What the Ontario Pension System Can Teach Americans
One neighbor to the north has come up with a way to over-fund their state pension system, so why can’t it be repeated here?
Bucking the industry trend, the Ontario Teachers’ Pension Plan announced it was 105% funded as of Jan. 1, 2017, its fourth consecutive year of being fully funded. The fund reported that net assets rose by $4.2 billion year-over-year in 2016 to $175.6 billion. The total-fund rate of return of 4.2% exceeded the benchmark of 3.5%, resulting in $1.3 billion in value-add.
The fund also reported a preliminary $11.5 billion surplus on March 29, 2017. Ontario Teachers’ Federation (OTF) and the Ontario government, which jointly sponsor the pension plan, will decide how to use surplus funds if they decide to file the 2017 funding valuation. The Ontario fund covers 318,000 active and retired teachers.
Meanwhile, back in the U.S., the state pension fund situation is much darker. A survey published Jan. 15, 2016 by Moody’s found that public pension funds in the U.S. are underfunded by $1.3 trillion, a slight increase from 2015. The worst state deficits are in Illinois ($195 billion); California ($180 billion); Texas ($123 billion); and, New Jersey ($85 billion).
So here is the big question: How did the Ontario Fund get overfunded when underfunding of municipal and state pension funds in the U.S. has become the norm?
A few reasons:
The Financial One
- The Ontario System is very good at basic portfolio implementation. According to Ron Mock, the fund’s president and chief executive officer, the fund is a long-term investor that has created a diversified portfolio with a steady stream of pension payouts and minimal volatility. This is one reason why the fund holds investments in 37 global currencies in over 50 countries. In those local currencies, the return on investments was 7.2%. Converting the return on those investments back into Canadian dollars, the currency in which pensions are paid, had a negative 2.8% impact on the Plan’s total-fund rate of return. By contrast, currency gains added 8.3% in 2015, Mock said.
The More Important Political One: Prudent Governance and No “Political Bagmen” Allowed
- This critical part is often what is lacking in state pension systems: The Fund has a “jointly sponsored” governance structure and close management ties between the fund’s two sponsors: the Ontario Teachers’ Federation, representing the members through their union affiliate organizations, and the Ontario Government, representing the employer.
The fund has worked at exceeding its funding standards by linking the interests of the Ontario Teachers Union and the Ontario Government together in a transparent corporate governance structure.
“These two entities must jointly agree on all contribution rate and benefit changes (up and down) and they also must agree on when to file a funding valuation with the regulator,” according to Deborah Allan, managing director of the Ontario Teachers’ Pension Plan.
Allan said the fund suffered several years of shortfalls, so the fund’s two sponsors jointly agreed a few years ago to adopt Conditional Inflation Protection, or a policy of making inflation adjustments to pension payments earned after 2009 based on the health of the pension plan, as indicated by the annual preliminary valuation.
In addition, board members set the discount rate, based on assumptions from an independent actuary. “Our discount rate is conservative by industry standards, but realistic,” she said.
All Board Members Are Professionals
Another important differentiation is how the six-person Ontario system board is comprised. All board members are expert professionals in investments, accounting, actuarial, and financial services executives. Allan added that “to put it crassly, there are no so-called ‘bagmen’ on the board; this is not a political-favor appointment.”
The fund said its board structure is a key reason for its success. This means the teachers’ federation and the Ontario government (which represents employers) are equally responsible for making sure the pension plan has funds needed to meet its long-term pension obligations.
In addition, they appoint experienced, professional experts to the pension plan’s Board who comprise the Partners’ Committee. Their responsibilities are to set benefit levels; establish the contribution rate paid by working teachers (which is matched by the Ontario government and other designated employers); and to decide how to address funding shortfalls or use surplus funds. Importantly, members of the Partners’ Committee do not sit on the plan’s independent Board, according to the fund’s web site.
No More Dream Vacations in Retirement
So what can the Ontario system teach state pension systems?
Given the very different regulatory, legal, actuarial, geographic and membership cultures between the Ontario system and individual U.S. state pension systems, the Ontario system does not seem riddled with politics. It also has accepted its legal and ethical responsibilities to its members. This is not the case in the U.S. where state pension systems are regularly looted to fund other projects or contributions are deferred in order to meet state budget shortfalls.
This is more than a cultural and legal difference. It has to do with how state and municipal pension plan participants are regarded in the U.S. and how elected officials regard, and more commonly, disregard, their constituents.
This is an old story and it is playing out every day at the state and federal levels. Politicians know what they are doing when they defer making pension contributions or weaken Social Security. These actions do not go unnoticed by average pension plan participants. Many of these working people know their lifestyles will suffer when they retire simply because they will have a tough time making ends meet, let alone funding that once-in-a-lifetime vacation.
This may be why Millennials and younger workers want to work less, so they can have more free time today to pursue positive experiences. They also know they will not be able to afford those dream vacations when they get older and stop working.
The gig economy will not provide luxuries and long-term financial security. By definition, the gig economy is only a way of living for today, not tomorrow. That is a sad for American workers, but the dominant political system is making a financially secure retirement an illusionary goal for millions of Americans. This is what the retirement crisis in America is all about, yet no one is taking about it.