Sustainability now, and in the future
Delivering benefit security means understanding the health of the Pension Plan today, looking decades into the future to identify potential risks, and developing a roadmap to guide decision-making in a variety of economic and demographic circumstances.
The CAAT Plan governors use three tools to evaluate the health of the Plan and chart its future course:
- Asset Liability Modeling Study
- Annual Actuarial Valuation
- Funding Policy
The use of these tools limits surprises, enabling Plan governors to make prudent, balanced decisions, and fine-tune the Plan’s investment program and asset mix to maximize performance.
Asset Liability Modeling Study (ALM)
An ALM study tests the Plan against a multitude of economic and demographic scenarios, now and into the future. It helps Plan governors understand the impact to the Plan of a variety of positive and negative scenarios. This forward-looking, long-term assessment allows Plan governors and staff to plan prudently, and creates a solid foundation from which to assess risks and opportunities.
Annual Actuarial Valuation
An actuarial valuation is a snapshot of the health of the Plan at a specific point in time. A valuation compares the liabilities and assets of the Plan, making assumptions about future growth of both, to analyze the health of the Plan on the date of the valuation. A valuation must be filed with the Provincial regulators at least every three years. The CAAT Plan conducts an interim valuation every year, even if it will not be filed, so that Plan governors always have an up-to-date measure of the Plan’s current health.
The Funding Policy guides the decisions that Plan governors can make at various funding levels. There are 6 funding levels, and required actions within each level are made whenever a valuation is filed. Within each level, Plan governors have different policy options which are grouped into the following categories: reserves, contributions, and conditional benefits.
Working Together for Benefit Security
The Valuation identifies the Plan’s current range in the Funding Policy, and the ALM Study identifies possible future scenarios that will improve or degrade the health of the plan. Plan governors can use the levers of the Funding Policy: contributions, reserves, and conditional benefits, and fine-tune the asset mix, which together help ensure long-term benefit security, stable contribution rates, and the likelihood of paying conditional inflation protection.
Delivering on the pension promise means looking ahead not just to next year, but to the next 20 years and beyond.
Derek Dobson, CEO and Plan Manager
Sustainability for the future – Results of the 2014 ALM Study
The 2014 ALM study tested the health of the Plan against a variety of demographic and economic scenarios up to 20 years in the future. The ALM study projects that the Plan’s health is expected to remain healthy over the long-term in almost all economic and demographic scenarios.
The change with the highest positive impact on the health of the Plan is a growth in active membership. Whether as a result of increased enrolment from existing participating employers, or by increased membership as a result of new employers joining, growth in membership is good for the Plan and its members. Conversely, the biggest risk to the Plan – one that cannot be mitigated by changing the asset mix – is closing the Plan to new entrants (meaning if new employees of participating employers are no longer eligible to join the Plan).
The ALM study also tested a series of economic risks, and the Plan’s health is expected to steadily improve in the future under all economic scenarios. Although the trend is expected to be positive, the Plan will still need to manage through periods of short-term volatility. The only scenario with a high likelihood of moving contributions above their current levels would be a long period of deflation and recession. The probability of the Plan remaining fully funded over the next 20 years is between 93% and 97%.
The Plan’s asset mix is being fine-tuned in response to the ALM study results and analysis. The two major asset categories: Liability Hedging and Return Enhancing will remain at the same percentages (43% and 57% respectively), but certain asset allocations will be updated to improve diversification.
Benefit Security – results of the 2015 Valuation
The January 2015 actuarial valuation has been filed with the pension regulators. It shows the Plan has a going-concern funding reserve of $773 million (compared to $525 million at the January 1, 2014 valuation). The Plan is 107% funded on a going-concern basis (compared to 105% at January 1, 2014). This improvement in the health of the Plan, despite there being no change in the assumptions (see below) is the result of continuing strong investment returns. In 2014 the Plan returned over 11.5% net of expenses, and the Plan’s 5-year average return is 11.8% net.
With this valuation, the Plan remains within Level 3 on the Funding Policy though with an improvement in the funding ratio and size of reserves. Contributions and conditional inflation protection – two of the key levers the Board uses to manage Plan funding will not change as a result of the valuation. Based on the results of this latest valuation, contribution rates are not scheduled to change until at least 2019 and conditional inflation protection is guaranteed to January 1, 2018.
The next required actuarial valuation is not due to be filed with the regulator until January 1, 2018.
Assumptions and Discount rate
The Plan ensures that the assumptions used in the valuation reflect reasonable long-term economic and demographic realities, and are appropriate to the Plan’s long-term goal of benefit security and contribution stability. Appropriate assumptions lead to secure retirement incomes, and appropriate costs for each generation of members. The valuation uses assumptions about long-term interest rates, retirement rates, and the lifespan of members: all factors that impact a pension plan.
Reviewing assumptions regularly to ensure they remain appropriate is an important component of good governance. For this interim valuation, the Board did not change any of the key assumptions, for example longevity. Past valuations have already recognized increases in the lifespans of CAAT Plan members.
A fundamental assumption used in an actuarial valuation is the discount rate. The discount rate reflects expected future investment returns based on the Plan’s asset mix. It is worth noting that actuarial discount rates do not impact the actual long-term cost of providing benefits, but are used to determine the timing of changes to contribution rates. In uncertain economic times, higher contribution rates build reserves to provide benefit security with resulting lower contribution rates in the future should the funding status improve.
For the 2015 valuation the Plan continued to use the discount rate of 3.8% real, assuming an additional 2% for inflation, for a nominal discount rate of 5.8%. (The 2014 valuation used the same discount rate.)
The discount rate of 5.8% sits in the acceptable range of possible discount rates proposed by the Plan’s actuaries. The Board of Trustees will continue to monitor the recent decline in interest rates and evaluate whether a change in future discount rates is required. As part of the valuation exercise, the Plan’s actuaries tested the Plan’s health using a variety of discount rates within the target range – both higher and lower than 5.8%. In each test, even with a much lower discount rate, the Plan remained fully funded, and member benefits were secure. The January 1, 2015 discount rate of 5.8% was deemed a prudent and reasonable assumption to achieve the desired balance of benefit security, intergenerational equity and contribution stability.
Lump sum on termination
Long-term Plan stability is improved when valuations are appropriate, and reflect reality.
A new assumption in this valuation is based on member choices at termination. In the past, valuations had made the simplifying assumption that all members would receive their benefit entitlements as a pension. As many terminating members choose to receive the lump sum value of their benefits upon termination of membership and with the impact of lower interest rates this simplifying assumption was changed. The 2015 valuation introduces a new assumption that 80% of non-retirement eligible members will elect to receive a lump sum payment. This is based on the Plan’s experience from 2007 to 2012, and more accurately reflects the cost of providing lump sum benefits in a low interest rate environment.
The Plan uses a common technique called ‘smoothing’ in measuring the assets in the valuation. Smoothing spreads the impact of investment gains or losses over a period of years, instead of recognizing them all at once. Smoothing out short-term volatile investment returns improves contribution rate stability, and benefit security. Without asset smoothing, Plan reserves would be $1,322 million based on the market value of assets at January 1, 2105. With smoothing and deferring some of the recent asset gains, the reserves are $773 million. Valuations in future years will recognize the asset gains from recent years.
Reading a valuation
The valuation summary below compares the January 1, 2014 valuation and the January 1, 2015 valuation.
|Going concern funding results
(modified aggregate basis)
|January 1, 2015||January 1 2014|
|Asset values||($ millions)||($ millions)|
|Market value of net assets||$7,965||$7,127|
|Present value of future contributions|
|Total actuarial value of assets||$11,492||$10,750|
|Liabilities for accrued benefits||$8,034||$7,650|
|Present value of future benefits for active members||$2,666||$2,554|
|Provision for inflation protection adjustments relating to post-2007 service to next required valuation||$19||$21|
|Total actuarial liabilities||$10,719||$10,225|
Going-concern and solvency valuation disclosure
A going-concern valuation assumes the Plan will continue indefinitely and is used to measure whether contribution rates are sufficient to keep the Plan fully funded in the long term. A valuation must be filed in accordance with pension law in Ontario and meet the standards of the actuarial profession. The Plan is 107% funded on a going-concern basis, which means it is within funding Level 3 in the Funding Policy.
The solvency valuation shows the status of the Plan if it had been wound up on the valuation date. For jointly sponsored plans like ours, the results are hypothetical only, as we are not required to fund for solvency deficiencies reflecting the ultra-low probability of the cessation of all participating employers at once and, instead, base funding requirements on the going-concern valuation. The solvency status is for disclosure purposes only. The Plan’s solvency position as of the January 1, 2015 valuation shows a deficit of $1.9 billion and a solvency ratio of 0.80.