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What is the purpose of the 5-year funded-health review?
Public Service Superannuation Plan Trustee Inc. (Trustee) is required to conduct a funded-health review of the Plan every 5 years, in accordance with provisions of the Public Service Superannuation Act (PSSA). The purposes of each review are to determine indexing (also known as cost-of-living adjustments, or COLA) for the next 5-year cycle (January 1, 2021 to December 31, 2025, in the case of the latest review), and to assess the appropriateness of the Plan’s benefits and contribution rates in light of the funded ratio of the Plan at the time of the review.

When did the Trustee complete the latest 5-year funded-health review of the Plan?
The Trustee completed the review on June 23, 2020.

What was the Trustee’s decision after it conducted the latest 5-year funded-health review?
The funded ratio of the Plan as at December 31, 2019 was 98.5%, using a market value of Plan assets as at that date. As per the Plan’s funding policy, indexing was mandated to be zero for the next 5-year cycle (January 1, 2021 to December 31, 2025).

Also as per the funding policy, the Trustee had to consider whether to adjust contribution rates. With advice from the Plan’s actuary, the Trustee determined that no change in contribution rates was warranted.

Why is the Trustee not able to exercise some discretion in granting indexing?
It is not a discretionary decision of the Trustee. The Trustee has no ability to consider indexing if the funded ratio is below 100% at the time of the 5-year review, which was as of December 31, 2019. Investment returns were generally quite strong in 2019.

Why wasn’t the Plan’s funded ratio higher as at December 31, 2019?
The PSSP had positive investment returns for calendar 2019. The overall return for this period, net of investment management fees, was 11.54%. The market value of the Plan’s assets increased by $550 million from December 31, 2018 to December 31, 2019. The PSSP had assets of $6,813,354,000 at the end of 2019. However, the Plan’s liabilities also increased very significantly over the same period.

What are the Plan’s ‘liabilities’?
The Plan’s liabilities are comprised of what it owes to members, both active and retired, in pension payment entitlements. They amount to several hundred thousand years of pension payments. Those entitlements are calculated by the Plan’s actuary, using assumptions about life expectancy and survivor entitlements for pensioners, and a range of assumptions for active members (age of retirement, pension amount at retirement, life expectancy, survivor entitlements).

Why did the Plan’s liabilities significantly increase in 2019?
The PSSP is a mature pension plan, with almost as many pensioners as active members. The liabilities associated with all Plan members rose significantly in 2019 due primarily to a sharp downward adjustment to an actuarial assumption called the ‘discount rate’. This effectively offset the substantial investment gains realized in 2019. The PSSP had liabilities of $6,918,434,000 at the end of 2019, being an increase of $543.4 million from December 31, 2018.

Why did a sharp reduction in the ‘discount rate’ have to be applied just at the time of determining indexing for the PSSP’s next 5-year cycle?
The timing of the discount rate reduction was dictated by macro-economic circumstances – primarily chronic low interest rates and slowing global economic growth. The Plan’s actuary, and the Canadian actuarial industry generally, tracked those macro-economic circumstances throughout 2019. By the end of 2019, the actuarial industry had no option but to significantly reduce its long-term investment return assumptions. It is important to appreciate that this was not exclusive to the PSSP but, rather, a marked shift that has broad application to Canadian (and, indeed, global) pension plans.

What, precisely, is the ‘discount rate’?
The discount rate is the percentage by which a pension plan’s total liabilities may be discounted (reduced) in consideration of investment earnings that are expected to accrue over time on the plan’s assets. In other words, a pension plan does not have to hold assets to fully match its liabilities to be considered ‘fully funded’ (on a going concern basis). It is enough that the total assets are almost as much as the total liabilities – the difference between the two being the permissible discount. The discount is an actuarial concept, and the discount rate for a pension plan at any point in time must be certified by the plan’s independent actuary in accordance with professional standards and practice.

Can you provide more detail about the discount rate, given its importance in assessing the Plan’s funded health and in determining the Plan’s funded ratio?
The discount rate for the PSSP moved from 6.00% as at December 31, 2018 to 5.50% as at December 31, 2019. The most important component of the discount rate is the Plan actuary’s best estimate of future portfolio returns, which estimate is based on long-term asset class analyses completed by the actuary’s internal capital markets experts. Those estimated future returns were driven down steeply by the macro-economic realities that had firmly emerged by the end of 2019: an historically low interest rate environment with no apparent likelihood of change for the foreseeable future, coupled with continued slowing of overall global growth. The projected returns for equity and fixed income asset classes were, as a result, pegged much lower by the actuary at the end of 2019 than they had been at the end of 2018 (or in immediately prior years).

What if the Plan’s discount rate had simply been left unchanged as at December 31, 2019?
If the PSSP’s discount rate as at December 31, 2019 had remained unchanged from what it had been as at December 31, 2018 – that is, 6.00% – the funded ratio of the Plan would have been approximately 104%, driven upward by the strong investment returns realized in 2019. Instead, the 50-basis point drop in the discount rate resulted in an actuarially-calculated increase in the Plan’s liabilities by several hundred million dollars, and a resulting drop of the funded ratio to 98.5% as at December 31, 2019.

Again, however, it is critical to appreciate that there was no choice but to reduce the Plan’s discount rate. The Trustee had absolutely no ability or discretion to leave it at 6.00% - where it was as at December 31, 2018.

Is the PSSP’s discount rate in line with the rate used by other Canadian pension plans?
The sharp decline of the PSSP’s discount rate in 2019 is not specific to the PSSP. It is anticipated that all defined benefit plans in Canada will be experiencing a similar decline. The PSSP’s discount rate has typically been at the high end of the range for public-sector pension plans in Canada. Even with the drop in the PSSP’s discount rate to 5.50%, once other plans make their own adjustments it is expected that the PSSP’s discount rate will remain higher than many other plans.

Might the PSSP’s discount rate be further reduced in future years?
That is a possibility. The PSSP’s discount rate, in line with the discount rates of other Canadian pension plans, has been steadily trending downward over the past several years. While further reductions cannot be ruled out, it seems unlikely that such a steep decline as was booked in 2019 will occur again.

From the perspective of PSSP pensioners, it seems unfair that they will have to cope without any indexing (COLA) for a 5-year period. Is there further information that might help explain this situation?
In the end, the PSSP’s very mature demographic is the crux of the challenge. The PSSP simply has a disproportionately high number of pensioners compared to its base of active members. The liabilities attached to the pensioner group is very large and, arguably, those liabilities were not as robustly funded over the past decades as they might have been. The Plan has been left in the unenviable position of having to pay both present and future pension obligations from a finite pool of money.

This brings the concept of ‘inter-generational equity’ squarely into focus. The Plan’s funding policy is constructed to achieve balance between present and future pensioners, and continually calculating the liabilities attributable to each is fundamental to that. The discount rate is key here. If it is higher than it should be, then future liabilities are underestimated, and an unfair burden may be placed on the Plan’s younger, active members. If it is lower than it should be, then future liabilities are overestimated, and an unfair burden may be placed on the Plan’s older, active members and existing retirees. The goal is always to fix a rate that can be substantiated using the best information and analysis available and to objectively strive to avoid inter-generational inequity.

When is the next 5-year funded-health review?
The Trustee’s next review of the Plan’s funded health will be in 2025, for the 5-year cycle starting January 1, 2026 to December 31, 2030. For that review, indexing and other funding determinations will be dependent upon the Plan’s funded ratio as at December 31, 2024.

Click here to view more Q&As that were published in the Fall 2019 edition of ‘your Pension Connection’ newsletter. They provide additional information regarding Indexing and about the Plan’s funded-health review in general.