Thank you for inviting us to speak with the committee today regarding the Canada Post pension plan.
I would like to make a few observations about the plan, during which I will make reference to the supplementary document that has been circulated, and then we look forward to taking your questions.
I'm an actuary with Mercer, which has been the plan's actuarial firm since its inception in 2000. In my role as an actuary, I work on the annual valuations of the plan prepared for funding and accounting purposes. Our valuations are performed according to the applicable legislation and regulatory guidance under the federal jurisdiction, and according to the professional standards of the Canadian Institute of Actuaries. The results of the valuation are presented each year to Canada Post's management, the pension committee of the board, and the pension advisory council, which includes representatives from management and the various unions.
Joining me is my colleague Michel St-Germain. Michel brings a broader perspective on trends in the pension landscape across the country and over time. Michel plays or has played various roles within the Canadian Institute of Actuaries and the Association of Canadian Pension Management.
I have a few comments on plan size. The Canada Post pension plan has been growing steadily since plan inception. As shown in figure 1 of the supplementary document, the plan's assets have almost tripled in size between 2001 and 2015. Over that same period, the solvency liability more than quadrupled.
The solvency deficit at the end of 2015 was about $6 billion, which has grown to about $8 billion so far in 2016. The biggest driver of the increased solvency liabilities and deficits has been the decline in interest rates in recent years. Figure 2 shows that the interest rate net of inflation used to value the solvency liability had fallen to 1.2% at the end of 2015 versus 2.25% 10 years earlier. By June 30, 2016, that rate had declined to 0.08%.
As it has grown, the plan has become very large compared to the size of Canada Post itself. We've illustrated this in two ways in figures 3 and 4. Figure 3 shows the size of the pension obligation on a corporate accounting basis as a percentage of corporate revenue. This excludes, by the way, the obligation for other non-pension employee benefits which are worth about another $4 billion. This ratio has grown almost every year in the last 10 from 226% to 390% of revenue. To put these numbers in context, the graph also shows the distribution of the same sort of results for organizations in the TSX Composite with DB, defined benefit, pension plans.
Clearly, the growth of Canada Post's pension plan has far outstripped that of its revenue, which has been consistently around $6 billion per year excluding the subsidiaries over the period shown.
Besides the fairly flat revenue, another reason for these large ratios is the relative generosity of the Canada Post plan benefits, for example, full guaranteed indexation. Given the current size of the active membership, and given that many of Canada Post's new hires continue to join the DB component, the plan is expected to continue to grow for many years to come.
Another way to look at relative size is given in figure 4, which shows the employer pension contributions over time also as a percentage of corporate revenue. Canada Post's contribution requirements in the absence of the CPC special relief measures, which Ms. Hemmings described, varied widely between 1% and over 15% during this period.
In figure 5 we show the historical contributions to the Canada Post plan. The solid blue and red bars show how the employee and employer current service contributions have changed over time to reflect a more balanced sharing of these costs. In addition to current service contributions, Canada Post is responsible for funding any deficits. Going concern deficits must be paid off over 15 years. Solvency payment requirements are more complicated since we are required under federal funding rules to determine the special payments based on a three-year average solvency ratio. There are details on these calculations in figure 8 of my supplementary document, but we won't go through those in detail unless they come up in questions.
The striped red bars show Canada Post's deficit contributions, which are over $1.6 billion in total, mostly for solvency deficits. There are two items worth pointing out on this graph. Since 2011, agent crown corporations like Canada Post have been permitted to reduce their solvency special payments up to a cumulative total reduction of 15% of plan assets. Canada Post used this to reduce its special payment requirements from 2011 through 2013 with a cumulative special payment reduction of $2.4 billion. That cumulative reduction limit of 15% of assets would have been reached in 2014 with the chance that the remaining required payments could exceed Canada Post's ability to pay.
In response to this issue, special regulations were enacted in early 2014—that's the CPC special relief—exempting Canada Post from special payment requirements for 2014 through to the end of 2017. The yellow bars in figure 5 show the special payments that would have been made to the plan if the CPC special relief had not happened.
In figure 6, we show the expected range of projected future employer contributions over the next five years, based on market conditions and valuation results as at year-end 2015. As shown by the small blue squares, the median projected contribution over this period ranges from about $260 million to $540 million. However, the graph shows that there's at least a 25% probability of required contributions exceeding $1 billion in 2019 and 2020, as shown by the top of the light green bar. Since year-end, market interest rates have declined significantly, so our current estimates of future contributions would tend to be higher than the ones shown on this graph.
The task force has proposed some options to modify or eliminate solvency funding requirements for Canada Post. The elimination of mandatory solvency funding would relieve much of the short-term funding pressure the plan places on Canada Post; however, significant risks would still remain in the longer term. Even in the absence of solvency special payments, the size of the plan relative to that of Canada Post would remain at least as large. For instance, the relative size of the accounting obligation in figure 3 is not affected at all by contribution requirements.
Currently, the going concern basis is much less expensive than the solvency basis; however, this is largely due to an assumption that the plan's asset mix—specifically, its allocation to riskier asset classes such as public equities—will yield higher returns than the conservative asset mix required for solvency purposes. While we expect that to be the case on average over the long term, it's not guaranteed to occur over any particular period. It's also worth noting that if members live longer than we have assumed, plan costs could increase.
Canada Post can reduce the risk of volatility in the net position of the plan by decreasing its allocations to risky assets; however, this will decrease the expected return and increase the cost. It's not hard to imagine the current going concern surplus turning into a deficit due to a bad experience. One year of asset returns like we saw in the market crisis of 2008 could result in as much as $2 billion of special payments being made to the plan over a 10-year period, even in the absence of solvency funding requirements. In addition, assumptions may change over time as the asset mix or the actuary's outlook for the future changes.
These types of risks are expected with traditional DB plans. It is the size of this plan relative to the size of Canada Post that makes this of special concern.
It's interesting to note that two of the most well-regarded public sector pension plans, Ontario Teachers' and the Healthcare of Ontario pension plan—HOOPP—are exempt from solvency funding, yet these plans have both taken steps to modify their benefits, particularly the level of guaranteed indexation, to control costs and volatility.
If Canada Post were to become exempt from having to fund on a solvency basis, we would also encourage consideration of additional changes to address the remaining risks.
On changes to investment policy, Canada Post plans to gradually reduce their allocation to riskier assets as the plan's position improves over time. This will make the plan less sensitive to changes in market interest rates, although it does not address the current deficit.
On defined contribution, a defined contribution, or DC, plan like the one offered by Canada Post represents the lowest cost volatility possible for the portion of the plan covered by it. DC designs are increasingly common, particularly in the private sector. Recently, Unifor agreed to a DC plan for new hires at General Motors when it became clear that GM would not be able to afford the DB plan. While extending DC to more members would slow the growth of the DB component of the plan, the problem of funding the existing DB component would remain.
On risk-shared plans, there are some middle-ground options, which aim to retain much of the predictable benefit stream of a traditional DB plan while significantly lowering cost volatility. Such plans share risks between the employer and members or across the members as a group, which is preferable to individual risk-bearing. One such planned design would reduce or eliminate guaranteed pension indexation, indexing pensions only when the plan's financial position permits, according to rules laid out in advance. Canada Post has been looking into designs like this.
Another option is a target benefit plan, or TBP. In a TBP, employer contributions would be predictable and clear rules would be set out in advance regarding the handling of surpluses and deficits, with some benefits at risk of reduction in bad times. The federal government tabled a bill earlier this month to permit the establishment of TBPs in the federal jurisdiction. We have discussed the TBP concept with Canada Post.
While risk-shared plans can work well for the future, benefits already accrued remain in the traditional DB plan, unless members or their unions consent to a conversion to the new plan.
One final option for consideration is joint governance. Some of the most successful large Canadian pension plans are governed on a joint basis with representatives from employers and members making decisions together. Ontario Teachers' and HOOPP are examples of such plans. Under the right conditions, this can work very well, but we believe that joint governance is best accomplished in conjunction with shared responsibility for the funding of any past service benefits.
This concludes our prepared remarks. We thank you and look forward to your questions.