Despite posting a 14.3% rate of return in 2010 and ending the year with $13.3 billion in investment income—the largest “value-add” amount in its history—the Ontario Teachers’ Pension Plan (OTPP) still faces “serious funding challenges” caused by a combination of factors, according to president and CEO Jim Leech.
The rate of return was ahead of the plan’s 9.8% benchmark, a performance Leech attributed to a strong investment team.
But despite the plan’s 2010 investment performance, the OTPP continues to struggle with a funding gap that stood at $17.2 billion as of Jan. 1, 2011 ($144.1 billion in plan assets and future contributions against $161.3 billion in liabilities representing the cost of future pensions), according to a preliminary valuation.
Leech said three key factors are at the root of this shortfall: investment losses incurred in the 2008 economic crisis, the economic outlook and its effect on returns and interest rates, and a systemic funding problem caused by a demographic shift in the teaching profession.
“Like all institutional investors, we lost money in 2008. We lost about equal to the Canadian average, which was 18%,” said Leech. He said the OTPP has employed a technique called “smoothing,” which allows plans to absorb inordinate gains or losses into future valuations to avoid “being whipsawed by the vagaries of the marketplace.” As a result, the plan has absorbed about $5.2 billion of 2008 losses each year, ending in 2012.
“That’s somewhat set off by the two years of strong returns in 2009 and 2010,” said Leech. “But smoothing pushes those [returns] out, so you don’t get the full impact immediately. So that’s why we still have the legacy of the 2008 losses.”
Regarding the second factor, chief investment officer Neil Petroff said that the 10-year outlook for growth in the S&P/TSX in 2010 was 4.6%; that figure was 6.4% in 1990. In addition, he pointed to low interest rates, which affect the amount of money the plan needs to earn in order to fund its pension commitments.
“In 1990, at 4.5% [interest rate], we’re talking about $600,000 required to pay a teacher’s pension over their retirement. Now, with 1.2% rates, the cost of that pension is close to $900,000, which is a huge difference,” said Petroff.
One of the key factors faced by the OTPP is a demographic shift that is leading to a systemic funding problem, said Leech. In 1990, the average Ontario teacher retired after 29 years of service and collected a pension for 25 years. In 2010, the average career was 26 years and the average number of pension years was 30. Teachers are starting their careers later than in previous decades, while a greater focus on healthy living and improvements to medicine are allowing people to live longer and, consequently, collect pensions for an increasing number of years, he said.
“There are really no pension plans that were designed that people would be employed for a shorter period of time than they were on retirement. This is a dynamic that is hitting every pension plan around the world. We just happen to be at the forefront because we’re always at the forefront of the baby boom in the profession,” said Leech.
With the next valuation filing required in 2012, the plan’s sponsors—the Ontario government and the Ontario Teachers’ Federation—have the balance of 2011 to study available options for balancing the plan’s assets and liabilities and reducing risk. Leech said the sponsors are considering the impacts of contribution increases and changes to benefits.
Both Leech and Petroff expressed confidence in the plan’s management and its ability to post good returns.
“Notwithstanding all this uncertainty, I believe we have the right team in place. And I know they’ll do everything in their control to earn the best risk-adjusted returns for this fund. There are a lot of things we can’t control, but we work very hard to make good [investment] decisions,” said Petroff.