Monday, May 27, 2013

OMERS To Reduce Pension Payouts?

Barbara Shecter of the National Post reports, OMERS considering proposal to reduce pension payouts:
Faced with a $10-billion pension-funding deficit, one of Canada’s largest pension funds is considering a drastic proposal that would reduce benefits paid to retiring workers — or force them to work years longer for the same retirement income.

The Ontario Municipal Employees Retirement System (OMERS) Sponsors Corporation, which determines benefits and contribution rates for one of the largest pension operators in the province of Ontario, is mulling a change that would reduce the key figure used to calculate how much money an employee will receive each year in retirement.

A decision on the proposed change to the formula, which would take effect in 2015, is expected by the end of June.

OMERS is an umbrella organization for more than 900 employers and their workers in the province, including paramedics, transit workers, firefighters, police and city workers. It represents almost 429,000 active and retired members.

Changes to the pensions overseen by OMERS are considered annually, but this year’s proposal to reduce the “multiplier” rate at which workers rack up retirement payouts — to 1.85% from 2% — is “more drastic,” according to Simon Archer, a pension specialist at law firm Koskie Minsky LLP in Toronto.

“This is the one that made my eyebrows go up,” he said after looking at the proposals. “Usually plans try not to touch that if they can avoid it.”

Mr. Archer said workers who are close to retirement would see little change, while new employees would be hit the hardest.

A sustained period of low interest rates has made pension promises more expensive for companies, forcing them to raise the amount of money both the employer and employees pay into pension plans, or reduce benefits.

OMERS had a deficit of $7.3-billion at the end of 2011, and already tried to remedy the growing problem by phasing in contribution rate increases over the past three years. At the same time, plan costs have been rising as members age.

There are legal impediments to reducing any benefits that have already been accrued by workers under a plan, but benefits based on future work — including by newly hired employees — are fair game, said Mr. Archer.

The new pension formula at OMERS would be applied to all earnings above a certain threshold beginning in 2015. In order to go into effect at all, it will require approval by two-thirds of the board of the OMERS Sponsors Corporation. The 14 members of the board include an equal number of employer and employee representatives.

Three of the employer representatives proposed the formula change, according to documents posted on the OMERS Sponsors Corp. website. The “key rationale” behind the request for the plan change includes the funding deficit, and the fact that contribution rates are already at an all-time high, the documents say, adding that these factors are “putting a significant strain on members and their employers at a time when our economy is also under stress.”

If the proposal is accepted, it will not affect retirement benefits accrued for work done through the end of 2014. The documents note that the impact on lower-income earners would be reduced because the new formula would be applied only to earnings above the maximum earnings level calculated in the Canada Pension Plan.

In addition, the change would give workers more room for RRSP contributions and they could still receive 70% of their pre-retirement income if they were willing to work longer — 38 years instead of 35 — to build up the additional benefit.

Individual plan members do not get to vote on the proposal, but John Pierce, vice-president of public affairs at OMERS, said feedback or input from them can lead to amendments or even withdrawal of any suggested pension plan changes.

This year’s OMERS proposals, which also include curbs on indexing for inflation and a delay in early-retirement eligibility, appear to address some of the concerns raised in a recent survey by global human resources consultant AON Hewitt. It suggested that Canadian pension plan sponsors have been slow to react to changing demographics and other challenges to pension sustainability.

Awareness of the trends “does not seem to have spurred plan sponsors into addressing long-term sustainability strategies as they struggle with short-term financial pressures and regulatory requirements,” AON Hewitt said in the survey released in early May.
Martin Mittelstaedt of the Globe and Mail also reports, Proposal before OMERS would require employees to work longer to get full pension:
Ontario municipal pension fund giant OMERS has received a proposal from some of its employer members to increase the amount of time it would take for workers in the plan to gain a full pension from 35 years to 38 years.

The proposal will be voted on at the end of June, but would require significant backing from union representatives at the Ontario Municipal Employees Retirement System to be approved.

Under the proposal – made by representatives from the Electricity Distributors Association, the Association of Municipalities of Ontario and the City of Toronto – the so-called multiplier of 2, now used to calculate when a person would be entitled to full benefits, would be cut to 1.85 starting in 2015.

“This is just one of the proposals that has been tabled,” John Pierce, vice-president of public affairs at OMERS, said Friday. He declined to predict whether the measure had enough support to be approved.

OMERS has an annual process of reviewing benefits and pension fund premium payments.

The pension fund has previously had proposals from employers to end inflation protection enjoyed by members, but the requests have not been approved because of the need for benefit reductions to pass with two-thirds support. Votes at the plan are divided equally between employers and worker representatives, making it difficult to get the needed support to approve cuts, which are usually anathema to union members.

OMERS, like many pension plans, is under-financed because of low interest rates and flagging stock market returns, and currently has a deficit of just under $10-billion. OMERS said it is about 86 per cent funded and expects the deficit to be eliminated gradually over the next 10 to 15 years.

The employer groups making the proposal said in a note that the because of the funding deficit, “contribution rates are currently at an all-time high putting a significant strain on members and their employers, at a time when our economy is also under stress.”

They said the change would involve only a small pension reduction for those close to retirement age and would be “not material” for them, while having “an immediate impact on funding.”

Currently, a full pension at OMERS is equal to 70 per cent of a person’s top five years of income. With the current multiplier, it would take 35 years to earn that amount. Those working fewer years receive a lesser amount based on multiplying their years of service by the multiplier of two.
I already covered this topic when I went over OMERS' 2012 results. Was a bit harsh on them but their results are in line with what other large Canadian pension funds posted last year. On the plan's deficit, I agreed with Patrick Crowley, OMERS' CFO, it's not something to worry about short-term. Moreover, OMERS is fully transparent and provides a fact sheet on the plan's funding status with details on a plan to return the plan to fully funded status. More information is available here, including a detailed document on OMERS' funding strategy.

Unfortunately, the media likes blowing pension plan deficits way out of proportion. An 86 per cent funded status is not a disaster, it's well within the norm and can be addressed. Ontario Teachers' Pension Plan is 97 per cent funded, which is negligible and hardly worth worrying about. Yes, plan members are living longer and demographic shifts are introducing longevity risk, but a rise in real interest rates will significantly reduce future liabilities.

Importantly, when it comes to pensions, the most important thing to keep in mind is future liabilities are predominantly impacted by the rise and fall of real interest rates. A steep decline in interest rates will widen pension deficits but a rise in rates will lower deficits (in financial lingo, the duration of liabilities is bigger than the duration of assets, so even if investment gains are strong, it won't be enough to make a dent in the deficit if real rates keep falling).

Having said this, common sense should also come into play when looking at pension sustainability and implementing sensible reforms. There is no guarantee that interest rates will rise significantly over the next decade. In fact,  they can stay low for a long time, especially if a deflationary Japan like slump engulfs the developed world. While echoes of a bond bubble make headlines, some fear we are already in a protracted period of low growth and risks of deflation remain high (slump in commodities might be a harbinger of future deflation).

Also, if people are living longer, then why not introduce measures to have them work longer before receiving a full pension? There is nothing set in stone that pension rules can never be revised. In particular,  shared risk between employers and employees is becoming the new norm and New Brunswick may indeed be the future of Canada's pension reforms.

As far as investments, OMERS took a decision a long time ago to shift a majority of their assets into private markets. They are not alone. CPPIB's long-term strategy is to increase its weighting in private markets and the Caisse plans to increase its global real estate holdings over the next 18 months, cementing its reputation as one of  the best institutional investors in an increasingly popular asset class.

Unlike others, however, OMERS prefers managing its private market assets in-house. There is some debate on whether the Canadian model is full of hot air, especially in private equity, but this does not apply to real estate and infrastructure. OMERS launched a giant infrastructure fund last year and they are internationally recognized for their expertise in direct  infrastructure investments. Canadian pension funds are world leaders in direct infrastructure deals, the most recent deal being PSP Investments' acquisition of Hochtief's airports unit for $1.4 billion.

Nevertheless, no matter what strategy is adopted in private markets, relying on investment gains alone to sustain future pension payouts is simply not a credible long-term strategy. Plan deficits are often blown out of proportion but plan sponsors need to revise their pension policies and look into adopting sensible proposals which will ensure the long-term sustainability of their defined-benefit pensions. This may include cutting cost-of-living adjustments, increasing contribution rates, extending the period of work to reflect demographic shifts and adopting a shared risk model which has worked well for Ontario Teachers', HOOPP and CAAT.

In short, there are no guarantees when it comes to the future of defined-benefit pensions. I'm a huge proponent of bolstering DB pensions and expanding C/QPP but also realize the structural shifts taking place in the world are raising the costs of these public pensions, and if reforms aren't implemented, these changes can jeopardize their future sustainability. When it comes to the pension promise, it's always best to plan ahead for unforeseen scenarios. Now more than ever, employers and unions need to work together to ensure the sustainability of defined-benefit plans.

Below, parts 1 and 2 of the Waterloo Pensions Debate (Waterloo Ontario, Dec 04, 2012), a heated debate between Fair Pensions For All, OMERS and CUPE. It is long but worth looking at. Listen to these presentations with a skeptical ear as there is a tremendous amount of scaremongering by those claiming to represent Canadian taxpayers. Their agenda is to dismantle DB plans and replace them with DC plans, effectively exacerbating pension poverty for all Canadians.