals of families. That is, they should be able to live off their reserve savings for a year or so if they were injured or fired and lost all their income.
So in your example, the teachers pension fund pays out about $500 million per month, so would be able to last 380 months with no income. Really well funded. Even taking into account that there are about 3.7 times as many future pensioners to be covered, they still have 8.5 years of reserves. Still really well funded.
This is a very simplistic analysis, since some pensioners die off as new ones are added; and a government body is unlikely to see all their income dry up, like an individual might due to sickness or job loss. On the other hand, an individual can often economize and cut expenses after a job loss; but a government body will often see its’ expenses go up – when the town’s biggest employer closes down the plant, there are all those laid-off workers collecting unemployment and other city services.
It’s important not to confuse size with “too much”.
The question is, if they spent $5.7B out of $190B on payouts last year - which seems to indicate overfunding - does this represent a “steady-state” situation or will the number of teachers retired grow significantly in the future? Since the baby boomers are reaching retirement age about now, I’m guessing the number retiring will be higher going forward; plus, people are living longer now, and salaries are still going up meaning higher pensions.
The way most defined benefit pension plans work in Canada, every 3 years the plan must produce an actuarial calculation (based on government standards) to show whether it has enough money to meet future obligations. If it is short, the employer(s) must show a plan to get caught up within 5 years.
The OTPP uses a 4.8% discount rate. This seems reasonable or perhaps a little conservative to me.
The estimated overfunding takes into account the expected liabilities of the plan in the form of pensions the plan will owe to its participants under reasonable assumptions. The OTPP’s actuary estimated that as of 12/31/2017, the plan needed $217.2 billion CDN to meet its obligations and the plan had $227.5 billion CDN in assets. Since the second number is 5% more than the first number, the OTPP is 5% overfunded according to the actuary. The plan doesn’t need to catch up because it has more assets than it expects to need.
The other issue is the structure of the plan. With a company DB plan, the company’s obligation is defined by the results of that actuarial estimate. However, IIRC the Teachers’ plan is for a multitude of employers (plus, don’t the employees themselves also contribute?), so it is simpler and convenient to not constantly adjust the amount up and down unpredictably. As you mention, 5% is not a huge cushion, it could disappear in a year if, say, someone started a trade war and hurt the world economy. If the total amount did get seriously overfunded, then maybe an adjustment of contribution levels would be called for. (I’m going to make a wild-assed IANAAccountant guess and say maybe over by 20% or 30% might trigger this.)