Ontario taxpayers received a painful dose of honesty from the Ontario Teachers’ Pension Plan President and CEO Jim Leech last week as he admitted the funding formula is broken beyond repair and that “revolutionary” changes to pensions are needed.Here are the five questions asked to Jim Leech by he Hamilton Spectator:
Leech spoke at a fundraiser in Hamilton on Thursday, after a decidedly brutal assessment of the Teachers’ Plan in the Hamilton Spectator the day before.
Leech pointed out that the plan’s current formulas were based on a 1970 actuarial report that assumed teachers would work for 27 years and retire for 20. As of 2012 teachers are indeed working for 27 years, but they are retiring for 30.
“There is no defined benefits plan ever conceived that you would draw from much longer than you paid in,” he said. “It mathematically doesn’t work.”
Documents released this month by the OTPP reveal that the fund had a $45.49 billion deficit as of the end end of 2011.
Previous statements had listed the fund deficit variously at $17 billion (2010), and $5.2 billion (2011). New accounting rules known as “pension relief smoothing” allowed funds to restate the true losses from 2008 by amortizing them over 5 years. This has tended to hide deficits from view.
The OTPP is recognized as one of the most successful plans in the world, with the highest 10-year returns worldwide, according to CEM Benchmarking. The fund earned an 11.2% return in 2011. Despite these outstanding returns, Leech admitted the fund has had a yearly shortfall for the past 10 years, because benefit payments drastically outrun contributions. He joined the pension fund in 2001 and has been President since 2007.
“There are now 1.5 working teachers for every retiree,” explained Leech. “In 15-20 years it will be 1:1. It was 10:1 in 1970 and 4:1 in 1990. As the signs came in that the assumptions were wrong, the change weren’t made.”
Pension contributions may vary, but benefits are guaranteed for life by taxpayers, in partnership with the fund. Leech suggested that solutions might include a change in the indexing of pensions and an adjustment to retirement ages.
The current Ontario budget recommendations make no mention of taxpayer’s liability for the fund, or other public sector funds such as the Ontario Municipal Employees Retirement (OMERS) fund, which recently declared their accumulated deficit as $9.2 billion. OMERS members have seen their contributions (matched by taxpayers) increase from 4% in the 1970s and 5.5 - 6.5% from 1978 to 2010, to as high as 14% today.
From 1998 to 2002 workers in Ontario took a “contribution holiday” and paid absolutely nothing towards their pensions, while increasing benefits and relaxing qualification rules.
It is currently estimated that the combined deficit for all taxpayer guaranteed public sector pension plans is more than $300 billion. This figure is not included in current government debt figures.
Last year Ontario taxpayers contributed approx. $1.4 billion to the Teachers’ Fund in regular contributions, plus an additional $522 million in top-up payments to be allocated towards the $44 billion shortfall.
This top-up payment is now annual, and expected to increase to $1.2 billion by 2014.
The total pension deficit reduction payment made by taxpayers to the four largest Ontario government worker’s plans was $2.4 billion last year.
As I stated in my comment covering Ontario Teachers' 2011 results, even if Teachers' keeps delivering stellar results over the next decade -- no easy feat in these schizoid markets -- investment returns alone will not cover the plan's structural deficit.
1. There is a lot of angst about the future of pensions. Do you share that concern?
Certainly pensions have become the subject du jour for the last year or so. I think it’s a function of the baby boomers reaching that golden age and probably aggravated by the recession which affected people’s nest eggs. There is angst and concern for people about whether they’ll have enough money to last them, pay for health care and maybe long-term care if it’s necessary. The majority of Canadians haven’t saved enough to provide for themselves. We have to face that. Coupled with that, we’re all living longer.
2. What are the current challenges facing the Ontario Teachers’ Pension Plan?
A 1970 actuarial report for the teachers’ pension plan made the assumption that teachers would work for 27 years and retire for 20. He was right about the 27 years of working but teachers are now retiring for 32 years. He didn’t do anything wrong, that was the best information at the time. But we’ve stopped smoking, we’re getting fit, we’re eating better and medical science is coming up with all the answers.
There are now 1.5 working teachers for every retiree. In 15-20 years, it will be 1:1. It was 10:1 in 1970 and 4:1 in 1990. That’s a challenge and it’s driven by the fact the profession isn’t growing. The ranks of teachers aren’t doubling and retirees are living longer … There is no defined benefits plan ever conceived that you would draw from much longer than you paid in. It mathematically doesn’t work.
3. What are the solutions to those challenges?
A number of plans, corporate, private plans are built on erroneous assumptions. As the signs came in that the assumptions were wrong, the changes weren’t made when they could have been evolutionary. Now, the changes have to be revolutionary.
It’s the same with every plan, the economic uncertainty we see means the inability to project with any degree of certainty about returns going forward means we need to be conservative or we are putting everyone at risk. Everybody knows we can’t solve this simply through investment returns. We’ve had the best returns in the world in the last 10 years and we’re still facing a shortfall. We will be the model. Our sponsors (Ontario Teachers’ Federation and the Ontario government) in the past have used conditional inflation protection so that when returns are low, the increases for inflation are suspended … Our sponsors are also looking at retirement ages for a better demographic balance.
4. Do Canadians need to change the way they think about retirement, especially those who don’t have workplace pensions?
There was a study done by David Dodge about a year and a half ago which found that if you want to earn 60 to 65 per cent income replacement for retirement, over 30 to 35 years of working you have to save 15 to 20 per cent each and every year. I’m not sure everybody is doing that … People have to take more responsibility. And we really think the move from defined benefit to defined contribution by many companies is a dumb-headed move. It will end up costing our society much more … We need something in the middle where an amount is guaranteed and then laid on top is something that’s more reflective of what the market is doing.
5. What do you think of the federal government’s recent change to the Old Age Security which bumps eligibility from 65 to 67?
The changes are necessary. As long as the saving period is long enough, it’s fair. It would be unfair to tell someone coming to the last yards of a marathon, “By the way, we’ve added four more miles.” But if you extend it 50 yards, they can probably handle that. I think we’re going to have to see more changes like that.
The long-term viability of Ontario Teachers' Pension Plan and any other defined-benefit plan rests on getting the governance and funding right. Teachers' sponsors have to sit down and make tough decisions which include raising the retirement age, increasing contribution rate, and cutting cost-of-living-adjustments.
This might not seem fair to young teachers entering the work force and I can understand them. Think of it as an inverse pyramid where younger teachers will be forced to pay more into their pension plan to cover the deficit and benefits to an increasing number of teachers who are retiring. It seems unfair but the truth is that funding formula was never adjusted to reflect the demographic shifts Jim Leech is referring to.
Having said all this, at the end of the day, Ontario's teachers are lucky to have some of the best pension fund managers in the world managing their plan's assets. I can say the exact same thing about members of the Healthcare of Ontario Pension Plan (HOOPP), the best defined-benefit plan in North America, remaining fully funded and leading its peers in 2011.
I also don't think it is useful to harp on Ontario Teachers' deficit as they're still 94% funded, which is excellent compared to other Canadian and US plans. The problem is they're facing stiff structural headwinds and are communicating their concerns openly with their plan members, which is exactly what they should be doing.
Finally, I like what Leech said about the shift from defined-benefit to defined-contribution from companies as being a "dumb-headed move". The real pension experts know that if governments are going to tackle the pension crisis now, they need to stop ignoring the obvious fix for pensions.
UPDATE: Jim Leech Responds
Jim Leech, President and CEO at the Ontario Teachers' Pension Plan, sent me these comments after reading my post (added emphasis is mine):
Read your blog today and was horrified at Mr Tuft's numerous misquotes/representations from my speech last week in Hamilton where I said that revolutionary changes were NOT required (speech is available here).I thank Jim for sharing his thoughts with my readers and agree 100% with him. Please read his entire speech carefully and once gain, listen to his comments below discussing 2011 results.
Thank you for pointing out some of the obvious points.
Fear mongering, especially when it is based on misinformation, is irresponsible. What people need is facts, in context:
1. Our sponsors are working together productively on long term solutions that will allow our plan to adapt to its environment. It's the plans who are not doing this that you need to worry about.
2 Smoothing is used throughout the pension sector not just for losses, but also for gains. This shields members and taxpayers from unnecessary short term contribution rate and benefit volatility. In our case smoothed gains actually exceed smoothed losses at this point in time.
3. Mixing funding valuations and financial statement valuations is amateur.
4. The context for revolutionary change is aimed at those who don't take steps now and insist on unrealistic assumptions in the 8% range while maintaining unaffordable benefits