Chapter 19: Liability Management

Introduction

No fiscal projection is a static plan. For any government, revenue and expense estimates are generally based on economic assumptions, policy decisions and direction, and the best available information at a given point in time. There is a lot of uncertainty that surrounds the estimates in the plan. Once released, it becomes subject to a number of risks that could emerge and impact the previously outlined fiscal objectives.

Any information or events that were unanticipated during the planning process present a risk to the fiscal projection. Risks can come from uncertainty in financial markets, project failures, legal liabilities, credit risk, accidents, natural causes and disasters, or events of an uncertain or unpredictable nature. For Ontario, as a sub-national jurisdiction, the risk of a policy change by the federal government continually exists.

These risks can have a positive or negative impact on the province’s actual fiscal results. Generally, positive impacts are easier for governments to manage. For example, in cases where economic performance turns out better than expected, the government has additional flexibility to manage existing priorities and meet its fiscal objectives. However, if the economy were to fall short of what was expected, then the province would feel the negative impact through lower government revenue, higher expense and, in Ontario’s current fiscal situation, larger deficits and increasing debt.

To help ensure that fiscal objectives are met, the Fiscal Transparency and Accountability Act requires Ontario’s fiscal plan to include a reserve to protect against unexpected and adverse changes in the revenue and expense outlook. In the 2011 Budget, the government included a reserve of $0.7 billion in 2011–12 and $1.0 billion in each following year through to 2017–18. However, the reserve in its current state does not provide enough flexibility for variances that may emerge over this time, especially compounding errors resulting from forecasted growth rates.

Recommendation 19-1: General risks can and should be handled through the contingency reserve, which should be set higher than in recent budgets and should grow over time to address the possibility of growth rate biases in the revenue projection. Modest internal risks should be addressed through an operating reserve. The contingency reserve should be increased to cover a 0.2 percentage point annual overestimate of revenue growth.

The contingency reserve should be set at an adequate amount to protect against forecast errors; it should grow over time to cover not only an error in level estimates but also to address the possibility of any growth-rate bias. Our recommendation is that the contingency reserve be increased to cover a 0.2 percentage point annual overestimate of revenue growth. Our longer-term projection is implicitly based on a projection of annual productivity growth of 1.2 per cent (i.e., increase in Ontario real output per hour worked). As discussed in Chapter 1, The Need for Strong Fiscal Action, we believe this is an appropriate assumption. However, we are well aware that the figure is considerably stronger than the actual productivity growth rate recorded over the past decade. Therefore, it must be considered to be at risk. It could easily be somewhat weaker, say 1.0 per cent. That would roughly translate into a 0.2 percentage point weaker growth rate in revenues over the entire projection period. This is precisely the sort of risk we envision when we recommend the contingency reserve be set to cover a 0.2 percentage point risk to revenue growth in the first year of this exercise (2010–11) and that it rise by 0.2 percentage points annually to 1.4 per cent in the target year. This requires the contingency reserve to be $1.9 billion in 2017–18, compared to $1.0 billion in the 2011 Budget.

Regardless of how prudent and rigorous the government is in its annual planning of revenue and expense, there are always risks that the government cannot account for. Many of these risks are unknown to the government at the time of budgeting. In previous years, these risks have resulted in major one-time costs, such as the government’s response to SARS and H1N1, or its support for the auto sector. Other risks are known at the time of budgeting, but the scope, extent or amount of the liability are unknown. A recent example of this type of risk is the additional forest firefighting resources the province has required. While the government anticipated a cost for this risk, the amount and severity were unknown. Finally, the province should plan for risks with an unknown probability of occurrence and cost. It is the unknown element of all these risks that makes them hard to plan for.

In the past, Ontario has used the operating and capital contingency funds — or the reserve in extreme cases — to mitigate risks in-year that would otherwise have had a negative impact on its financial results. While this strategy has been effective, in a period of severe fiscal and economic challenges, wholly absorbing the cost of these risks without a mitigation plan will prove increasingly difficult if the government is committed to returning to balanced budgets.

Recommendation 19-2: Specific risks should be addressed through an explicit strategy. Care should be taken in budget-setting processes to diligently identify any known risks of significant fiscal magnitude, and a strategy developed to mitigate those risks.

To increase the probability of securing the 2017–18 target, risks and liabilities should be identified as early as possible in the planning process. Ministries must be vigilant in anticipating what could go wrong with all projects. Strategies will need to be developed to identify and reduce specific risks to the fiscal plan, such as federal government action and pension liabilities. The following section identifies liability risks that require the province to develop management plans for moving forward. This is intended to be an illustrative list of risks that should be currently known and subject to mitigation strategies. There are, no doubt, many more current risks, and more will undoubtedly surface as we move through the projection period. As such, the liability management strategy must be very fluid.

Upcoming Liability Risks

Pension Benefits Guarantee Fund

Ontario’s Pension Benefits Guarantee Fund (PBGF) was created in 1980 and was intended to assist pensioners and plan members when occupational pension plans are wound up with insufficient funds to cover promised benefits, and the employer is unable to make the required payments. The PBGF is administered by the Superintendent of Financial Services and generally covers single-employer defined benefit pension plans in the private and broader public sectors. Ontario is the only jurisdiction in Canada to provide such coverage.

In 2009, the government retained an independent actuarial firm to conduct the first actuarial study of the PBGF, including revenues and claims, to inform the development of long-term policy. The study, released in 2010, concluded that the PBGF was not sustainable in its current form and noted that overall assessments would have to increase by as much as 1,000 per cent if coverage were increased to $2,500 a month as had been previously recommended by the Arthurs Commission.1

On several occasions over the last 30 years, there has not been enough cash in the Fund to cover large anticipated PBGF claims. In those instances, several loans were made from the Consolidated Revenue Fund to cover claims. The only loan amount still outstanding is $242 million of a $330 million loan made in 2004 to cover a significant claim. In 2010, the government made a $500 million grant to the PBGF to initiate the PBGF reform process and stabilize the Fund in the near term. In May 2011, $384 million was paid out of the Fund in partial settlement of another significant claim.

Ontario is the only sub-national jurisdiction in the world with a pension benefits guarantee fund. With fewer than 1,600 covered plans, and PBGF exposure concentrated in certain industries, risk is not spread according to insurance principles. To fully insulate the PBGF from catastrophic claims and update coverage levels, significantly higher assessments and larger reserves would be required.

Recommendation 19-3: We recommend that the province either terminate the Pension Benefits Guarantee Fund or explore the possibility of transferring it to a private insurer. The Fund is no longer sustainable in its current form as it presents a large fiscal risk for the province in the event of another economic downturn.

Liability from Pension Funds in the Broader Public Sector

Introduction

Ontario Public Service (OPS) and broader public-sector (BPS) pension plans include some of the largest plans in the country — both in terms of the value of assets and number of members. The province provides funding to these plans through both direct and indirect mechanisms.

The topic of pensions is multi-faceted and technical, with varying governance structures and risk-sharing arrangements, as well as distinct funding and accounting considerations. Many aspects of the plans could be reviewed. Yet the Commission’s mandate suggests our focus be on the fiscal dimensions and hence our approach has been rather narrow. We examine the public cost of the plans, the risks they represent to the Province’s fiscal plan and strategies to manage these risks.

Given the government’s significant exposure to liabilities associated with some of these plans, we believe that steps should be taken to improve transparency and strategic planning with respect to pension expense in an effort to better manage this risk.

Recommendation 19-4: The Ontario government should conduct and publish its own liability management assessment of the public-sector pension plans and develop plans to contain any fiscal risks identified.

Description of BPSPension Plans

There are currently five plans consolidated in the province’s financial statements: Public Service Pension Plan (PSPP); OPSEU Pension Plan (OPSEUPP); Ontario Teachers’ Pension Plan (TPP); Healthcare of Ontario Pension Plan (HOOPP); and Colleges of Applied Arts and Technology (CAAT) Pension Plan.

The PSPP is solely sponsored by the province, and the remaining four plans are Jointly Sponsored Pension Plans (JSPPs). In the case of solely sponsored plans, the employer is wholly responsible for funding any shortfall. In contrast, JSPPs require that both employer sponsors and employees share responsibility for making up any shortfall by negotiating some combination of contribution increases and prospective benefit reductions. These obligations are set out in the Pension Benefits Act, its Regulations and individual plan documents.

TABLE 19.1      Public-Sector Pension Plans Reflected in the Province's Financial Statements
Pension Plan Assets ($ Billions) Active Members Contribution Rates (%) Retirement
Employees Employers Factors*
PSPP 17.4 41,000 9.5 9.5 Factor 90 or
Age 60 + 20 Years
OPSEUPP 13.3 47,000 10.0 10.0 Factor 90 or
Age 60 + 20 Years
TPP 107.5 175,000 12.0 12.0 Factor 85 or
35 Years
HOOPP 35.7 170,000 9.2 10.67 Age 60 or
Age 55 + 30 Years
CAAT 5.5 19,000 12.9 12.9 Factor 85 or
Age 60 + 20 Years

Notes: Teachers’ Pension Plan contribution rate is scheduled to increase from 12.0 per cent in 2011 to 13.1 per cent over three years, with full implementation in 2014. The CAAT contribution rate is scheduled to increase to 13.7 per cent by 2014. “Years” indicates Years of Service. Public safety workers (e.g., fire, police, paramedics) have a normal retirement age of 60 and can generally retire earlier.

Ultimate Question

One of the biggest questions from a liability management perspective is who is ultimately responsible should a plan or plans get into serious financial difficulty. The answer is different for different types of pension plans. Most of the major public-sector plans are jointly sponsored, which means employer sponsors and members share this responsibility.

The government, and hence the taxpayer, bears significant risk as joint sponsor of the TPP and the OPSEUPP, and sole sponsor of the PSPP. This is a serious potential liability. For the other major public-sector plans, HOOPP and CAAT, employers share legal liability for funding shortfalls with members.

Because of the significance of this risk, it is critical to ensure greater public clarity and address fiscal and liability issues associated with these plans.

Recommendation 19-5: Clarify who bears the ultimate financial responsibility for funding deficits of the public-sector pension plans as the Commission encountered considerable confusion on this issue.

Health of the Plans

There are two types of actuarial valuations that public-sector plan sponsors are required to prepare: a funding valuation and an accounting valuation. Each valuation employs different methods and assumptions.

The funding valuation is prepared in accordance with the Pension Benefits Act and actuarial standards, and is intended to secure the benefits provided by the pension plan. The funding valuation also determines the contributions necessary to fund the benefits being earned. The funding valuation is used to determine whether a pension plan is actuarially sound.

However, the contributions determined by funding valuations do not represent the province’s pension expense for budgetary purposes. Pension expense is based on actuarial valuations that are prepared on an accounting basis. These valuations are prepared in accordance with recommendations of the Public Sector Accounting Board (PSAB), and are based mainly on the present value of benefits earned by plan members, not the cash contributions.

Three of Ontario’s largest public-sector pension plans currently have funding shortfalls. These include the three pension plans that are directly sponsored or co-sponsored by the province (i.e., PSPP, OPSEUPP and TPP). These shortfalls are largely the result of investment losses during the financial crisis in 2008 as well as the low level of long-term interest rates.

The following summarizes the current funded status of the three plans that are directly sponsored or co-sponsored by the province:

  • The TPP is a jointly sponsored, defined benefit pension plan, with assets of about $107.5 billion as at Jan. 1, 2011. The TPP’s preliminary Jan. 1, 2011, funding valuation revealed an unfunded liability of $17.2 billion. A balanced Jan. 1, 2011 valuation was filed with the Financial Services Commission of Ontario (FSCO) in June 2011, which (1) reduced benefit indexation for future service to 60 per cent of the annual changes in the consumer price index; and (2) increased the contribution rate for both the province and plan members by 1.1 percentage points for the next 15 years.
  • The PSPP is a defined benefit pension plan solely sponsored by the province. It had assets of about $17.4 billion as at Dec. 31, 2010. The PSPP’s Dec. 31, 2010, funding valuation had a $1.19 billion unfunded liability, which the province is eliminating over 15 years.
  • The OPSEUPP is a jointly sponsored defined benefit pension plan with assets of about $13.3 billion as at Dec. 31, 2010. The plan had an unfunded liability of about $586 million in the Dec. 31, 2010, funding valuation. Retirement of the OPSEUPP shortfall is being shared equally between the government and the plan members. Their respective Rate Stabilization Funds, composed of reserves that were set aside during years of surpluses and are now being drawn down to finance shortfalls, are sufficient to cover this deficiency.

Both HOOPP and CAAT are not directly sponsored by the province, but are consolidated in the province’s financial statements. HOOPP, which had assets of about $35.7 billion, was fully funded as at the last valuation date of Dec. 31, 2010, while CAAT had assets of about $5.5 billion and a small surplus.

Many of these plans responded to the shortfalls created by the financial crisis by increasing employer and employee contribution rates. For example, in the case of the TPP, teachers and the province each contributed 8.9 per cent above the Year’s Maximum Pensionable Earnings (YMPE) in 2006. That rate has increased since then to 12.4 per cent in 2012 and will rise to 13.1 per cent in 2014. The CAAT surplus is largely attributable to the fact that the contribution rate for employers and plan members is set to increase from 12.9 per cent in 2012 to 13.7 per cent by 2014.

Three plans (HOOPP, CAAT and TPP) have taken steps to reduce or eliminate the level of guaranteed inflation protection on a prospective basis. This action has mitigated the pressure for further contribution rate increases.

Rates of Return

In accordance with PSAB rules, the province values the liabilities of the pension plans consolidated in its financial statements using long-term nominal rates of return varying from 6.25 to 6.75 per cent. This reflects public-sector portfolios, which include equity investments.

Some argue that the actuarial positions should also be valued using more conservative (lower) rates of return based on a portfolio of fixed income securities, as is the case in private-sector accounting standards. This is neither the current accounting convention under the PSAB rules, nor consistent with expected long-term rates of return on a diversified investment portfolio, including both equities and bonds.

Nevertheless, it would be useful for the government to conduct a sensitivity analysis of the health of these pension plans. This test could be as simple as assuming a static change in the long-term rate of return, or could rely on a probability distribution of expected investment returns. This type of analysis is consistent with current Canadian Institute of Actuaries’ standards of practice for individual pension plans.

In the case of more conservative estimates, the Commission believes this analysis could reveal significant funding deficiencies across public-sector plans. While this result would not suggest any immediate action needed to be taken, it would support the development of a liability management plan to address the volatility of equity investments.

Recommendation 19-6: In the proposed liability management assessment report, the government should make public the current and prospective financial health of public-sector pension plans.

Recommendation 19-7: In the liability management assessment report, the government should test the fiscal health of the plans against the possibility of rates of return being higher or lower than assumed. This could be done using a higher or lower discount rate, or could rely on a probability distribution.

Impact of the Plans on the Fiscal Framework

Prior to 1993–94, the government accounted for its pension expenditures on a cash basis, and the amount contributed to the plans that it sponsored represented the pension expense. However, the province has changed its method of accounting for pension expense, as recommended by PSAB. Under these rules, cash contributions do not represent the province’s pension expense for financial statement purposes.

Ontario’s pension expense is now calculated using accounting valuations, which measure the present value of pension benefits earned in a given year, per the PSAB rules. These rules require economic assumptions to be management’s best estimates, including the expected rate of return on the investments of the pension fund. These accounting valuations are used to determine the pension expense figures underlying the fiscal plan. The pension expense is adjusted based on interest income or expense, as well as amortized actuarial gains and losses.

While pension expense is expected to moderate over the long term (50 years), the recent rise is largely due to past investment experience. Most pension plans recognize investment gains and losses gradually over five years and these recognized amounts are amortized over the expected average remaining service life of plan members. As a result, expense in any given year reflects the gains and losses from a decade ago or more.

Current pension expense includes the effects of some of the large investment gains from the late 1990s and losses from recent market losses. These gains had the effect of reducing pension expense during the early to mid-2000s. As the large gains are phased out, pension expense has risen, exacerbated by the amortization of more recent market losses.

<3SO border="0" cellpadding="0" cellspacing="0" width="100%"> TABLE 19.1      Historical and Projected Pension Expense by Plan
($ Millions)   PSPP and
OPSEUPP
TPP HOOPP CAAT TOTAL 2005–06 227 295 663 70 1,255 2006–07 172 345 719 82 1,318 2007–08 131 342 750 93 1,316 2008–09 321 50 853 94 1,318 2009–10 536 255 956 153 1,900 2010–11 726 522 938 184 2,370 2011–12 759 526 1,023 177 2,485 2012–13 862 908 1,123 206 3,099 2013–14 858 1,385 1,227 230 3,700 2014–15 784 1,354 1,231 232 3,601 2015–16 831 1,372 1,301 237 3,741 2016–17 938 1,409 1,370 233 3,950 2017–18 1,051 1,472 1,456 232 4,211 3SO>

As noted elsewhere in this report, growth in total program expense must be held to 0.8 per cent if the province wishes to balance its budget by 2017–18. Total pension expense, including HOOPP and CAAT,2 grew at an average rate of more than 13 per cent from 2005–06 to 2010–11. As demonstrated above, pension expense is expected to continue to grow at a rate well in excess of 0.8 per cent through 2017–18. Should these high rates of growth persist, total 2005–06 pension expense will have more than tripled by 2017–18.

Currently, pension expense is about two per cent of total program spending growth and is responsible for much of the total increase in program spending under the 0.8 per cent growth cap. Total program spending can rise $6.3 billion from 2010–11 to 2017–18. This program pension expense will, under the Preferred Scenario, take up $1.8 billion or almost 30 per cent of the total increase. It will go from 2.1 per cent of total program spending in 2010–11 to 3.6 per cent in 2017–18 in our Preferred Scenario.

Plan-specific costs are spread across various schedules and explanatory notes, and the total pension expense is not identified in any single place in the province’s financial statements. The Commission is only aware of the province publishing pension expense figures once in recent history — the 2009 Ontario Budget. In the Commission’s framework, pension expense attributed to PSPP, OPSEUPP and TPP is embedded in the residual spending category (i.e., excluding health, primary and secondary education, post-secondary education and social programs). Pension expense attributed to HOOPP and CAAT is found in health and post-secondary expenditures respectively.

Although the volatility in the investment returns plays a large role in determining the expense in the out-years, an adjustment to prospective benefits would be recognized in the year the change is made. This would have the effect of lowering the future expense as soon as the plan is amended.

Contribution Rates

As noted earlier, contribution rates have been trending upward in public-sector plans in recent years and these rates are now high relative to past experience and to those in the private sector. About half of private-sector plans require contributions from plan members and, where contributions by plan members are made, those contributions tend to be lower than those found in public-sector plans. This makes it difficult to make comparisons between benefit levels in the two sectors.

Given the high levels of employee contributions to these plans, plan members may well be unwilling to agree to further increases. For example, CAAT and TPP members now pay more than 12 per cent in employee contributions. Higher contribution rates mean lower disposable income for plan members, particularly for those at the outset of their careers.

The government should shift its focus from contribution rate increases to changes in future benefit levels when faced with future shortfalls. Measures should be taken to reduce prospective benefits to limit the need for further contribution rate increases.

As noted above, many public-sector employees are members of JSPPs, which require that both sponsors agree to any prospective benefit changes. Employer plan sponsors, including the government, colleges and hospitals, should work with employee sponsors to develop solutions that limit contribution increases. The government may need to consider legislative options should the parties be unable to reach agreements to address these issues.

Recommendation 19-8: The government’s objective, when faced with pension funding deficits, should be to reduce prospective benefits rather than increase the contribution rate beyond current levels. This would help to close the funding gap and reduce the accrual of pension benefits on a prospective basis, mitigating the impact on the fiscal plan. The government may need to consider legislative options, should negotiations with plan sponsors be unsuccessful.

Benefits

Even if the government’s share of contributions for future service were limited, this would not in itself reduce the rate of growth of pension expense for financial statement purposes. There are two ways this goal could be achieved:

  1. Reduce the benefits earned by plan members in the future; and/or
  2. Increase the share that plan members pay towards financing new deficits.

If employees are willing to maintain current benefit levels through an increased employee share of total contributions, this would require legislative changes to the Ontario Pension Benefits Act and the federal Income Tax Act, if employees would be contributing more than 50 per cent.

In the absence of a larger share of total contributions paid by employees, the government could undertake negotiations to reduce benefits on a prospective basis, such as changes to indexation or early retirement provisions (e.g., by increasing the early retirement factors noted in Table 19.1). These types of actions would reduce future benefit accruals and thus growth in pension expense.

Recommendation 19-9: The government should accelerate work on the design of public-sector benefits and make containing the growth in the cost of benefits part of the broader public-sector compensation negotiation strategy.

BPSEfficiencies

Most hospitals, colleges, municipalities and school boards operate as separate employers but participate in a single pension plan. In comparison, much of the rest of the BPS, including the university sector (as discussed in Chapter 7, Post-Secondary Education) and the energy sector, has a very fragmented pension arrangement, with more pension plans than institutions. These plans vary widely in size and the benefits they provide, as well as the contributions made by employers and plan members.

This fragmented arrangement suggests that, due to their size, some institutions may not be realizing the economies of scale that would result if this function were more centralized. The consolidation of administrative processes and practices, including the pooling of assets for investment purposes, may generate savings. With a consolidated approach, the administrative functions for plan administration and investment management would be carried out by another body, and each employer/sponsor would remain the legal administrator of its plan(s), retain its fiduciary responsibilities and determine plan benefits.

Recommendation 19-10: The province should examine opportunities to achieve savings and better investment returns through the consolidation of the administrative functions and investment pooling of pension plans across the broader public sector.

Transparency

Pensions are deferred compensation, and are too often viewed separately from wages and other, more immediate benefits. In Chapter 15, Labour Relations and Compensation, we discuss the need to broaden the perspective on public-sector compensation to make it more inclusive. Pension benefits and their cost must be part of that equation. To accomplish this, the cost of public-sector pensions to taxpayers must be more transparent.

As noted above, currently the only way to compile a full picture of public-sector pension expense is by pulling together different entries and notes in the government’s financial statements. Making these expenses more transparent will assist the government in developing a comprehensive compensation strategy. It will also assist in making comparisons across sectors, including the private sector.

Recommendation 19-11: The province must make the government’s cost of the public-sector pension plans — both in concept and in magnitude — much clearer in the Public Accounts and other financial statements, including the Budget.

Environmental Risks

Under the Environmental Protection Act (EPA), the province has the “right to compensation” for loss or damages incurred as a direct result of a hazardous spill, and for all reasonable costs and expenses incurred for a cleanup. However, as discussed in Chapter 13,  Environment and Natural Resources, difficulties can arise in situations when the owner of a contaminated site becomes insolvent, no longer exists, or lacks sufficient funds to pay for the cleanup. While the province can take legal action to ensure the polluter pays for the environmental cleanup, most often the province is left with the responsibility of the cleanup and the associated costs.

Recommendation 19-12: To better protect the province against the costs of environmental cleanup, adjust the current legislative framework so that more focus is placed on the polluter-pays principle.

Other options include the introduction of a program like Superfund, currently in place in the United States, that has federal authority to clean up the nation’s uncontrolled hazardous waste sites.

Risks to Ontario Posed by the Federal Government

In some areas of responsibility, the federal and provincial governments work together to help provide services to Ontarians, but as a sub-national jurisdiction Ontario is always subject to the risk of a policy change by the federal government. Such policy changes can cause disruptions to both provincial fiscal planning and public services; therefore, allowances must be taken to account for unplanned changes.

Negotiations for a comprehensive free trade agreement with the European Union (EU) are underway and the outcome of these negotiations could have significant impact on the cost of prescription drugs in Ontario. The potential harmonization of patent rules with the EU could cost Ontario dearly since generic drugs would be kept off the market for a longer time. If all three of the EU pharmaceutical intellectual property proposals are adopted, estimates suggest it could cost Ontarians up to $1.2 billion annually ($551 million for the Ontario government and $672 million for the private sector),3 which would more than wipe out the savings achieved through the government’s recent drug reforms. The province should work with the federal government to ensure that a Canada–European Union Free Trade Agreement (CETA) does not undermine Ontario’s interest in expanding the use of generic drugs.

Ontario and the federal government share a common personal income tax base to help simplify the process of filing returns. This common tax base could lead to significant costs to Ontario moving forward, since Ontario generally parallels any federal government tax changes to maintain similarity. As an example, the federal government has proposed changes related to the expansion of income-splitting and doubling the current annual limit on contributions to Tax-Free Savings Accounts. These two proposals alone could result in $1.3 billion less in revenue annually for Ontario.

Discussed in greater detail in the federal-provincial relations portion of Chapter 20, Intergovernmental Relations, changes in the Canada Health Transfer (CHT) beginning in 2017–18 stand to cost Ontario about $239 million per annum based on current forecasts, but could reach about $421 million if GDP growth falls to the three per cent floor. These reductions will grow over time. By 2023–24, Ontario’s CHT payment could be $2.3 billion to $3.8 billion lower than under the current formula. As discussed in Chapter 5, Health, over the long run, health costs tend to increase more rapidly than nominal GDP. By tying the federal transfer for health to GDP growth, it is almost inevitable that, over time, the federal government’s contribution to total health spending will continuously decline.

In Canada, responsibility for the Criminal Code rests with the federal government while responsibility for implementation lies mainly with the provinces. As addressed in Chapter 14, Justice Sector, and Chapter 20, Intergovernmental Relations, recent crime legislation will place further demands on the provincial court and corrections systems, only adding to the fiscal burden of the provinces as the federal government has not yet recognized or addressed the additional cost. The provincial government has projected Ontario’s inmate count to increase by 1,265 to 1,530 inmates in 2015–16 as a result of Bill C-10. The lowest cost estimate of the impact of the federal crime bill is ongoing annual increases in operating budgets of $22 million to $26 million per year at maturity. In the worst-case scenario, the province would be required to procure a new 1,000-bed facility to offset the resulting impact. The estimated capital cost of a new facility is $900 million, with ongoing operating costs of $60 million per year.

Recommendation 19-13: Work with the federal government to mitigate risks to the Ontario fiscal framework from federal policy changes. Known risks at the time include the Canada–European Union Free Trade Agreement (CETA) being negotiated, proposed changes to personal income taxes and the federal omnibus crime bill (Bill C-10).

Social Housing

Social and affordable housing4 is provided by Ontario’s municipalities. However, Ontario is responsible for setting rules and standards, flowing federal dollars to municipalities, and directly funding various housing and related support programs. Much of Ontario’s social housing was constructed over 30 years ago, resulting in a need to invest in repair and rehabilitation work. At the same time, Ontario’s population continues to grow and to age, which requires specialized affordable housing. In July 2011, the province signed a three-year bilateral agreement with the federal government for investment in affordable housing. The agreement will provide $480.6 million, cost-shared 50/50 between the federal and provincial governments, to fund the creation or repair of about 6,000 affordable housing units. There is currently no federal funding commitment beyond the end of the current agreement. The absence of an agreement with the federal government for affordable housing would impact both capital programs (repair and construction) as well as operating programs (rental supplements).

Recommendation 19-14: Ontario should negotiate with the federal government to commit to a housing framework for Canada that includes adequate, stable, long-term federal funding and encourages its housing partners and stakeholders, including municipal governments, to work with the federal government to secure this commitment.

Risks to Ontario Posed by the Municipal Sector

Similar to the shared responsibility of service delivery between the federal and provincial governments, the province works with the municipal sector to provide services to Ontarians. As discussed throughout this report, there are instances in which all three levels of government are responsible for public service delivery. While the province and its municipalities should continue to develop their partnerships in the funding and implementation of service delivery, in some cases the province may ultimately be considered liable in the event of a default by an Ontario municipality.

Municipal Infrastructure

About 40 per cent of public infrastructure in Ontario is owned by the province’s 444 municipalities. Assets include roads and bridges, water and wastewater infrastructure, transit systems, affordable/social housing, solid waste facilities, public buildings, Conservation Authority infrastructure, and land. Since the 1950s, municipalities’ share of public infrastructure has grown significantly.

Municipalities are responsible for maintaining their infrastructure — a responsibility clearly defined through policies that govern municipalities. The province also has an ongoing obligation to help ensure the safety and sustainability of municipal infrastructure. The province accomplishes this through a variety of policy instruments (e.g., standards and inspections) as well as funding programs that support municipal infrastructure priorities. Despite these efforts, there are continual calls on senior governments to ensure adequate investment in municipal infrastructure.

In recent years, there have been numerous efforts to quantify the need for investment in municipal infrastructure and develop provincial policies and funding programs in response. While policies have rightly focused on specific issues (such as drinking water safety), there is a need for a more comprehensive plan that points the province, municipalities and the federal government in the same direction as efforts are made to address the ongoing challenge of underinvestment in the sector. While probably part of the solution, this challenge cannot be resolved through funding alone. More fundamental reforms are needed for the sector to be on a sustainable footing.

Asset management planning for municipal infrastructure should be comprehensive and achieved through a one-window requirement of the province. Poorly maintained infrastructure delivers a lower quality of service, costs more to repair and replace, and can increase risks to health and safety from potential failures. Asset management provides the information needed to make strategic decisions about investing in the maintenance, rehabilitation and replacement of assets. This tool helps optimize service delivery, minimize risk and provide services more efficiently. While many municipalities are practising asset management, there are no set standards for how this should be done. Some municipalities have detailed asset management plans while others do not. In Chapter 12, Infrastructure, Real Estate and Electricity, we recommend that more emphasis be placed on achieving greater value from existing assets in asset management plan reporting requirements than is currently proposed in the Long-Term Infrastructure Plan (LTIP).

As a starting point, an effective plan would include a set of principles to guide future investments and policies. Examples of principles include:

  • Recognition that safe and sustainable municipal infrastructure is a shared priority for all orders of government;
  • Municipalities are the stewards of their own infrastructure;
  • Comprehensive asset management plans should guide investment decisions;
  • Health and safety issues are top priorities; and
  • Small communities face unique challenges that require tailored solutions.

For this work to be meaningful, a range of tough issues needs to be tabled, debated and resolved through new or amended policies and programs. Examples include exploring:

  • If municipalities are using the range of revenue, financing and organizational tools available to them effectively;
  • How a one-window approach to asset management (where one plan satisfies a range of provincial requirements) could be implemented;
  • If the way the province has been funding municipal infrastructure is yielding the best possible outcomes;
  • If “stable and predictable” funding (as the municipal sector calls for) is a good solution or if it will perpetuate the problem;
  • What role the private sector should play in all aspects of municipal infrastructure (with “no role” not being a viable approach);
  • How grants can be used as an incentive to achieve financial sustainability; and
  • If small/economically disadvantaged communities should receive entitlement funding for infrastructure.

This is an opportune time to take stock of the current approach to municipal infrastructure, make any needed policy improvements, and develop a plan that will be in the phases of implementation when the time comes for new rounds of infrastructure funding programs. Even if the process takes a few years, it will help ensure that whatever funding and policies are developed along the way address the most pressing priorities — priorities identified through robust asset management plans. It will also allow the province to negotiate more strongly with the federal government on municipal infrastructure priorities and ensure the most critical needs are being addressed.

Pan/Parapan American (Pan Am) Games

In the summer of 2015, Toronto and the Golden Horseshoe region will host the 2015 Pan/Parapan American Games. The budget for hosting the Games is about $1.4 billion, and the province is providing $500 million.

The province guarantees to cover any deficit for the Games and as such is responsible for any cost overruns beyond the approved $1.4 billion budget. As the deficit guarantor, the province has a major interest in ensuring that appropriate measures are in place to minimize risk to the business plan and ensure the budget remains within the approved financial envelope. Provincial consent/approval is required if any major areas of Pan Am expense (i.e., venue operations, transportation, communication services) increase by five per cent or $5 million. As well as ensuring that checks and balances are in place to spot potential increased expenditures, the province must also be vigilant in holding the parties involved to account for any overrun in expenditures.

Recommendation 19-15: Work with the municipal sector to mitigate risks to the Ontario fiscal framework by ensuring that commitments are adhered to. Known risks at this time include potential overruns in municipal infrastructure and the Pan Am Games.

Unknown Risks

It is naive to believe the seven years from 2010–11 to 2017–18 will unfold exactly as projected by the government or the Commission, especially in light of the widespread uncertainties that currently persist over the world economy and its financial system. As the province proceeds along its course towards returning to fiscal balance, many of the risks already discussed could certainly emerge. For the province to continue to meet its fiscal targets, sufficient contingencies will need to be allocated. In an era where political, environmental, economic and technological factors are constantly changing, the fiscal plan must also be prepared for the unexpected and must provide contingencies and mitigation plans for any unknown risks as well.

Consistent with this approach, an adequate contingency reserve should be included to protect against forecast errors. The level of the contingency reserve should grow over time as the budget projection is pushed further out into the future, to provide the government with a degree of latitude for handling general risks that emerge.

Additionally, given the tight constraints that will be imposed on ministry operating budgets, a centrally held operating reserve should continue to be maintained that can be accessed only through a process involving Cabinet and Treasury Board. The operating reserve will be used to address cases where health and safety might be compromised or services to the most vulnerable are jeopardized. The operating and contingency reserves will be used to address unknown risks that materialize.

For risks known in advance, the province should form an explicit strategy to address these risks in advance. Care should be taken in the budget-setting processes to diligently identify any known risks of significant fiscal magnitude, and a strategy developed to mitigate those risks moving forward to increase the probability of securing the fiscal targets outlined by the government.

Taxpayer Protection Act

In this report, we set out a plan based largely on spending restraint to return the province to fiscal balance in 2017–18. The policy framework recommended should permit the province to remain in balance beyond that time. However, we have noted a number of risks to the economic and fiscal environment that could throw a fiscal plan off track. The province would want as much flexibility as possible to be able to respond. That response might be specific to the particular risk that manifests, or it could require further adjustments to spending and revenues. There are no substantial constraints on the government’s ability to manage expenditures. However, we believe most will agree that it would be exceedingly difficult to drive program spending growth below the 0.8 per cent annual increases we have laid out here. Hence, unforeseen events may require a strengthening of revenues. The Taxpayer Protection Act (TPA) significantly fetters the government’s capacity to make decisions regarding revenues due to its restricting conditions on increasing tax rates or introducing a new tax. This is not to suggest that tax increases should be taken lightly. With or without the TPA, it is unlikely any government would pursue that option lightly, given pressure from taxpayers. Further, implementation of the principles of transparency, efficiency and equity we discuss in this report would sharpen the tests the public would put to governments wishing to raise taxes in the future. In brief, it should be possible to maintain both spending and taxes as tools to address fiscal pressures without causing the public to lose confidence that taxes will not be raised for unjustifiable reasons.

Recommendation 19-16: Modify or eliminate the Taxpayer Protection Act so that both spending and taxes can be used as required to address threats to fiscal sustainability.

1. This estimate did not take into account the $500 million grant made in 2010.

2. While included in Table 19.2 for the sake of completeness, pension expenses related to HOOPP and CAAT are contained in the health and post-secondary sector expenses, respectively. As such, they do not constitute part of the residual expenditure.

3. Paul Grootendorst and Aidan Hollis, “The Canada-European Union Comprehensive Economic and Trade Agreement: An Economic Impact Assessment of Proposed Pharmaceutical Intellectual Property Provisions,” 2001, Canadian Generic Pharmaceutical Association.

4. Social housing is also known as “assisted housing,” meaning housing where tenants either pay lower end of market rent or rent-geared-to-income (RGI) and receive government assistance. Affordable housing generally refers to rental stock for low-income families who are not receiving subsidies but pay lower than market rent.