Tuesday, May 1, 2012

Nova Scotia Teachers' in a $1.6 Billion Hole?

CBC News reports, $1.6B hole in N.S. teachers' pension plan:

The Nova Scotia Teachers' Pension Plan had a terrible year in 2011 and is now in the worst shape it's ever been in.

Last year, the fund had a return on investment of 0.83 per cent and the plan's unfunded liability reached $1.655 billion — the deepest hole it has ever recorded.

It is now just 71 per cent funded, down from 76 per cent funded in 2009.

The figures were released Friday in the plan's annual review.

Tough 'investment environment' blamed

“This year’s results, while disappointing, certainly reflect the very challenging investment environment that the plan is faced with,” said John Carter, chairman of the Nova Scotia Teachers’ Pension Plan Trustee Inc.

“We continue to see unprecedented levels of market volatility, similar to the last three years, which continue to impact the plan’s returns. Meanwhile, diminished investment returns along with record low interest rates have reduced the plan’s funded ratio. That said, the plan performed in line with other Canadian pension plans.”

The report said that despite the hole, it has enough money to continue to pay pensioners now and into the future.

"The trustee has been diligent and proactive in managing investments during the current economic situation," the report says.

"The problems that face the plan’s financial health are complex and require thoughtful and forward‐thinking solutions."

Three options to fix shortfall

It says there are three options for addressing the shortfall:

  • Increasing investment returns
  • Increasing contribution rates
  • Reducing benefits.

"The trustee has no current direction from the plan sponsors to increase contributions; however, this may be necessary in the future," the report says.

The shortfall means that teachers who retired after Aug. 1, 2006 will not have their pension benefits indexed this year. Teachers who retired before that date do get the cost of living adjustments.

Under pension regulations, teachers who started drawing their pensions after Aug. 1, 2006 lose their cost-of-living indexing if the fund is more than 10 per cent in deficit. In that event, the province is responsible for paying half the value of the cost-of-living increase.

In 2011, a Nova Scotia pension expert warned taxpayers will be on the hook for hundreds of millions of dollars if major changes are not made to the province's pension funds.

Benefits Canada also reports, N.S. teachers’ pension unfunded by $1.6 billion:

The trustees for the Nova Scotia teachers’ pension plan say volatile world markets contributed to a $511-million growth in the plan’s unfunded liability last year.

The annual report released Friday by the Nova Scotia Pension Agency says the unfunded liability for the plan is $1.65 billion as of Dec. 31, 2011.

Diminished investment returns accounted for nearly half of the increase to the unfunded liability, said John Carter, chairman of the Nova Scotia Teachers Pension Plan Trustee Inc.

Carter said record low interest rates also played a part in reducing the plan’s unfunded ratio.

He said as a result, the trustees are looking at ways to improve the plan’s long-term health, although it is not at risk of running out of cash.

“People will get their pensions,” he said. “Anybody that’s in the system now will get their pension for their life.”

But he said a solution needs to be found to improve the health of the plan. “The last two or three years have been tumultuous to say the least.”

The plan’s funding ratio of 71% means a cost-of-living adjustment will not be available to pensioners who retired on or after Aug. 1, 2006. The plan must be funded to 90% for indexing to kick in.

Under an agreement with the province, taxpayers will have to contribute an amount equal to what the retirees lost in indexing once the calculation is determined after July 1.

Steven Wolff, CEO of the Nova Scotia Pension Agency, said that amount was about $8 million in 2010 and was expected to be in the vicinity of $10 million last year.

Wolff said about 2,200 pensioners are affected by the indexing provision.

As of the end of December, the pension plan had 13,525 active members, 5,488 inactive members and 12,014 pensioners, the agency said.

The funding deficit is causing a political stir in Nova Scotia as Premier Darrell Dexter has a wait-and-see approach while Tories want a taxpayer bailout ruled out:

A year-end report on the plan, released Friday, showed it had a $1.7-billion unfunded liability as of Dec. 31, 2011. That’s how much the plan would be short if it had to pay out all its obligations that day. It was 70.9 per cent funded.

A Friday release from the Nova Scotia Teachers’ Pension Plan Trustee Inc., which includes government and teachers’ union representatives, said the plan has enough money to cover benefits for many years to come.

Dexter said Monday that analysts say pension plans, hammered by stock markets that plummeted in 2008 and that have been volatile since, will eventually get healthier, but there are mixed opinions on when that will happen.

“One of the problems continues to be, is the question of whether or not you’re going to make amendments to a plan in what has been a very volatile time on the markets,” Dexter said.

“There has been a lot of encouragement from people to sit tight on these plans and allow for the natural cycle of the markets to complete its course.”

Trustee chairman John Carter said last week that changes have been made to the plan’s asset allocation to decrease volatility, and there have been discussions about improving the plan’s long-term health. Union president Alexis Allen said that means looking at funding policies and benefit structures.

The plan was 79 per cent funded, with a $1.2-billion unfunded liability, on Dec. 31, 2010.

Progressive Conservative Leader Jamie Baillie said Monday that the current unfunded liability is “gigantic” for a province this size, and it’s not enough for Dexter to wait to see what happens with the markets.

“Well, guess what? They’re going to be volatile forever, so the time has come to tell Nova Scotians what are the parameters around the funding of the teachers pension plan, and the benefits of the teachers pension plan,” Baillie said.

“Making the markets an excuse for delaying any action until after the next election should scare both teachers and Nova Scotia taxpayers today because of the size of the problem.”

Since the plan is less than 90 per cent funded, there’s no indexing of benefits for people who retired on or after Aug. 1, 2006.

Under a 2005 agreement between the union and the then-Tory government, taxpayers kick into the plan an amount equal to the indexing not paid. The amount will be determined after July 1.

Baillie said it’s up to the trustee to determine how to bring the plan into balance, but the premier should “tell them that there will be no more taxpayer bailouts to make that happen.”

The province made changes to the other major public plan — the Public Service Superannuation Plan, for civil servants and other public-sector workers — in 2010 that helped wipe out the $1.5-billion unfunded liability the plan carried in December 2009.

The finance minister was the sole trustee at the time, but the move to joint trusteeship is underway.

Changes to benefits, retirement eligibility for new hires, the transfer of $536 million into the plan, along with improved market performance brought the plan back to fully funded status a year ago.

Critics have called the transfer a bailout, while Finance Minister Graham Steele has said it was refinancing.

My take on all this? The $1.6 billion pension deficit means the plan is now 71 per cent funded, which is a concern but far from being a disaster. Having said this, it's clear that stakeholders will need to figure out a way to improve the plan's funding by increasing investment returns and contributions and reducing benefits.

On the funded status, Bernard Dussault, Canada's former Chief Actuary, sent me these comments:

The assumptions used to estimate a pension plan' liabilities are generally too optimistic, which results in portraying a too favourable financial situation if the funding ratio is over 100%. On the other hand, if the funding ratio is under 100%, then another series of much less favourable assumptions based on current, market rates must be used along with a solvency valuation basis.

In other words, if and when a pension plan performs well, it is allowed to show an unreasonably overestimated funding ratio, but if and when it is not performing well, it shall show an unreasonably underestimated funding ratio. Reasonable ("best estimate") assumptions should rather (or also) be used in both cases. Using reasonable best estimate assumptions for the NS Teachers ' Pension Plan' would most likely bring its 71% funding ratio over 90% and portray a much less dramatic picture of its financial situation.

On their investment portfolio, I have a hard time accepting the argument that a "tough investment environment" was to blame for the poor investment results. Other plans like Ontario Teachers' and HOOPP faced the exact same environment and delivered markedly better results in 2011 than the Nova Scotia Teachers' Pension Plan (and most other Canadian DB plans).

Why is that? There are a lot of reasons. First and foremost, they have a better governance model. Their pension fund managers are properly compensated for delivering performance and they are much better than anyone else on matching assets to liabilities.

I mention this because as I see Canadian pension plans riding hot foreign equity markets in the first quarter of 2012, I think it's foolish to hope that investment returns and higher bond yields will fix the pension crisis.

Moreover, DBRS is warning that pension plans are too optimistic in their assumptions:

Canadian defined benefit pensions may appear healthier than they actually are because they aren’t conservative enough when determining their future financial obligations to retirees, a report by DBRS suggests.

DBRS said current discount rate assumptions — used to calculate the pension plans’ future obligations — are reasonable in the short- to medium terms but of concern over the long term.

“In DBRS’s view, the current funded status of defined benefit plans is overstated and the aggressive discount rates used do not reflect the current low interest rate environment,” the report said.

“Potential problems arise over the next generation of pensions as the first wave of baby boomers reaches retirement age,” the report said.

“As a result, DBRS anticipates that payouts to plan participants will likely increase dramatically between 2011 and 2029. This could create potential future shortfalls for pension plans that will require significant contributions from plan sponsors and could be very difficult to manage over the long term.”

Defined benefit pension plans pay a promised amount when an employee retires. Many companies have switched to defined contribution plans in which the eventual payout is determined by the investment performance.

Earlier this month a report by Aon Hewitt suggested that the solvency position of most defined benefit pension plans improved only slightly in the first quarter despite a strong rally on equity markets over most of that period.

The Aon Hewitt report found that the median solvency ratio of defined benefit plans in Canada increased only one percentage point in the quarter to 69 per cent. As well, about 97 per cent of the pension plans in the sample it looked at had a solvency deficiency.

The results somewhat mirrored earlier findings by Mercer, whose Pension Health Index showed the solvency ratio of its model plan rising three percentage points to 63 per cent at the end of March.

The solvency funded ratio measures the financial health of a defined benefit pension plan by comparing the amount of assets to total pension liabilities in the event of a plan termination.

The solvency ratio is way too harsh as most Canadian pension plans are not going to be terminated any time soon. And DBRS and others who keep harping on the low discount rate used by Canadian plans to discount future liabilities should look at the ones US pension plans are using before claiming Canadian plans are using optimistic assumptions.

Below, you can skim through Nova Scotia Teachers' Pension Plan Annual report 2011 (to view full screen, click on the link or first box below). Once again, their funded status is a concern but hardly a disaster and they are taking steps to address this as well as market volatility by changing their asset mix. Politicians shouldn't politicize this deficit and blow it way out of proportion.
Nova Scotia Teachers' Pension Plan Annual Report 2011

No comments:

Post a Comment