Sign of looming pension crises

One of the big difficulties that will be faced by the elderly population in developed countries will be the cut-backs their pension systems will undertake. The problem is that many pension plans, like mutual fund salespeople, over-promised the future and built in rosy asset return expectations. A good sign of the current state of affairs is the situation faced by the Ontario Teacher's Pension Fund.

If I recall, the Ontario Teacher's Pension Fund is the second or third largest pension fund in Canada. It may also be the best managed mega-fund in Canada. Yet, it is facing a short-fall, even after many years of strong performance. The Globe & Mail reports:

The pension fund said Tuesday it earned 13 per cent on its investments last year, boosting its asset base to $96.4-billion from $87.4-billion at the end of 2008.


The returns beat several other major public pension funds that have so far reported 2009 results, including the Caisse de dépôt et placement du Québec, which earned 10 per cent last year, and the Ontario Municipal Employees Retirement System, which posted a 10.6-per-cent return for 2009.

But Teachers chief executive officer Jim Leech said 2009 was “confounding” because the strong returns did little to hold back a soaring funding deficit.

By the end of 2009, Teachers estimated its pension funding shortfall was $17.1-billion, up 580 per cent from just $2.5-billion at the end of 2008. The shortfall is the difference between projected future benefits and the actuarial value of the plan's assets.

“2009 was great from an investment and member service perspective, yet may seem confounding from a funding perspective,” Mr. Leech said in a release.

The rapid increase in the shortfall was due to falling interest rates last year, which caused the fund's liabilities to rise. Pension funds measure their long-term liabilities based on interest rates.

Mr. Leech said every one percentage point reduction in real interest rates – that is, the rate of interest after inflation – increases the fund's pension costs by $25-billion. With real rates falling 0.6 per cent last year, it added $15-billion to funding costs, he said.

Reading this story it appears that the short-fall is due to increasing present value of future obligations (if the discount rate falls, present value of future obligations will be higher.) Barring a highly inflationary environment, the pension fund requires some changes: cut benefits or increase fund contributions.
 
In addition, I would say that the increasing number of retirees (relative to workers entering the workforce) and the possibility of somewhat poor asset returns in the future (although it's hard to see returns worse than in the last decade,) will compound the difficulties.
 
I feel this is an important story because if the Ontario Teacher's Pension Fund, one of the best managed with the strongest returns (for a mega fund,) is seeing some issues, one doesn't need to think hard to realize the sorry state of affairs for other pension funds, who are not as well managed. The public, government-influenced, pension funds at least have strong transparency but I really wonder about private, corporate-influenced, pension plans.
 
 
Institutional money managers, as well as managers of hedge funds and private equity funds that pension funds invest in, were probably cruising to riches in the last few decades but I suspect they may finally have to start earning their paycheque.