Funding Valuations
Funding basics and how it works
The defined benefit pensions paid from the Plan is funded by two sources:
Equal contributions from participating employers and active members; and
Net investment earnings of the Plan’s assets.
OMERS is a maturing plan, and now pays out more in benefits than is collected in contributions. This gap is expected to continue to grow over time. Maturity makes the Plan increasingly dependent on investment returns to pay pensions. Roughly 70% of the benefits provided by the Plan will need to be funded by investment returns.
An independent actuarial firm regularly assesses the health of the Plan by performing valuation. The valuations results include the “funded ratio” which is the ratio of net investment assets to long-term pension liabilities. It is an indicator of the long-term financial health of the Plan. It is calculated on a “smoothed” and “fair value” basis:
Smoothed
"Smoothed" evens out the variations in annual returns over a five-year period. In this way, contribution rates and benefits are set using a more stable, long-term view of investment performance. It is primarily used for funding and regulatory purposes.
Fair Value
"Fair Value" uses year-end values of OMERS assets without any adjustments.
The funded ratio calculated on a fair value basis will vary more than the smoothed basis. The variation could be significant in some years.
The funded status of the Plan is an important consideration for the OMERS Sponsors Corporation (SC) when making decisions about contribution rates and benefit levels.
The funded ratio on a fair value and smoothed value over the last 10 years is as follows:
The SC Board is comprised of 14 members, half of whom are appointed by employer groups and half of whom are appointed by unions and associations. This Board sets contribution rates and pension benefits based on many considerations including the Plan’s funded status and its projected long-term health. If a funding deficit exists in the Plan, the SC can address it by:
Increasing contributions; or
Invoking Shared Risk Indexing (SRI) for benefits earned on or after January 1, 2023 (accrued pension benefits earned before December 31, 2022, remain 100% protected against inflation); or
Making changes to benefits (note that pensions that members have already accrued cannot be reduced); or
Adopting a combination of these options.
OMERS pensions include inflation protection. Inflation protection is guaranteed on pensions benefits earned before January 1, 2023 based on 100% of the rate of inflation subject to a maximum of 6%. If inflation rises by more than 6% in a given year, the excess amount will be carried over to the next year when inflation is less than 6%. Inflation protection on benefits earned after December 31, 2022 is based on Shared Risk Indexing (SRI). If SRI were to be invoked, inflation protection on benefits earned after December 31, 2022 may be lower than 100% of the rate of inflation. Click here for more information on how we calculate annual inflation increases to Plan benefits.
SRI was introduced in order to improve the Plan’s resilience as it matures. The SC can decide to reduce future inflation increases on benefits earned after January 1, 2023 based on an annual assessment of the Plan’s financial health. SRI introduces a new option for managing funding shortfalls. Specifically, SRI allows risk to be more equitably spread across all generations of active and retired members. With SRI, both active members --through possible contribution increases or future benefit reductions --and retired members -- through decreased inflation protection --can contribute to improving the Plan’s financial health.
Here are the key facts you need to know about SRI:
It does not impact pensioners who retired to January 1, 2023.
SRI only applies to benefits earned on or after January 1, 2023. For clarity, accrued benefits earned prior to December 31, 2022 receive guaranteed inflation protection and are not subject to SRI.
OMERS will notify you in advance whether SRI will be invoked, and what the percentage of indexation will be.
invoking SRI requires approval from two-thirds (2/3) of the SC Board;
if SRI is invoked, the percentage increase for the portion of pensions earned after 2023 can be anywhere from 0% - 100%;
Pensions can never go down as a result of SRI being invoked; and
If SRI is invoked, the SC will continue to annually assess the Plan’s health and determine if and when inflation increases can resume.
Actuarial valuation basics
The Pension Benefits Act (Ontario) requires that actuarial valuations be completed and filed for registered defined benefit pension plans, such as the OMERS Primary Pension Plan. There are two types of actuarial valuations that are performed:
going-concern
“going-concern” valuations assess the health of the plan assuming the pension plan continues indefinitely
solvency valuations
“solvency valuations” assess the health of the plan as if there had been a wind-up of the Plan on the valuation date
OMERS funds the Plan, and establishes its benefit levels and contribution rates, on a going-concern basis. We are also required to perform a valuation on the financial health of the Plan under the highly unlikely event that the Plan is being terminated.
Here are the key elements to understand about the going-concern actuarial valuation:
it is a regular assessment performed by an independent actuarial firm at a point in time. It measures the health of the Plan by determining its “funded ratio”
the “funded ratio” is determined by comparing pension liabilities (i.e., the present value of the pension benefits that OMERS members have earned) on a going-concern basis against its assets (i.e., how much is invested on behalf of the members to meet the pension obligation)
as the valuation assumes the plan continues indefinitely (i.e., going concern basis), the actuary will use assumptions to project future pensions. Learn more about assumptions here.
the “funded ratio” is a financial health measure that describes whether there enough funds today to pay the future pensions that members have earned.
“surplus” exists when the funded ratio exceeds 100% -- i.e., when assets exceed the pension liabilities.
“deficit "exists when the funded ratio is lower than 100% -- i.e. assets are less than the pension liabilities.
The funded ratio is highly dependent on the assumptions that are used to calculate it, as described in more detail below.
The results of the actuarial valuation are one of the many considerations that the Sponsors Corporation uses to make decisions about contribution and benefit levels of the OMERS Plan.
Assumptions used in a pension funding valuation
When performing a long-term assessment of the OMERS Primary Pension Plan (Plan), the actuary makes many assumptions about expected future events. Together with our actuaries, OMERS staff spends considerable effort in selecting these assumptions, using our historical Plan experience where applicable, and applying professional judgement. The key assumptions used in the going-concern valuation include estimates of:
How long our members live
At what ages members retire
At what rate of inflation do the pensions received by our retired members increase
At what rate do the salaries of our active members grow
Other demographic experience, such as rates of termination, and the likelihood of a member having a surviving spouse at death
The long-term investment returns earned by the Plan’s assets, which are used to determine the discount rate used to measure our liabilities (described below)
The real discount rate is by far the most important assumption used to determine the Plan’s liabilities.
Understanding the discount rate
The discount rate is the interest rate used to estimate the present dollar value of the pensions that OMERS is projected to pay over the long-term. The “real” discount rate, is determined using two components:
Real discount rate = Nominal Discount Rate – Inflation assumption
Nominal discount rate is median expected long-term net rate of return of the Plan assets less a margin for adverse deviations.
Inflation assumption is the long-term expected change in the Consumer Price Index (CPI), currently 2.0% per year.
This key actuarial assumption is used to calculate the present value of members’ future pension benefits and is based on a variety of factors including long-term investment return expectations. The discount rate is the assumption to which the pension obligation of the Plan is most sensitive.
2014 | |
|---|---|
Real Discount Rate | 4.25% |
Long-Term Inflation Assumption | 2.25% |
Nominal Discount Rate | 6.50% |
2015 | |
|---|---|
Real Discount Rate | 4.25% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 6.25% |
2016 | |
|---|---|
Real Discount Rate | 4.20% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 6.20% |
2017 | |
|---|---|
Real Discount Rate | 4.00% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 6.00% |
2018 | |
|---|---|
Real Discount Rate | 4.00% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 6.00% |
2019 | |
|---|---|
Real Discount Rate | 3.90% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 5.90% |
2020 | |
|---|---|
Real Discount Rate | 3.85% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 5.85% |
2021 | |
|---|---|
Real Discount Rate | 3.75% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 5.75% |
2022 | |
|---|---|
Real Discount Rate | 3.75% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 5.75% |
2023 | |
|---|---|
Real Discount Rate | 3.75% |
Long-Term Inflation Assumption | 2.00% |
Nominal Discount Rate | 5.75% |
2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | |
|---|---|---|---|---|---|---|---|---|---|---|
Real Discount Rate | 4.25% | 4.25% | 4.20% | 4.00% | 4.00% | 3.90% | 3.85% | 3.75% | 3.75% | 3.75% |
Long-Term Inflation Assumption | 2.25% | 2.00% | 2.00% | 2.00% | 2.00% | 2.00% | 2.00% | 2.00% | 2.00% | 2.00% |
Nominal Discount Rate | 6.50% | 6.25% | 6.20% | 6.00% | 6.00% | 5.90% | 5.85% | 5.75% | 5.75% | 5.75% |
Setting the discount rate is key to managing the Plan and addressing risk. When selecting a discount rate, we need to balance competing goals of sustainability, affordability and meaningfulness, across generations of members.
A discount rate that is too high increases risk for future generations of members in the event that we were to enter a period of low economic growth, high inflation or both. This is a pressure on sustainability and increases the risk of future negative changes to the Plan, which would make benefits less meaningful and/or contributions less affordable.
A discount rate that is too low improves long-term financial sustainability by reducing the reliance on future investment earnings. However, it could hurt affordability for the current generation of members, by increasing required contributions and potentially triggering negative changes to benefits, impairing their meaningfulness.
Since the last discount rate strategy was approved in November 2021, the economic environment changed significantly. Between March 2022 and September 2023, in an effort to tackle rising inflation levels, the Bank of Canada raised the overnight interest rate 10 times, from 0.25% to 5.0%. During the same period, the yield on Canadian 10-year bonds has more than doubled, creating more attractive opportunities for typically safer fixed income assets. In light of the changed economic environment, OMERS revisited our discount rate strategy to understand what adjustments may be needed to best ensure the Plan’s long-term sustainability, affordability and meaningfulness.
At its meeting on August 16, 2023, the AC Board approved an updated strategy and target for the real discount rate used to measure OMERS pension liabilities.
Our revised discount rate strategy outlines a set of principles that guide our decision-making when defining a long-term discount rate target range and a valuation discount rate. Those principles are as follows:
Reflect the current and forecasted economic environment.
Include a margin for adverse events and other strategic reasons.
Incorporate flexibility in defining the discount rate range and valuation discount rate to improve sustainability.
Account for the Plan’s current and projected financial health and maturity.
We will prudently lower the valuation discount rate as funding improves, and the Plan becomes more mature, to build buffer for adverse events.
We will prudently increase the valuation discount rate to mitigate short-term funding pressures (such increases are envisioned to be commensurately short-term in nature).
The result of implementing these principles is a long-term target range for our real discount rate of 3.5% to 4%. This is an increase from the previous long-term target range of 3% to 3.25%, largely as a result of the increase in the interest rate environment. Over the past several years, OMERS has reduced our real discount rate from 4.25% to 3.75%. As at December 31, 2022, OMERS real discount rate was 3.75%, which is at the mid-point of the new range. The flexibility afforded by a higher discount rate range improves prospects for stable funding requirements and benefit levels.
Asset Liability Study and Target Asset Mix
“Our long-term strategic asset mix is the key determinant of our overall risks and return.” – OMERS Statement of Investment Beliefs
At the August 16, 2023 meeting, the AC Board also approved a new target asset mix for OMERS investments effective January 1, 2024. OMERS new strategic asset mix (effective January 1, 2024) is set out in the table below, along with a comparison to our current portfolio composition.
Asset class | Strategic target mix | Actual mix |
|---|---|---|
Fixed Income |
|
|
Equities |
|
|
Real Assets |
|
|
Economic leverage, recourse debt and cash | -20% | -5.3% |
The most significant changes relative to the June 30, 2023 portfolio are an increase in allocations to fixed income investments (as these asset classes are more attractive in higher interest rate environment) and a decrease to more volatile public equities. Overall, we expect the new asset mix to deliver similar returns to the past, but with lower volatility.
The new strategic asset mix was determined based on an Asset Liability Study, which had three principal objectives:
Minimize the likelihood of OMERS being forced to make adverse changes to contribution or benefit levels.
Optimize the financial health and funded position of the Plan by improving our ability to generate healthy returns and grow our assets beyond our liabilities.
Ensure that we have sufficient liquidity in the portfolio, both to meet expected cash obligations and provide flexibility to take advantage of opportunities as they emerge.
Key learnings from the study are:
Having more fixed income investments is preferred in a higher interest rate environment, as they can now provide meaningful income, while improving our liquidity.
Diversification across asset classes remains critical to an effective asset mix. Maintaining our capabilities to invest in each of our asset classes is vital to ensuring that we can deploy and rotate capital in response to cycles and opportunities.
Real assets provide an attractive return-risk profile and inflation protection.
Equities provide return-enhancing opportunities.
The prudent use of leverage enhances returns, notwithstanding the current challenges that rising interest rates have placed on our leveraged investment strategies.
Role of the Administration Corporation (AC) and Sponsors Corporation (SC) in the valuation process
Both the OMERS Administration Corporation (AC) and Sponsors Corporation (SC) work together, closely and collaboratively to meet a singular goal: to make OMERS a sustainable, affordable and meaningful defined benefit pension plan. Together, they both play, separate, but important roles in the valuation process.
The Administration Corporation:
determines the regulatory minimum and maximum funding in accordance with the Pension Benefits Act (Ontario), and the Income Tax Act (ITA).
establishes and approves the assumptions used in the valuation
The Sponsors Corporation:
The Sponsors Corporation is responsible for determining if contribution or benefit levels need to be adjusted.
Filing a funding valuation
OMERS is required to file a funding valuation with the regulator, the Financial Services Regulatory Authority (FSRA) of Ontario at a minimum of once every three years, in accordance with the Pension Benefits Act (Ontario). To continually monitor the financial health of the Plan, OMERS performs annual valuations. Not all of these annual valuations, however, are required to be filed with FSRA. OMERS may choose to do so anyway. Funding valuations are performed by the Administration Corporation (AC), and the decision to file a valuation that is not required to be filed is the responsibility of the Sponsors Corporation (SC).