Key funding considerations:
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. At the same time, members are contributing to the plan for fewer years than in the 1990s, and their retirement periods are longer.
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.
The record-long economic expansion and equity bull market ended in 2020 as the COVID-19 pandemic brought on the deepest economic crisis and fastest equity market drawdown since the Great Depression. The economic downturn and financial market correction, however, were short-lived as the unprecedented level of policy support provided the impetus for the equally impressive equity market rebound during the second half of the year. In that regard, 2020 has been marked by a period of heightened asset market volatility, reflecting the uncertainty surrounding the pandemic.
While some semblance of stability has returned, as the economic recovery begins to take shape and the markets have priced in a more favourable outlook, the potential for future setbacks remains. This is particularly true in the near term as the economic scars from the pandemic begin to emerge. A material drop in asset prices will negatively impact asset values. Currency volatility also has an impact on assets. 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.
While promoting intergenerational equity, CIP is also an effective lever for mitigating funding risks. Over time, as the proportion of service that members have earned after 2009 continues to grow, 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.
As CIP applies to more pension beneficiaries, it will be able to absorb a greater loss, making it a more effective risk management tool.