Pension management a matter of assuming and adjusting
Defined benefit pension plans, such as the Alberta Teachers’ Pension Plan, require funding so that contributions are sufficient to fund the pensions as teachers earn them. To do that, pension plans employ actuaries to calculate the pension benefits owed and then compare this amount (the plan’s liability) to the value of the plan’s assets.
In order to calculate the value of all future benefits, actuaries need to make assumptions about plan members. These assumptions include the members’ expected retirement choices, life expectancies and future salaries. The plan also needs to make assumptions about economic factors such as expected investment returns and the inflation rate.
When reality varies from assumptions, the plans can experience a loss and be underfunded, or they can experience a gain and be overfunded. Since these plans are designed to be funded on an ongoing basis over the workers’ careers, and in order to provide a level of equity among generations of workers, funding deficiencies generally must be paid off over a maximum period of 15 years.
The Alberta Teachers’ Pension Plan has a series of deficiencies totalling $2.3 billion. (This relates only to benefits earned for service after August 1992, as pensions for service prior to September 1992 are funded solely by the Alberta government). The three major reasons for these deficiencies are lower than expected returns on investments experienced during the severe market crashes of 2001 and 2009, continued low interest rates and increased life expectancy.
If a pension plan fails to meet funding targets, or if targets are unrealistic, contributions must be increased to fund deficiencies. In the Alberta teachers’ plan, contributions have been increased for both government and teachers. Teachers currently contribute 5.1 per cent of their salaries to fund the plan’s deficiencies. These deficiency contributions will decrease over the next 13 years as each respective deficiency is fully funded.
However, since 75 cents of every pension dollar paid out comes from investment returns, setting targets that are too conservative will also require that contributions be increased. In order to protect the plan’s assets while still meeting expected rates of return, the board of the Alberta Teachers’ Retirement Fund (ATRF) has taken a number of steps to ensure that investment strategies will return sufficient funds while remaining within an acceptable risk tolerance.
The ATRF board has taken several steps to reduce the plan’s funding risk. One of these steps was to decrease the assumed annual investment return to 6.25 per cent from 6.75 per cent. And, after a detailed modelling study, administrators adjusted the plan’s mix of assets, a move intended to maintain an acceptable average long-term contribution rate for both government and teachers while minimizing the probability of higher contribution rates.
For complete information on the plan’s funding and investment strategy, please review the ATRF’s annual report at www.ATRF.com. ❚