Speech to the Ontario Teachers Federation Board of Governors

Transcription

1 Speech to the Ontario Teachers Federation Board of Governors Remarks by Robin Korthals, Chair, Board of Directors Ontario Teachers Pension Plan Delta Meadowvale Resort & Conference Centre August 22, 2006

2 - 1 - Good afternoon everyone. It is a privilege for me to be here today to bring you up-todate on the activities and performance of your pension plan. Bonjour à tous. J espère que vous avez passé un bon été. It certainly has been an eventful year to-date. We ve had to navigate some volatile equity markets, advise you and your plan co- sponsors about the tough choices needed to keep the pensions of Ontario s teachers fully funded, and manage through the first strike in our history. Given all of these challenges, this is a good time to review our recent performance, as well as the outlook for the future. But before we get into details, I d like to give you some context for my comments today by reminding you of the serious responsibilities we are committed to fulfilling at the Ontario Teachers Pension Plan. First, we are responsible for administering the pensions of Ontario s 268,000 current and retired teachers; Second, we set and implement the plan s investment strategies; And finally, we provide information on the plan s funding status to help its sponsors the Ontario government and you at the OTF decide on appropriate benefit and contribution levels. Today, I want to talk about how we are measuring up in each of these areas give you a mid-year report card, if you will starting with our performance in meeting the day-today needs of the plan s members. First, let s update some of our statistics. We now have 104,400 pensioners on our monthly payroll, having added 3,200 as of this July. That brings our monthly pensioner payroll up to $315 million as of July 31, and our projected total for the year is $3.8 billion.

3 - 2 - Every year, our challenge is to find new and better ways to meet members growing service and information requirements while working smarter to manage costs. Thanks to the efforts of Rosemarie McClean and her dedicated team of service professionals, we ve continued to do just that. That s not just my opinion; it s also the verdict of the plan s members. We measure our performance by the Quality Service Index, or QSI. This is a measurement of service satisfaction based on an independent, third-party survey. Our mid-year results are in, and you will be pleased to know that our QSI results are as strong as our final results for I know I don t need to tell you that as we achieve these high QSI ratings the most difficult feat is repeating them; that every shift upwards is significant. While the ratings of our members and our peers are very important to us, we are just as determined to make sure our services are delivered in the most cost-effective way possible. The reason is simple. Every dollar saved on plan administration and service is another dollar that can be directed into funding teachers pension benefits. I m pleased to report that so far this year we are on track to coming in marginally below 2005 s cost per member. These good service results were achieved despite experiencing a five-week strike. I am happy to report that relationships have largely returned to normal. As I mentioned at the outset, the second part of our mandate is to set and implement the plan s investment strategies. Our goal is to earn relative returns greater than the fund s benchmarks for the asset classes in which we choose to invest, while at the same time incurring less risk as measured by lower volatility than those of the benchmarks. We use composite benchmarks that reflect the asset class as well as the country in which we are investing.

4 - 3 - For example for equities in Canada we use the S&P and the TSX, and in the U.S. we use the S&P 500. To manage investment volatility, we have a well-diversified asset mix: 45% in equities, 22% in fixed income and 33% in such inflation-sensitive instruments as real estate and commodities. Let me give you a snapshot of some examples of what the investment team does to achieve its results. During the first half of 2006, our real estate portfolio, which is managed by Cadillac Fairview, made its largest single non-north American investment. They acquired a 46% interest in MultiPlan, a private real estate company headquartered in Rio de Janeiro. On the media sector front, our significant Bell Globemedia investment of late last year will grow considerably if, as we expect, the CRTC approves the BGM acquisition of CHUM Limited announced in June. We intend to provide both debt and equity financing for this investment. We also joined with Providence Equity Partners to purchase Kabel Deutschland, Germany s largest cable operator, with 10 million subscribers. And in keeping with our tradition of sports and entertainment investments, we acquired an interest in market leader Easton-Bell Sports. We also have made an innovative move to hedge our risk against catastrophic oil price increases. We purchased options for 10 million barrels of oil for delivery on 2010 and that is the equivalent of 4% of Canada s annual oil exports. The third facet of Teachers mandate is to provide information on the plan s funding status and help sponsors decide on appropriate benefit and contribution levels. This is an

5 - 4 - ongoing process, but one that received a lot of attention this year because of the recommended contribution rate increases the first since 1990 for teachers as well as the province and other employers. As you know, the rate increases were required to close a $6 billion shortfall in the plan s funding identified in the plan s 2005 valuation, which was filed this June. In a nutshell, the shortfall developed because plan benefit costs have been increasing faster than the value of the plan s assets, despite the strong return on our investments over the past few years. Accordingly, the plan sponsors recently decided in favour of an increase in employer and teacher contributions to the pension plan, equal to 3.1% of base earnings, to be phased in over a period of three years beginning January 1, As a result, contributions for both teachers and employers will increase to an average of 11% of earnings from the current level of 8%. Naturally, we recognize that nobody welcomes the idea of paying more to maintain the same level of retirement benefits. But I d like to take just a moment to explain why the new rate increases are necessary, why they should not come as a surprise, and perhaps most important, why these increases are being used to fund a $6 billion shortfall, as compared to the $20 billion shortfall as of January 1, 2005 that we were discussing last spring. To do so, we need to start at the very beginning. And the starting point here is that pensions will cost what they cost. Our challenge and it is a huge one is to estimate to make assumptions, if you will of what that future cost will be. Assumptions are the tool that allocates costs between different generations of plan members. If they are too conservative, current members pay more than they should; if they are too liberal, future generations are left to pay more. The ideal, of course, is to find the balance that equalizes the treatment of all generations.

6 - 5 - That said, let me explain why the valuation assumptions changed from the originally proposed conservative 3.1% to the more liberal 3.7% that was filed in June. This change is, after all, the underlying factor behind the shortfall shrinking so dramatically. I remind you that every 1% increase in the interest rate assumption decreases liabilities by 22%. To put that in dollar terms, the move from 3.1% up to 3.725% improved our funding position by almost $12 billion. The interest rate was not the only assumption that was changed, however. There were also two others. The first reflected teachers future salary increases in their negotiations with the province. The second assumption reflected the fact that retirement rates for unreduced pensions have been lowered than had been assumed. These two factors together improved the plan s funding position by $2.1 billion. The board of directors was willing to accept the less conservative 3.7% valuation because the partners agreed to an improved, offsetting risk mechanism. The agreement features five key elements: First is the increase in contributions by members and the government to eliminate the remaining $6 billion shortfall that still remained after the new valuation assumption. Second is that contributions will not exceed 15% of base earnings above the Canada Pension Plan limit. If rates must climb higher than 15% to keep the pension plan healthy, reductions in future benefits would be considered. Third is a commitment from the partners to undertake a survey of members to gather member preferences, should a future shortfall exist, for (a) further contribution rate increases or (b) future benefit reductions. There is a further commitment from the partners that the findings of that survey will be taken into account in the decision-making process as to whether contribution rates are

7 - 6 - increased or benefits for future retirees are decreased following the next valuation if the balance is still negative. Fourth is that benefits cannot be improved and contribution rates cannot be decreased unless pension plan assets exceed liabilities by 10%, which is up from the previous 7.5% requirement. While prudent, it will be many years before this move has any impact. And Fifth is a discussion with other industry experts regarding pension plan assumptions. The board is reassured by these commitments, because we feel they could allow the risk to be shared between younger teachers and future retirees moving forward. With retirees representing 40% to 50% of the plan s liabilities, we considered this to be a rational and realistic approach. We could not have accepted the higher valuation assumption otherwise. To do so, we and our actuary felt, was to put an unnecessary and unfair burden on the shoulders of the younger teachers. And given our responsibility to all members, regardless of age or tenure, we considered that alternative untenable. I am especially glad to have the opportunity to speak with you today, because I want to personally ask for your support as we move forward towards the next filing, which looms in the near future. Because the partners opted for the January 1, 2005 valuation date, and valuations are required every three years, that next filing is January 1, 2008: a mere 16 months away. Given the five points I just reviewed, you can see that considerable deliberation must occur. As we know, interest rates have changed considerably have dropped, that is since the January 1, 2005 valuation date. As I mentioned earlier, for every 1% increase in the interest rate assumption, liabilities decrease by 22%. And the move from 3.1% up to

8 % improved our funding position by almost $12 billion. That brought the shortfall to $8 billion. The other revised assumptions I mentioned earlier, that is teachers salaries and unreduced pension retirement rates, brought it down to $6 billion. And the contribution rate increase makes up the final $6 billion. But although interest rates are up from January 1 of this year, we are not optimistic that they are going to increase significantly before January 1, Applying the January 1, 2005 assumptions and contribution rate increases to the January 1, 2006 valuation which you will recall was roughly $32 billion would still leave a shortfall of $10 billion. And as you know, we cannot file a shortfall. That is why I say that much is left to resolve. Of paramount importance to this process are the results of this November s survey, which will give members the opportunity to voice their opinions and table their preferences. I want to thank you all in advance for your support in this important effort. I know you understand it is undertaken with the need for balance between all members current and future financial well-being in mind. I understand that the first planning meeting of the OTF, the province, management of the pension plan and the polling company is scheduled for early September. This session is designed to get the whole process off with a jump start, setting the survey mechanisms in place together and gaining agreement on survey objectives and timetables. I can t tell you how pleased I am that this is a joint effort with all parties working together towards the same goal. Now, to return to the shortfall issue, let s just recap why these measures are necessary. When there is a shortfall, there are fewer people to pay for it, relative to the total number of members and relative to the size of the liabilities. This plan is demographics driven. In 1970, there were more than 10 teachers working for every retired member under the plan. Today, that ratio is 1.6 to 1 and within the next 15 years or so, we re expecting a 1:1 ratio. What this means is that more benefits are being

9 - 8 - paid out of the plan than contributions going into it, and it s a gap that continues to grow wider each year. In addition, contribution rates had to be increased because benefits are richer than when the plan was introduced. Although benefits have increased for example the introduction of the 85 factor, which currently adds about $3 billion in liabilities based on the age/service profile of today s membership there has been no offsetting increase in contributions to close the growing gap. Finally, the long-term investment climate may deteriorate. For teachers starting today, contributions will finance their pensions if they can be invested at a real rate of return that equals 5% from the day of deposit until the last pension payment is made, and that could be as long as 70 or more years from now. But producing that kind of return will be harder than it s been in the recent past. As investment guru Warren Buffett likes to say, the rearview mirror is always clearer than the windshield. That s why I refer you again to the book The Triumph of the Optimists, from which I quoted in our latest annual report. There, the author studies the rate of return obtained in 16 countries for the period 1900 to For an investor with a traditional asset mix of 60% equity and 40% fixed income, only one of those 16 countries enjoyed a rate of return of more than 5% after inflation. And only seven of them came in over 4%. Equities represent our single largest asset class. Historically, they have generated returns equal to their dividend yield, plus economic or GDP growth, and any change in the price/earnings multiple. Combining all of these factors leads us to expect equities, traditionally the highest performing asset class, to return 4 to 5% after inflation. In fact, looking ahead to the next 10 years, we expect this environment of modest inflation and low interest rates to continue. The Bank of Canada will likely be able to realize its 2% target for inflation, which is close to the targets of other central banks.

10 - 9 - Successful control of inflation is a global phenomenon, and the consensus forecast for inflation across the world s major economies is about 2%. Within this environment, we expect that most of our assets, including equities, bonds and real estate, will yield only single digit returns. Of course, we have to remember Ontario Teachers Pension Plan is not alone in facing these issues. Private and public pension plans throughout Canada and most of the developed world are grappling with the challenges of aging membership bases as well as declining real rates of return on the assets under their management. Over the past five years, these factors have created a growing deficit at more than half of the country s traditional defined benefit pension plans. Simply stated, these funds do not have the assets they need to cover future pension promises. Don t just take my word for it. According to Henri-Paul Rousseau, head of the Caisse de depot et placement du Quebec, the country s largest institutional investor, We do not have a pension plan problem, we have a retirement crisis. Something s got to give. At Teachers, we will of course continue to work hard to find new ways to add value through our investment approach, while appropriately managing the plan s exposure to risk. And I am confident that we will be able to continue to outperform our benchmarks. Again I caution, however, that although we expect to outperform the market, the market isn t what it used to be. But we all need to recognize that even the most brilliant investment results will not be enough to overcome the demographic trends and overall investment climate that await us. Accordingly, we will continue to be vigilant about communicating the funding challenges facing the plan and advising sponsors of the steps we must take today and in the future to ensure that teachers pensions can be counted on. We have also begun rolling out a comprehensive print- and web-based communication program that details the impact of the rate changes for each member and explains the rationale behind them. And as I said,

11 we look forward to the launch of the members survey in the fall and to reviewing the results by early in the New Year. If my description of the challenges facing the plan has given you any cause for concern today, I would have to say that s a good thing. Why? Because ongoing vigilance and awareness are critical if we are to meet our obligations. Let me assure you that the accrued pensions we have promised to Ontario s teachers remain secure. It is not unusual for pension plans to have shortfalls in some decades and surpluses in others. What s important is that we take action from time to time to balance our assets and liabilities and ensure that the promise of a secure and predictable retirement income is a promise we keep for every teacher in Ontario. Thanks to the performance of our investment managers, and most importantly, the prudent steps we are taking to advise plan sponsors on adequate contribution and appropriate benefit levels going forward, I am confident we are doing just that. My final comments to you today truly are concluding remarks. This is my last speech to you as Chair of the Ontario Teachers Pension Plan, as I am retiring from the board when my term expires December 31. It has been a privilege to serve as Chair since 2000, and indeed to have been on the board since The position of Chair is an especially exhilarating one because it must always consider the objectives of both sides of the table: the members and the province. The OTF and the province will work together to appoint a new Chair from the current Board of Directors. Thank you for your attention.