Plan Funding Risk
Plan funding risk is the potential that the SC will need to increase contributions or reduce benefits as a result of unfavourable investment performance, adverse Plan experience, or Plan maturity. Increasing Plan maturity through time means the Plan will have less capacity to bear Plan funding risk in the future, everything else being equal.
Unfavourable investment performance includes circumstances where Plan returns in the long term are lower than the Plan's discount rate, and where fluctuations in the Plan's short-term returns require changes to contributions/benefits. Many economic factors – including financial market volatility, persistently low interest rates, and a high level of competition for asset classes – present risks that impact the ability to generate returns that meet or exceed the Plan's discount rate. Accordingly, each year, OAC tests the reasonableness of the Plan's discount rate to ensure it contains sufficient margins to protect the Plan against adverse experience over the long term.
An important factor in setting the Plan's discount rate is our target asset mix, which is approved by the OAC Board and which reflects target allocations across a set of asset classes. OAC conducts periodic studies (the most recent being in 2016) to adjust the Plan's target asset mix to ensure investments are allocated in a way that optimizes the Plan's ability to return to full funding by 2025. The asset mix also helps our ability to pay pensions without having to sell assets, while minimizing the risk of unexpected Plan design changes.
The Plan has recently enjoyed several years of strong investment returns, fueled by an increase in global economic growth and the effects of low interest rates, which has generated intense competition for private investments. As the population in the world's major economies age, we anticipate that global growth will slow, and that future investment returns will be lower compared to the past 10 years.
Adverse Plan experience includes unexpected changes in life expectancy (such as increased longevity), salary increases, and retirement and termination trends. Continuing adverse Plan experience, leading to actuarial losses, requires a change to actuarial assumptions that negatively impact pension obligations and funding requirements. Life expectancy, in particular, has steadily increased over time. This means retirees collect pensions for longer periods, which increases the pension liabilities. We monitor our Plan experience against actuarial assumptions annually, and conduct a detailed Plan experience study at least once every five years.
Plan maturity is the phenomenon of a declining active membership relative to the retired member population, whether due to increasing longevity, a decline in new members, retirement patterns or other factors. Since all Plan funding risk is currently borne by active members and employers, this trend means the cost of funding Plan deficits is increasingly concentrated in a relatively smaller group. The ratio of active members to retired members is a common measure of Plan maturity. The Plan is maturing, as this ratio was just below 2:1 at the end of 2017, compared to slightly less than 3:1 in 1997. As the proportion of contributing members continues to decrease, annual contributions will become less than annual pension payments. We will rely upon investment income to make up the difference, leaving the Plan more vulnerable to economic downturns. We expect the Plan to continue to mature for the foreseeable future.
A recent Membership Evolution Study looking at workforce and employment trends suggests that our active membership may shrink over the next 25 years. Declining active membership intensifies the Plan maturity challenges described in this section.
Beginning in 2019, members and employers will be impacted by gradual enhancements to the Canada Pension Plan (CPP). These will include increasing the CPP income replacement rate from 25% to 33% of earnings, with consequently higher employer and employee contributions. The OMERS pension formula does not adjust for changes in CPP automatically. As a result, the combined pension benefit future retirees will receive from CPP and OMERS will increase in the long term. As more dollars are being directed to secure more retirement income outside of OMERS, this puts further pressure on OMERS contribution rates, decreasing the available dollars members and employers have to absorb future increases.