April 18, 2011
In our financial updates over the last few months, we have frequently referenced the challenges the University faces with the Queen's Pension Plan (QPP). This issue has been percolating for some time now and we feel it would be important and helpful to explain, in a little more detail, the challenges and dilemmas we are facing with the QPP. There is a guide to the QPP on the HR website which will give you full information about the plan.
By now, you may be familiar with the basic facts of the QPP problem. The plan takes in contributions from employees and the University, based on a certain percentage of salaries and wages, and invests this money with the intention of earning a sufficient rate of return to be able to meet the commitments to pay pensions when the employees retire. The plan is managed by the Pension Committee, with the expert advice of actuaries. The Government of Ontario also gets involved, as the regulations require the plan to be valued every three years, and if there is a shortfall in the plan, then that problem has to be addressed by the University.
Managing the plan involves making guesses way off into the future about the inflows and outflows of cash, and rates of return on investments. It also involves guessing how long pensioners are going to live (actuaries call this the "mortality rate"), and about long-term interest rates in the Canadian economy.
If any of these guesses (actuaries call them assumptions) turn out to be wrong, then in the very long run the plan may not be able to pay out all the pensions unless the University and the employees put a large amount of extra money into it each year for several years. Unfortunately, this is the point we have reached. The next part of this update talks about each of the separate reasons for the problem, but bear in mind that it is the combination of all of them that has had this impact – the plan is not currently in balance. The longer it is left in this condition, the worse the problem will become.
The investment portfolio was hit badly when the financial markets crashed very suddenly in 2008. While the markets have been doing quite well recently, the market value of the pension investments is not where we would like it to be. Figure 1 shows the value of the investment portfolio each August 31 for the last 5 years. (August 31 is the anniversary of the plan, and the date on which the government regulations require the plan to be valued.) Over 2006 to 2010, the actuaries were assuming an average return on investments of 6% each year. If this had held true, the market value of the plan would have been closer to $1.5 billion instead of the $1.3 billion we see on the graph.
Figure 1: Pension Plan Asset Changes 2006 to 2010 - Market Value
As we mentioned, each member of the plan has deductions from their pay that go into the plan. That amount is more than matched by the University. These amounts all form part of the investments made by the plan, but they are accounted for separately for each employee, so that we know at any one time how much money is available for each person at retirement.
Two years ago, when the global financial crisis struck, revisions to the plan were already under discussion. For years it has been recognized by the University administration and the employee groups that the QPP is in need of some adjustments. Pensioners are living longer than expected, and the rate of contributions to the plan has fallen behind the rate at which benefits are being paid out. (See Figure 2).
Figure 2: Pension Plan Asset Changes 2006 to 2010 (Plan year September 1 to August 31)
To ensure the long-term viability of the plan, all parties agreed that some changes needed to be made and entered into discussions about possible solutions. The discussions were still underway at the time of the 2008 investment market crash. By summer 2010, it had become very clear that more substantial change, than was previously being considered, was going to be required to keep the plan afloat. The University administration suspended the discussions and formed a Pension Working Group, which was mandated to re-assess the state of the pension plan and recommend appropriate action.
Estimates of future Canadian interest rates are also important because they factor into the government-required calculations that are done for the plan every three years. We are now in what seems to be a prolonged period of very low interest rates, and while this is good news for people with mortgages, it will impact the calculations of the amount the QPP must set aside to pay pensions. In essence, our actuaries have to calculate a capital amount that would be needed to satisfy each member's pension benefits: the lower the interest rate the larger this "annuity" must be. This also contributes significantly to the funding problem: the lower the interest rate, the greater the amount of money that needs to be set aside for each member of the plan.
When an employee approaches retirement, HR calculates the pension that he or she will receive.
When the investment market has done well over an employee's working life, the employee's pension will be based on the amount that's accumulated in his or her individual account. On the other hand, if things haven't gone so well in the investment markets, (like now), many more people will be projected to retire on their minimum guaranteed pension, creating an unprecedented draw on pension plan funds.
This is where the Government of Ontario steps in and requires each pension plan to have two liabilities calculated for it: a going concern liability (which assumes the plan will continue on into the future, as we all want it to) and the solvency liability (which assumes it would have to be wound up immediately). The solvency liability is much bigger than the going concern liability, because of having to calculate immediate pensions for everyone, as opposed to continuing on with contributions until employees eventually retire. These calculations will determine how much the employees and the University must contribute to the pension plan in the future. The last formal valuation was done as of August 31, 2008, just before the crash, and the next one will have to be done as of August 31, 2011. The actuaries made a preliminary valuation as at August 31, 2010 that indicated the going concern liability to be about $199 million and the solvency liability to be about $325 million.
Luckily, the government will not expect us to cure the problem all at once. Queen's University is not the only public sector organization to be in this situation, and the government is bringing in a law and regulations applicable to universities which will allow them, on certain conditions, to defer the first solvency payment for three years, and then to allow 10 years for this liability to be dealt with. This is known as "solvency relief". However, the University will still be required to make the going concern payments, and to pay interest on the solvency liability, and making these payments will be challenging enough.
The need for significant change should not be underestimated. There has been some commentary suggesting that the market has recovered to pre-2008 levels and so the need to take action has lessened. While we can appreciate it would be comforting to believe that, it is our responsibility to dispel that notion. The QPP has not recovered to 2007 levels. Bluntly stated, simple market recovery is not enough for two important reasons. It neglects both the pre-existing issues with contribution rates and the three years of lost gains the plan experienced while recovering from the market plunge. The long-term projections for the performance of the Plan assumed a degree of growth during the last three years, not stagnation. In essence, this means the Plan is now sitting at well-below 2007 levels while the demand for retirement benefits is still growing. That imbalance is not sustainable.
In short, we are obliged to fix the problem and on a very short timetable. Appropriate action is required now to make the most of the solvency relief options that are available, under law, and make the QPP sustainable in the long term.
We have consulted with the plan's actuaries, and they have confirmed that we need to have a remediation plan in place as quickly as possible or else the problem will continue to escalate to unmanageable levels. In 2014 – three short years away – the University will be required, by law, to begin making additional contributions to bridge the gap between what the plan has in it and what the Provincial law says must be in it.
Also, it's important to know that we cannot, by law, expect current employees to pay for the part of the plan deficit that applies to people who have already retired – the University must bear that alone. Nor can the University reduce existing pensions. Along the same lines, the University cannot make retroactive changes to the level of benefits already earned by people who are now contributing to the plan.
At the moment, employees contribute about 5% of salaries and wages to the pension plan, while University contributes about 10%. If we can't meet the conditions the government is imposing, starting one year after the August 31, 2011 valuation, the University's contributions would have to rise to over 30% of payroll to meet our funding obligations. That would mean an additional $70 million annually would be drawn away from our operating budget.
The University administration has invited the unions and other employee groups back to the pension discussion table. We are hopeful of making progress and are anxious to resume talks. The financial projections make very clear the urgency of this need. We look forward to any and all suggestions on how to tackle this challenge. Our common interest is in ensuring the future financial health of the Plan (and, by extension, the plan's members) while, at the same time, ensuring the future financial health of the University, itself.
We remain thankful to the faculty, staff and students of Queen's for your continuing support. Should you have any questions or comments, please do not hesitate to email us at firstname.lastname@example.org.
Bob Silverman, Provost and Vice-Principal (Academic)
Caroline Davis Vice-Principal (Finance and Administration)