Primary Plan Funded Status

In 2017, the funded ratio increased to 94% from 93% in 2016. The funded ratio is a key indicator of the long term financial health of the Plan.

With $93.6 billion of pension obligations as at December 31, 2017, compared to $87.0 billion as at December 31, 2016, the Primary Plan ended 2017 with a funding deficit of $5.4 billion, compared to a deficit of $5.7 billion at the end of 2016. Net assets on a smoothed basis were $88.2 billion as at December 31, 2017, compared to $81.2 billion the previous year. There were no changes to contribution rates or benefits in 2017 and these will remain at current levels in 2018.

The funded ratio is the relationship of Plan assets to pension obligations on a going-concern basis. Plan assets are calculated by smoothing investment returns – above or below the Plan's discount rate – over a five-year period. By smoothing asset values, contribution rates can be set and benefits designed while taking a longterm view of investment performance. The deficit represents the difference between the pension obligations and the smoothed value of assets. At the end of 2017, unrecognized investment returns were $6.0 billion compared to $3.4 billion in 2016, which will be recognized over the next four years.

The improvement in funded status during 2017 was the net result of the following factors:

Funded Ratio
%
  Deficit
$ billions
93% Beginning of year $ (5.7)
1 Contributions from members and employers to pay down the deficit 0.8
2 Recognized investment returns in excess of the discount rate 2.0
(3) Reduction in the discount rate by 20 basis points (2.7)
1 Primary Plan experience and other factors 0.6
n/a Interest on deficit (0.4)
94% End of year $ (5.4)

The main factors contributing to the improvement in the Plan's funded status are member and employer contributions, and investment returns. The Plan's net investment return was 11.5%, which exceeded both OMERS operating plan target of 7.3% and discount rate of 6.2%. As at December 31, 2017, OMERS reduced the discount rate from 6.2% to 6.0%.

The Plan's funded status, on a smoothed basis, has improved for the fifth year in a row, mainly due to contributions above the benefits accrued, along with positive investment returns in excess of the discount rate. OMERS goal is to return the Primary Plan to full funding while reducing the discount rate further over time. OMERS 2020 Strategy advances our funded status to achieve full funding by 2025 and we remain on course.

The following chart tracks the funded status of the Plan over the past 10 years.

Plan Funded Ratio

Plan Funded Ratio

Managing the Plan's Funded Status

Making good decisions to protect the Plan's funded status is critical to keeping the Plan healthy over the long term. Three levers are available to manage the Plan's funded status:

  • contribution rates
  • benefit design
  • investment returns

Responsibility for implementing strategies to manage the three levers is shared between SC and OAC.

The SC sets contribution rates and benefit levels, taking into consideration the Plan's funded status (surplus, reserve or deficit). Decisions are guided by a clear framework – a Funding Management Strategy – that protects the Plan's funded status, and supports pension security and sustainability for current and future retirees.

OAC determines the actuarial assumptions and methods used to calculate pension obligations – including the Plan's discount rate, based on advice from an independent actuary – and sets minimum funding requirements in accordance with pension laws and regulations. OAC is also responsible for investments on behalf of the Plan.

Achieving OMERS target to be fully funded by 2025 is conditional upon actual investment returns and demographic experience.

OMERS is committed to taking a strategic and co-ordinated approach to using the three funding levers so that decisions are fair, balanced and supportive of long-term sustainability objectives. Contributions and benefits must be balanced to keep pensions secure and sustainable, while ensuring the Plan provides meaningful retirement benefits for its members. We continue to pursue investment returns that meet or exceed our long-term targets.

Funding Management Strategy

The Funding Management Strategy, which was adopted by the SC Board in 2014, includes three funding zones, and provides parameters for setting contribution rates and benefits within each zone. The Strategy strives to maintain a healthy balance between the Plan's assets and long-term pension obligations. It clearly sets out the conditions for when contributions and benefits will be adjusted to manage the Plan's long-term financial health.

As the funding status improves, and as the Plan moves from deficit to surplus management zones, the SC will take a conservative approach to reducing contribution rates and restoring benefits.

The Plan is currently in the Deficit Management zone. In the absence of any unforeseen events, OMERS funded status is targeted to reach 100% no later than December 31, 2025. The 2017 combined employer and member contribution rate of 21.3% exceeds the minimum contribution rates of 19.6% under the PBA. In the event the Plan should move further into deficit and the minimum contribution rates under the PBA exceed 21.3%, the Funding Management Strategy calls for such additional deficit to be funded by a combination of benefit reductions and contribution increases. Contribution rates are subject to an overall cap of 22.6%, after which any remaining deficit is to be funded through benefit reductions.

Once 100% funded status is achieved and the Plan enters the Reserve Management zone, the Funding Management Strategy calls for contribution rates to be reduced to normal cost, plus 2%, until the funded status reaches 105%, and then reduced further to normal cost, plus 1%, until the funded status reaches 110%. Normal cost is the present value of pension benefits accrued during the year. In other words, it is the contribution rate that pays for current service without the deficit payments. Benefit reductions, which occurred while in Deficit Management zone, are restored at the point when the Plan reaches 105% funded status. Restoration will be on a prospective basis, which means it will only impact benefits earned in the future – not those that have already accrued.

Above a funded status of 110%, the Plan enters the Surplus Management zone where the objective is to maintain the 110% funded status and further restore benefits. Contribution rates will be set so as to fund the normal cost of benefit accruals. Benefits will be restored retroactively, but only when doing so will not reduce the funded status to below 110%, and when it is considered prudent to do so. Additional contribution rate reductions and benefit enhancements also may occur, but only to the extent the funded status is not reduced to below 110%.

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.

Discount rate

The discount rate is the interest rate used to calculate the present value of anticipated future benefit payments. This rate impacts the Plan's pension obligations and minimum contribution rates. The discount rate is comprised of two main components: 1) the real discount rate (before inflation), which reflects expectations of future real investment returns from the Plan; and 2) an assumption for future inflation.

The discount rate at December 31, 2017 is 6.0%, compared to a discount rate of 6.2% at December 31, 2016. This reflects a reduction in the real discount rate of 20 basis points from 4.2% to 4.0%. The assumption for future inflation remains unchanged at 2.0%.

Reducing the real discount rate by 20 basis points in 2017 increased the pension obligation and deficit by $2.7 billion and reduced the funded ratio by 3%. The 2018 normal cost of the Plan increased by 0.8% of contributory earnings to 17.4% of contributory earnings. If the 2017 Actuarial Valuation Report is filed with the Financial Services Commission of Ontario, the Minimum Contribution Rate required by law in 2019 will increase to 20.8%, which is less than the current blended contribution rate of 21.3%, indicating that no contribution rate increase would be required through to 2021.

As at December 31, 2017, the real discount rate of 4.0% is net of a strategic margin of 0.25%. Strategic margins are a lever within the discount rate which works to protect the funded status of the Primary Plan from volatility. In the event the Plan were to experience a shock, such as a future financial crisis, OMERS may release strategic margins to increase the discount rate and stabilize the funded status of the Plan, contribution rates and benefits.

In the coming years, we anticipate further reductions to our discount rate to protect against investment and liability risk, which will reduce funding risk over time and provide for stable contribution rates and benefits. OMERS objective is to reduce the Plan's real discount rate to 3.75%. As we reduce our real discount rate, the normal cost of the Plan will increase. Each five basis point reduction in the real discount rate, as at December 31, 2017, would increase the 2018 normal cost by 0.2%. At the end of 2017, we are on track to meet our longterm objectives.

Opportunities to Reduce Plan Funding Risk

A sustainable defined benefit pension plan will deliver an appropriate range of benefits within an acceptable range of costs, across generations and through both favourable and adverse circumstances. Plan design and the way that contributions and benefits are managed through time, are fundamental to ensuring the Plan remains sustainable.

In 2017, OMERS Sponsors Corporation launched a Comprehensive Plan Review to evaluate and explore opportunities to enhance plan sustainability and address funding risks. The review will model the Plan's longterm financial health, and explore benefit and contribution management approaches which manage risk. The objective is to keep benefits relevant, and costs affordable, for current and future generations of stakeholders.