OMERS Sponsors Corporation Co-Chairs Brian O'Keefe and Marianne Love, and OMERS Administration Corporation Chair John Sabo, outline the steps OMERS is taking to address the funding challenge.
Public and private sector pension plans around the world have reported sudden and steep funding shortfalls, in most cases as a result of the 2008 global credit crisis and related stock market meltdown. To get back on course, many plans have cut benefits, increased contribution rates and changed their investment strategy.
Your OMERS Primary Pension Plan did not escape the 2008 stock market meltdown. Fortunately, the commitment to prudent investing somewhat softened the market shock, leaving your plan in better financial shape than many others.
Still, OMERS faces a funding challenge that has to be addressed.
The OMERS Sponsors Corporation (SC) – comprised of both plan member and employer representatives – makes decisions about plan changes. (OMERS Administration Corporation is responsible for plan administration services and investment matters). The SC decided that immediate action was required to address the funding shortfall and made the following diffi cult decisions:
OMERS pension formula, inflation protection in retirement, survivor benefits, disability benefits, and the benefits of current retirees are not affected.
OMERS is confident that its current investment strategy will earn average annual investment returns above the 6.5% target needed to fund benefits over the long term, taking into consideration the volatility of the investment markets – in 2009, the Plan earned 10.6%. The strategy should help to return your plan to surplus within 10 years instead of the 15 years it would otherwise take based solely on the announced plan changes.
In this message, we explain:
A decade ago, your plan was flush with wealth. In 1998, it had a $6 billion surplus – an all-time record – due to high investment returns during a long period of low inflation and low wage growth. Times were good – and looked like they would stay that way. But within six years, the surplus had vanished for four principal reasons.
OMERS was forced to introduce a contribution holiday between 1998 and 2003 in accordance with requirements of the Income Tax Act for managing "excess" surplus. Under the rules at that time (they have since been relaxed), a Canadian pension plan's surplus of assets over its benefit obligations could not exceed 10% of obligations. This curbed the growth of your plan's assets by $5.3 billion.
OMERS stakeholders decided to improve benefits at a cost of $3.5 billion. Other plans took similar action at that time.
All told, our plan "spent" $8.8 billion on the contribution holiday and benefit improvements between 1998 and 2003.
In 2001 and 2002 the stock market collapsed as a result of the dot.com bubble bursting. OMERS had negative investment returns in those years, which your plan had to recognize.
By 2005, the Plan had a $2.8 billion funding deficiency. However, by earning industry leading average annual investment returns of approximately 13% between 2003 and 2007, OMERS eliminated the $2.8 billion deficit and achieved a small surplus at the end of 2007.
The 2008 global credit crisis hit and cost OMERS $8 billion in investment losses.
This is where things stood at the end of 2009:
Faced with this outlook, the Sponsors Corporation had to act – and it has.
OMERS has three options (or a mix of them) to address the deficit – earn higher investment returns, increase contribution rates, or reduce future benefits.
Over the past five years, OMERS earned 6.6% on an annualized basis, including the 2008 loss. Unfortunately, the 2008 market meltdown hit at a time when the Plan had only just returned to a small surplus. Eliminating the resulting large funding shortfall by earning substantially higher – and unsustainable – returns would require taking on considerable risk. This is not an option for a prudent pension plan investor.
Market risk is a major concern right now. Crises in financial markets are common, often caused by corporate and government mismanagement and periods of panic among investors. Investors must be prepared for uncertainty, volatility and surprises. That means staying true to our principles of tight risk management and prudent investing.
A second option is to increase contribution rates as other plans have done by phasing in changes over three-year periods.
A third option is to reduce future benefits, a response implemented at some other plans.
Ontario pension plans are required by the Pension Benefits Act to file a funding valuation with the pension industry regulator at least every three years. A funding valuation estimates the cost of liabilities and the value of assets. If liabilities exceed assets when a valuation is filed, the plan must take steps to address the shortfall over 15 years. Your plan would have been required to file the December 31, 2011 valuation with the regulator. If the SC had not decided to act now, contribution rates would have automatically increased by as much as 4% of a member's earnings (matched by the employer) on January 1, 2013. Instead, the SC has decided to fund the projected deficit on a phased-in basis by filing the 2009 funding valuation with the regulator this year, and changing contribution rates and benefits over a period of time. The impact of the annual contribution increases will be less severe, and managed over an extended time.
The SC met frequently earlier this spring and summer and reached decisions on addressing the funding deficit in June. Here's what they decided:
1 Contribution rates will be increased temporarily for both employers and plan members until the Plan regains surplus.
2 The increased rates will be phased in, effective with the first full pay in each year. The rate increases, as an approximate percentage of a member's earnings, are as follows:
See tables illustrating the 2011 rates and the financial impact of the contribution rate increases for members and employers. A total contribution rate increase of 2.9% (on average, of a member's earnings, matched by the employer) over the three-year period would translate into an increase in pension contributions of approximately 30% to 40%. The net impact for a member will be less as OMERS contributions are tax-deductible.
3 After 2012, there will be changes to the calculation of benefits members receive if they terminate employment before they are eligible for an early retirement pension – before age 55 for normal retirement age 65 members and before age 50 for normal retirement age 60 members. The changes will only impact service entitlements accrued after 2012. These plan members will not receive pre-retirement inflation protection; nor will they receive subsidized early retirement. These changes will reduce your plan's long-term liability cost. More information on the benefit changes.There will be no change in the benefit entitlements of current retirees, member survivors or active members who stay in the Plan until their early retirement date.
4 The following two future actions will be taken: a) to elect not to provide "grow-in rights" (optional for plans like OMERS, under recent Ontario legislation) which increase the costs of benefits provided to certain terminating members; and b) to develop and document protocols and guidelines for future Plan decision making.
OMERS is implementing an investment strategy that recognizes investment crises will erupt from time to time.
This is the "new normal." A key element of our strategy is to reduce your plan's exposure to stock markets that are expected to be highly volatile in the next several years. We have improved our capabilities in global macroeconomic research and financial analysis so that we can better anticipate market trends and continue to pinpoint investment opportunities.
OMERS is shifting capital into private market assets that can generate predictable, acceptable and sustainable returns. These assets include high-quality real estate properties and regulated or quasi-regulated infrastructure investments.
Another key initiative is to directly invest in and actively manage as many of OMERS investments as possible, instead of paying hefty fees to external fund managers to do this work (as is typical in the pension industry). Direct investing and active asset management by a dedicated team of qualified investment professionals translate into lower costs and higher returns.
All told, these and other initiatives should generate annual returns in the 7% to 11% range and help to return your plan to surplus within 10 years – well ahead of the 15 years it would otherwise take to get back on track from increases in contribution rates.
Despite the financial impact of Plan changes on Plan members, the OMERS Plan continues to deliver great value.
A member who retires with 30 years of service in the Plan will receive back in pension payments, on average, up to 10 times the contributions (plus interest) they paid to OMERS during their career.
For more information about OMERS benefits, please see the Members section.