Thursday, March 26, 2009

Will Big Pensions Swallow Smaller Ones?


The CBC reports that Ontario will hit a record $14.1 billion deficit in 2009:

Ontario will rack up a record $14.1-billion deficit in 2009 as it commits billions to infrastructure projects and job retraining aimed at pulling the province out of a recession, provincial Finance Minister Dwight Duncan revealed on Thursday in the tabling of his $108.9-billion budget.

The fiscal plan also proposes corporate tax cuts to ease costs for struggling businesses and stimulate investment in Ontario’s sagging economy, which has shed hundreds of thousands of jobs in recent years.

The budget forecasts a deficit of $3.9 billion in the 2008-2009 fiscal year, followed by a deficit of $14.1 billion in 2009-2010. It anticipates Ontario will run deficits for the next seven years, with a proposed return to balanced books no later than the 2015-2016 fiscal year.

The province and the federal government have also agreed to harmonize the provincial sales tax and GST into a single 13 per cent sales tax by July 1, 2010, which Duncan called the "next essential step" in growing the province's economy and improving competitiveness.

It also allocates a $3.4-billion contingency fund, from which an unspecified amount can be directed toward a bailout package for the province’s beleaguered auto industry once negotiations with automakers are completed.

One proposal that caught my eye was that Ontario may turn its largest pension fund, the Ontario Teachers' Pension Plan (OTPP), into an even bigger entity that could manage money for civil servants, university endowments and other groups:

The province's Liberal government is introducing new legislation that would allow smaller pension plans and “institutional investors in the public sector” to use Teachers to handle their money and administer pensions, for a fee.

The move, contained in the provincial budget Thursday, would give added heft to an organization that is already one of the largest and most influential investors in Canada. Teachers had about $108-billion in assets as of the end of 2007. It will disclose how much that figure declined in 2008 when it unveils its year-end financial results next week.

Allowing other funds to plug into Teachers' investment expertise would lower costs and bring “enhanced investment opportunities for future OTPP clients,” the budget documents say. Teachers would even be permitted to manage pension money for groups outside of Canada.

The government also used budget day to announce or confirm other initiatives to help corporate pension funds hit hard by the turmoil in the financial markets.

Provincially-regulated pension funds will get up to 10 years, in some cases, to make the payments needed to make up a solvency deficit. In the meantime, the government will conduct a study to determine the health of its Pension Benefit Guarantee Fund, which pays some pension benefits when companies go out of business and their pension funds are wound up. The fund had a $102-million deficit as of March 31, 2008.

Queen's Park will also change tax law to allow workers who are at retirement age to begin drawing a pension, yet keep working and accumulating pension credits.

And the budget promises the McGuinty government will work with Ottawa and the other provinces to investigate ways to increase pension coverage. About 80 per cent of private-sector employees in Canada do not have a defined-benefit pension from their employer.

So Ontario Teachers' will get more assets to manage. This isn't a bad idea given that Teachers' has an excellent reputation and it can manage funds better at a lower cost.

But the proposal is sure to raise some eyebrows after Teachers' reports its results next week. As I reported in the past, I expect Teachers' is heading for a fall.

Also, I read that the Ontario Municipal Employees Retirement System (OMERS) wants a piece of the action as big pensions to hold umbrella over smaller ones:

Should the big pension plans in Ontario become an umbrella for smaller pension plans? That appears to be the route the province’s Liberal government would like to see taken.

In its budget, the province is introducing new legislation that would allow smaller pension plans and institutional investors in the public sector the right to hand over their portfolios and the responsibility of administering pensions to the Ontario Teachers’ Pension Plan for a fee.

OTPP, which had $108-billion of assets under management as of Dec. 31, 2007, is the third-largest pension plan in the country.

The benefits would include higher revenue for OTPP, lower administrative costs and "enhanced investment opportunities" for future clients of the fund.

The proposal is consistent with recommendations made by the Ontario Expert Commission on Pensions Report (otherwise known as the Arthurs' Report), released in November, which suggested the cumulative effect of handing over the reins of small funds to larger plans would mean lower investment fees, better in-house investment expertise, and the ability to spread investment risk through diversification.

"We support such a proposed amendment and we commend the government for moving quickly for recognizing and acting on the recommendations of the Arthurs' Report," said Deborah Allan, spokeswoman for OTPP.

While the Ontario government singled out OTPP, Michael Nobrega, president and chief executive of the Ontario Municipal Employees Retirement System (OMERS) has previously stated his support for a consolidation of public pension funds in the province. OMERS already manages pension money for Ryerson University, Transit Windsor and a small plan for Ontario Hydro, and is being approached by others.

"To the extent these opportunities come our way, we'd look favorably at them," Mr. Nobrega told journalists at a press conference last month.

I am sure he would. After taking a drubbing in private equity, OMERS would love to manage more assets so they can place bigger bets in private markets.

You see when it comes to pensions, size matters. You get to brag about how big you are and how great you are. It's all about "pension envy".

But politicians may want to rethink this strategy. If you are going to cover more smaller plans using a bigger plan, you'd better bolster the governance, making sure that the pension managers are not taking excessive risks with the funds they manage.

Finally, if you ask me, neither OTPP nor OMERS should manage these smaller plans. I think HOOPP's results in 2008 and over the past 10 years speak for themselves.

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