Terms Explained: Financial reporting
Brandon Weening, SVP, Corporate Finance
November 5, 2021
Reading time: 2 minutes
Typically in the first few months of each year, we publicly share our financial results through our report to members, our annual report, and on our website. This reporting covers the Plan’s financial health, how our investments have performed, provides an overview of our long-term strategy, and gives an update on our member services initiatives.
It might be complicated to understand some of the terms we use, so we’ve written this ‘Terms Explained’ blog which highlights the top words or phrases we use in financial reporting. This is the first of our ‘Terms Explained’ series. We hope you find it useful!
Our funded status is a measure of the Plan’s long-term financial health. It’s conveyed through our “funded ratio” (see definition below).
Funded ratio – smoothed and fair value
The funded ratio is the ratio of net investment assets to long-term pension obligations. It can be calculated on a “smoothed” or “fair value” basis.
“Smoothed” evens out the variations in annual returns over a five-year period by making certain ‘actuarial adjustments’ to our asset values. In this way, contribution rates and benefits are set using a more stable, long-term view of investment performance.
“Fair value” uses year-end values of OMERS assets, without any adjustments. Because our investment returns vary each year, this calculation results in a funded ratio that will also vary year over year. In some years the variation will be significant.
This is the interest rate used to estimate the dollar value of OMERS long-term pension obligations. It includes two components: a “real” rate before inflation and net of a margin for risk, and an inflation estimate.
Setting the discount rate is key to managing the Plan and addressing risk. Lowering it increases the dollar value of our pension obligations, and therefore decreases our funded ratio – but lowering it can also help make the Plan more resilient against future adverse experience.
Basis points (shortened to ‘bps’ and pronounced as ‘bips’), is a measure of a percentage change. One basis point is equivalent to one one-hundredth of a percent (0.01%). We typically use it to refer to changes in our discount rate. For example, in 2020, we decreased our discount rate by 5 bps, from 5.90% to 5.85%.
This is a measure of the investment income we’ve earned – including through interest, dividends, rent payments and fair value increases – less expenses incurred, divided by the average value of our investments during the year. The higher the net return, the more we’ve earned, relative to our asset base.
Liquidity has nothing to do with water! Instead, this term refers to those assets that are cash or very close to cash, that could be quickly converted into cash. Having liquidity means having assets to meet your obligations. Some of our assets are very liquid – we own cash, short-term deposits, government bonds – while some of our assets are less liquid – for instance, large infrastructure assets that generate power, or office buildings in major cities. We regularly monitor our liquidity relative to our obligations.
This is a term we use to describe the return we expect to achieve. For example, every year we set a total Plan benchmark for our net return; in 2019, our benchmark was 7.5%. We also set annual benchmarks for each of the asset classes we invest in. Throughout the year we compare our actual performance against our benchmark to assess whether we’re meeting the expectations we’d set.
Currency hedging is like taking out insurance, which you buy to protect yourself from an unforeseen event. We sometimes buy a currency hedge – which is essentially a contract, with a bank or some other highly-rated institutional counterparty – to reduce the effects of currency fluctuations. Generally, without a foreign currency hedge, the value of an investment outside Canada will increase or decrease depending on how foreign exchange rates move compared to the Canadian dollar. With a foreign currency hedge, that increase or decrease gets neutralized.
We pay pensions in Canadian dollars, and have in the past hedged our exposure to major foreign currencies like the US dollar or the Pound Sterling.
Brandon is a Senior Vice President who leads our Corporate Finance team. That team is responsible for reporting OMERS financial performance every year. He has been with OMERS for over 7 years.