: INDEPENDENT REVIEW OF THE ACTUARIAL FUNDING REPORT ON THE ONTARIO RETIREMENT PENSION PLAN (ORPP) - June 30, 2016

Prepared by: Eckler Consultants & Actuaries

Christopher G. Brisebois, FCIA FSA CFA
Robert L. Brown, FCIA FSA ACAS
Jill M. Wagman, FCIA FSA

Eckler Ltd.
110 Sheppard Avenue East, Suite 900
Toronto, Ontario
M2N 7A3

Table of Contents

Executive Summary

Introduction

The Ontario Retirement Pension Plan (ORPP) is a new pension plan being created for Ontario. The ORPP is a mandatory pension plan requiring contributions of 1.9% from each employee, along with a matching contribution from their employer, unless they are covered under a comparable pension plan. The ORPP is designed to provide roughly 15 per cent of a worker’s pre-retirement income up to a maximum earnings cap of $90,000 in 2017 dollars.

In order to demonstrate the sustainability of the ORPP over a long- term projection period, the Ontario Ministry of Finance (“the Ministry”) engaged Willis Towers Watson (“WTW”) to prepare an Actuarial Funding Report with an effective date of January 1, 2018, based on the terms and provisions of the Ontario Retirement Pension Plan Act (Strengthening Retirement Security for Ontarians), 2016 (“the ORPP Act”).

Consistent with actuarial best practice, the Ministry engaged Eckler Ltd. to conduct an independent actuarial review of the Ontario Retirement Pension Plan Actuarial Funding Report (“AFR”) and its findings.

Terms of Reference

Eckler Ltd. conducted its review of theAFR prepared by WTW, in accordance with the following terms of reference:

  • Conduct a thorough actuarial review of the ORPP’s AFR.
  • Provide detailed commentary to the Ministry on its contents, including identifying any potential weaknesses or omissions, looking specifically at:
    • AFR data (e.g., data sources, assumptions, reliability, etc.);
    • Actuarial assumptions and methodology (including similarities/differences with CPP assumptions);
    • Key results and findings (including the balance sheet, sensitivity and sustainability analysis, as well as inter-generational and intra-generational equity);
    • Risks for possible analysis; and
    • Plan provisions regarding draft legislation.
  • Recommend changes to the current ORPP AFR and future valuation reports.

We were also asked to provide our professional opinion on the following three questions:

  • Has the work been completed in accordance with accepted actuarial practice and statutory requirements (if any)?
  • Did the actuaries have access to relevant information required to perform the projections, and were relevant tests and analysis performed on the data? Where data were not directly available, were appropriate tests for reasonableness completed?
  • Are the actuarial assumptions and methods reasonable for use in completing the Actuarial Funding Report?

Opinions

With respect to the three questions listed above, it is our opinion that:

  • The work of Willis Towers Watson has been completed in accordance with accepted actuarial practice and statutory requirements.
  • The actuaries had access to the data required to perform the projections, and they completed such relevant tests and analysis on the data as might be expected.
  • The actuarial methods used in completing the AFR were reasonable and the assumptions selected by Willis Towers Watson were also reasonable, both individually and in the aggregate.

Recommendations

We make the following Recommendations for future actuarial valuations of the ORPP:

Recommendation 1: Once the ORPP Administration Corporation (the “ORPP AC”) has completed its development of an investment strategy for the ORPP assets, the results of the preliminary projections should be updated using a best estimate real rate of investment return assumption that appropriately reflects this strategy.   In addition, the sensitivities around the real rate of investment return assumption could incorporate stochastic analysis once there is more visibility on the investment strategy with the goal of gaining greater insight on risk.

Recommendation 2: We recommend that the sensitivity analysis for all key variables apply a stochastic element based on the historic frequency distribution of the noted variable, as is the case with the CPP sensitivity analysis.

Recommendation 3: In the future, we recommend that a valuation model be created by the designated actuary to achieve maximum flexibility and transparency.

SECTION 1. INTRODUCTION

This report presents the results of an independent external review of the Actuarial Funding Report that has been prepared by Willis Towers Watson. The final report reviewed was dated June 23, 2016. At that time, the ORPP Act had received Royal Assent but had not yet been proclaimed.

Terms of Reference

In accordance with our terms of reference, our review focused on the AFR and the actuarial findings contained in the AFR.  We were not asked to, and did not, review or repeat the calculations or projections.

The terms of reference for our review were as follows:

  • Conduct a thorough actuarial review of the ORPP’s AFR.
  • Provide detailed commentary to the Ministry on its contents, including identifying any potential weaknesses or omissions, looking specifically at:
    • AFR data (e.g., data sources, assumptions, reliability, etc.);
    • Actuarial assumptions and methodology (including similarities/differences with CPP assumptions);
    • Key results and findings (including the balance sheet, sensitivity and sustainability analysis, as well as inter-generational and intra-generational equity);
    • Risks for possible analysis; and
    • Plan provisions regarding draft legislation.
  • Recommend changes to the AFR and future valuation reports.

Our report provides our opinion on the following three questions:

  • Has the work been completed in accordance with accepted actuarial practice and statutory requirements (if any)?
  • Did the actuaries have access to relevant information required to perform the projections, and were relevant tests and analysis performed on the data? Where data were not directly available, were appropriate tests for reasonableness completed?
  • Are the actuarial assumptions and methods reasonable for use in completing the Actuarial Funding Report?

Procedures Followed

Our review was conducted by three actuaries, Christopher G. Brisebois, Robert L. Brown and Jill M. Wagman, further supported by Eckler staff.  The review work took place over the period May 16 to June 30, 2016. 

We received a copy of an initial draft of the AFR (dated April 22) on May 16.  Following our initial review of the report, we met with the Ministry staff and members of the ORPP’s actuarial team to discuss our preliminary findings and to request additional information in support of the underlying data and assumptions used in the report. The following week we met with the Ministry staff, the ORPP actuarial team and with Ian Markham, Philip Morse and Julie Belair of Willis Towers Watson. Subsequent meetings with the Ministry staff, the ORPP actuarial team and Willis Towers Watson were held by teleconference to confirm certain details and assist us in finalizing our report. We received the final version of the AFR on June 27th and finalized our report on June 30, 2016.      

All of these parties responded promptly and fully to each request we made.

In conducting our review, we referred to the 26th Actuarial Report on the Canada Pension Plan prepared as at December 31, 2012 and the independent review report of the CPP valuation conducted by the CPP Actuarial Review Panel, dated March 7, 2014.

We also made reference to the following Canadian and International actuarial standards and Exposure Drafts:

  • The Rules of Professional Conduct of the Canadian Institute of Actuaries
  • The Canadian Actuarial Standards Board’s Standards of Practice
  • International Actuarial Association’s International Actuarial Standard of Practice 2 – Financial Analysis of Social Security Programs (“ISAP 2”) and International Actuarial Standard of Practice 1– General Actuarial Practice (“ISAP 1”)
  • The Canadian Actuarial Standards Board’s Exposure Draft for Standards of Practice – Use of Models
  • The Canadian Actuarial Standards Board’s Exposure Draft for Standards of Practice  – Establishment of Social Security Practice-Specific Standards

Finally, we carefully reviewed the details of the ORPP Act.

After reviewing all of the information, the three reviewing actuaries were able to reach agreement on all of the opinions and recommendations presented in this report. 

Social security programs are extremely complex, as their future contributions and expenditures are dependent on the participating workforce, the economy, their investment structure and administration costs. The complexity in evaluating the sustainability of the ORPP at this stage is magnified due to the fact that this is a new plan, with no existing membership data, administration or investment/asset structure in place.

In our work, we have concentrated on what we consider to be the most important issues – in particular, the data used, the methodology, the key actuarial assumptions and the quality of the report.  As described in Section 3 (Data) of this report, we reviewed the sources of the data, and the processes used by WTW to test and analyze the data, but our mandate did not include a detailed audit of the data.  Similarly, we reviewed the procedures used by WTW to test the actuarial computer model, but our mandate did not include a verification of the accuracy of the model. 

Statutory Actuarial Requirements

Section 44 of the ORPP Act specifies the requirements for the actuarial valuation of the ORPP, with the first formal actuarial valuation taking place with an effective date of December 31, 2018 and subsequent valuations conducted every three years.

Section 44(4) of the ORPP Act defines the Sustainability Rate as follows:

Sustainability Rate means the lowest total contribution rate, determined in accordance with the regulations, that, if implemented three years after the day after the valuation date, would be projected to result in the ORPP being able to satisfy its obligations, as they become due, for 100 years after the valuation date.”

For the ORPP to be considered funded on a sustainable basis, the ORPP Act requires that the actuarial valuation must demonstrate that the Sustainability Contribution Rate Differential (SCRD), determined at the end of the three year period following the valuation date, is greater than -0.10% and less than +0.10%, where the SCRD is equal to the Total Contribution Rate less the Sustainability Rate.

Section 45 of the ORPP Act prescribes the mechanisms that must take place in the event that the ORPP is determined to have a funding shortfall, while Section 46 of the ORPP Act addresses the mechanisms required to address the situation where the ORPP has a funding excess.

Purpose of the Actuarial Funding Report

The AFR was prepared as at January 1, 2018.  Its purpose is to:

  • provide the Ministry the projected financial status of the ORPP over a long projection period,
  • provide the Ministry the information needed to evaluate the sustainability of the ORPP, as defined in the ORPP Act,
  • provide the Ministry the information needed to assist the Government with finalizing the plan provisions in accordance with the ORPP Act, and
  • provide the Ministry the information needed by the Canada Revenue Agency (CRA) to approve the registration of the ORPP under the Income Tax Act, Canada.

As the ORPP Act had not been proclaimed and the related regulation had not been finalized when the AFR was prepared, the AFR is intended to be preliminary in nature. Furthermore, since the ORPP AC has not yet finalized an investment strategy, WTW has relied on the Ministry to set the real rate of investment return assumption and the investment expense assumption, both key assumptions used to project the ORPP assets. Although WTW confirmed in their report that they considered these assumptions to be plausible, WTW made no opinion on whether the investment strategy ultimately selected by the ORPP AC would generate such returns, so the results of the projections may be subject to change.

Key Results

Based on the initial projections made of the ORPP’s financial status, the AFR demonstrates that the ORPP is sustainable for the period until 2117. Specifically:

  • The number of ORPP Active Contributors is projected to be 4.6 million in 2020, out of a total working-age population of 9.3 million. By 2117, the number of ORPP Active Contributors is projected to reach 7.6 million out of a total working-age population of 17.1 million.
  • Based on the legislated total contribution rate of 3.8%:
    • The assets of the ORPP are expected to grow faster than expenditures over the period from 2018 to 2030, reaching an estimated $97 billion ($72 billion in 2016 dollars) by 2030, with annual contributions and expenditures projected to be $8.7 billion and $1.4 billion respectively in 2030 ($6.5 billion and $1.1 billion in 2016 dollars). The ratio of assets to expenditures is expected to peak in 2030 at a ratio of 69.1;
    • By 2060, assets are projected to reach $960 billion ($394 billion in 2016 dollars), with annual expenditures exceeding contributions for the first time, projected to be $28 billion and $26 billion respectively ($12 billion and $11 billion in 2016 dollars). The ratio of assets to expenditures is projected to be 33.8 in 2060;
    •  In 2095, the ORPP is projected to reach a mature condition, and the ratio of assets to expenditures is expected to level off at approximately 25.5; and
    • By 2117, the ORPP’s assets are projected to reach $9.6 trillion ($1.3 trillion in 2016 dollars), with annual contributions and expenditures projected to reach $222 billion and $373 billion respectively ($30 billion and $50 billion in 2016 dollars).
  • The Sustainability Rate as defined in the ORPP Act is 3.78% of pensionable earnings.
  • The AFR produces a Balance Sheet as at both January 1, 2018 and January 1, 2028.  This is an Open Group Valuation, so that future contributions are treated as assets.  Future liabilities include Operational Costs. The AFR shows that assets are equal to 100.4% of liabilities at both dates.

Interpretation of Results

The AFR also presented:

  • A number of sensitivity tests, which illustrate the results that would be obtained under various changes in either future experience or actuarial assumptions, and
  • A calculation of the internal rate of return of several cohorts of ORPP participants (that is, the projected rate of return each cohort is expected to achieve on its combined employee and employer contributions if the actuary’s best-estimate assumptions are realized).

All of the results are estimates.  All but the sensitivity tests represent the actuary’s “best estimates” (with the exception of the assumptions provided by the Ministry), with no deliberate margins for conservatism or other intentional bias, in line with the requirements under Section 2.3 of ISAP 2.

It is essential to recognize that these results are not predictions. They simply present what the outcome will be if all of the assumptions are realized.  The parameters involved (for example, fertility rates, net migration rates, mortality rates, rates of labour force participation, retirement rates, rates of price increase, real wage growth, real rate of investment return, each projected from January 1, 2018 for 100 years, etc.) are forecasts of unknowable future events and, therefore, are not amenable to precise prediction.  Thus, it is important that readers of the AFR look at the sensitivity tests to understand that the range of possible actual outcomes is wide, and could even be wider than illustrated by the sensitivity tests.

The most significant risk factor indicated by the sensitivity tests chosen by WTW is the real rate of investment return, an assumption that was provided to the actuaries by the Ministry after it had been benchmarked for consistency with other plans. The next two most significant assumptions indicated by the sensitivity tests chosen were the real wage growth and mortality rates.    

Outline of this Report

Sections 2 and 3 of this report address the first two questions in our terms of reference regarding Professional and Statutory Requirements and Data.

Section 4 (Actuarial Assumptions and Methods) addresses question 3 in our terms of reference.

Section 5 (Other Issues) provides further important commentary.

Section 6 (Recommendations) summarizes our three main recommendations.

The Executive Summary provides an overview of our findings. 

SECTION 2. PROFESSIONAL AND STATUTORY REQUIREMENTS

In this Section, we address the following question:

“Has the work been completed in accordance with accepted actuarial practice and statutory requirements (if any)?”

Background

To address this question, we have considered each of the following:

  • Canadian Institute of Actuaries Rules of Professional Conduct:  The signing actuaries, C. Ian Markham and Philip Morse are Fellows of the Canadian Institute of Actuaries (CIA), the professional body governing the education, qualification, conduct and work of actuaries in Canada. The CIA promulgates the professional rules and ethical standards with which a member must comply and thereby serve the public interest.  The Rules of Professional Conduct are the Institute’s highest level of guidance to its members.  Failure to adhere to the rules results in disciplinary proceedings.
  • CIA General Standards of Practice:  These standards govern the work performed by actuaries in Canada. There are general standards governing all areas of practice and practice-specific standards governing work in specific areas, namely: insurance, occupational pensions, workers’ compensation, actuarial evidence and post-employment benefit plans.  Currently, there are no practice-specific standards of practice governing work on social security programs, so only the General Standards of Practice are relevant to this review.
  • International Actuarial Association International Standards of Actuarial Practice for General Actuarial Practice (ISAP 1) and Financial Analysis of Social Security Programs (ISAP 2):  The International Actuarial Association (IAA) is a worldwide association of professional actuarial organizations. The IAA promulgates model standards of actuarial practice. These standards are not binding on actuaries in a particular country except to the extent that their national actuarial organization makes them so or the terms of the actuary’s engagement require their application or if the actuary specifically claims that the work complies with an ISAP. As of the date of this review report, the IAA has issued two International Standards of Actuarial Practice:  ISAP 1 General Actuarial Practice and ISAP 2 Financial Analysis of Social Security Programs.  As of yet, the CIA has not made either of these IAA International Standards of Actuarial Practice binding on its membership. However, since these IAA standards provide guidance specific to social security programs, and since WTW has voluntarily applied these standards to their work, we have considered both ISAP 1 and ISAP 2 in this review. 
  • The Ontario Retirement Pension Plan Act (Strengthening Retirement Security for Ontarians), 2016: the plan provisions and measures of sustainability used for the projections in the AFR were based on the ORPP Act, as directed by the Ministry.   

Canadian Institute of Actuaries (CIA) Rules of Professional Conduct

The following Rules of Professional Conduct of the CIA are particularly relevant to this review:

  • Rule 1:  A member shall act honestly, with integrity and competence, and in a manner to fulfil the profession’s responsibility to the public and to uphold the reputation of the actuarial profession.
  • Rule 2:  A member shall perform professional services only when the member is qualified to do so and meets applicable qualification standards.
  • Rule 3:  A member shall ensure that professional services performed by or under the direction of the member meet applicable standards of practice.

We are satisfied that the WTW actuaries have met the requirements of the CIA Rules of Professional Conduct.

Further to Rule 3, the next two Subsections expand on our assessment of WTW’s compliance with the CIA General Standards of Practice and the IAA ISAP 1 and ISAP 2.

Canadian Institute of Actuaries (CIA) General Standards of Practice

The General Standards of Practice of the CIA are extensive and detailed. The topics covered include numerous matters relevant to the AFR such as:

  • materiality,
  • knowledge of the circumstances of the case,
  • approximations,
  • subsequent events,
  • data sufficiency and reliability,
  • control procedures,
  • reasonableness of results,
  • documentation,
  • actuary’s use of another person’s work,
  • selection of assumptions,
  • provision for adverse deviations, and
  • reporting.

The CIA standard on assumptions requires that the assumptions, individually and in the aggregate, should be appropriate. We have concluded that the assumptions that WTW selected for the AFR were reasonable (noting that certain assumptions were provided by the Ministry and therefore were not subject to WTW’s discretion in their role as actuary), both individually and in the aggregate, and are therefore appropriate.   

The CIA standard on provision for adverse deviations (such a provision is sometimes referred to as a margin for conservatism) states that the actuary “should not include a provision [for adverse deviations] if the related work requires an unbiased calculation.” As the Government has specified that the ORPP funding be designed such that benefits are earned as contributions are made, to preserve intergenerational equity, WTW has not included margins in their assumptions. Rather, they have selected “best estimate” assumptions, both individually and in the aggregate. The consequence is that the overall projections, other than the sensitivity tests, are “best estimates” and do not include any provision for adverse deviations.

It is important to note that WTW relied on the Ministry to set three key assumptions used in the projections and makes no opinion on the appropriateness of these assumptions:

  • the expected real return on investments;
  • the investment expenses; and
  • the per capita administration costs.

Since the ORPP AC has not yet finalized an investment strategy, it would be imprudent for WTW to opine on these assumptions.  Further, since the ORPP is a new plan, with no current administration structure in place, WTW was not prepared to provide an opinion on the appropriateness of the per capita administration costs assumption.

While WTW did not opine on the real rate of investment return, they performed independent analysis to assess whether the assumption was plausible by comparing to the investment return assumptions (net of investment management expenses) employed by several large Ontario pension plans. WTW also modeled the potential real investment returns for some investment strategies which would be considered customary in Canada, to ensure that there are a reasonable range of asset mixes that could be expected to generate the specified real rate of investment return (net of investment management expenses). As a result, WTW confirmed that the real rate of investment return assumption provided by the Ministry was plausible.

In our opinion, the work on the AFR complies with the relevant portions of the CIA General Standards of Practice.

International Actuarial Association (IAA) ISAP 1 General Actuarial Practice and ISAP 2 Financial Analysis of Social Security Programs

ISAP 1 is very similar (but not identical) to the CIA General Standards of Practice.  In our view, the work on the AFR complies with the relevant portions of ISAP 1

ISAP 2 sets out specific standards of practice for actuaries performing financial analyses of social security programs. The topics covered by ISAP 2 include the following:

  • Appropriate Practice — Data, Assumptions, Independent Peer Review
  • Communications — Report on Financial Analysis, Opinion

In particular, ISAP 2 provides guidance to actuaries conducting financial analysis of a newly established social security program, including taking into account relevant experience in comparable social security programs. Further, ISAP 2 specifies that where the financial analysis has been based on incomplete data, the actuary should so disclose and consider recommending the analysis again as new information becomes available.  

In our opinion, the work of WTW complies with ISAP 1 and ISAP 2.

The ORPP Act

The ORPP Act defines the Sustainability Rate and prescribes the mechanisms that must take place in the event that the ORPP is determined to have a funding shortfall or excess. WTW’s assessment of the ORPPs sustainability is based on a 100 year projection of assets and expenditures, to derive the Sustainability Rate as defined under the ORPP Act.

Opinion on Professional and Statutory Requirements

In our opinion, the work of Willis Towers Watson has been completed in accordance with accepted actuarial practice and statutory requirements.

SECTION 3. DATA

In this Section we address the following question:

“Did the actuaries have access to relevant information required to perform the projections, and were relevant tests and analysis performed on the data? Where data were not directly available, were appropriate tests for reasonableness completed?”

Background

There are three key segments of data needed to project the funded position of the ORPP, as follows:

Purpose Examples of Data Source
membership data
  • population by age and sex
  • labour force
  • participation rate
  • earnings of contributors
  • Ministry’s Economic Policy Branch – Income, Employment and Demographic Issues Unit demographic projection from 2015 – 2090 (developed July 2015)
  • Ministry’s Office of Economic Policy – Economic and Revenue Forecasting and Analysis Branch economic projection from 2015 – 2035 (developed July 2015)
  • Ministry’s Office of Economic Policy – Statistical and Quantitative Research Branch 2012 tax data (T1 and T4 extract)
data for demographic assumptions
  • current Mortality rates
  • future Mortality improvement rates
  • fertility rates
  • migration rates
  • Ministry’s Economic Policy Branch – Income, Employment and Demographic Issues Unit demographic projection from 2015 – 2090 (developed July 2015)
  • The 26th Actuarial Report on the Canada Pension Plan as at December 31, 2012, published in November 2013 by the Office of the Chief Actuary
  • Report on Canadian Pensioners Mortality, released in February, 2014 by the Canadian Institute of Actuaries
validation data
  • population projections
  • labour force participation rates
  • economic assumptions
  • Population Projection for Canada, Provinces and Territories – 2013 to 2038 (Statistics Canada Medium Projection), prepared in September 2014
  • The Provincial Outlook 2015 – Long Term Economic Forecast, prepared in March 2015 by the Conference Board of Canada (CBoC)
  • The C4SE Provincial Economic Forecast, prepared in January 2015 by the Centre for Spatial Economics
  • The 26th Actuarial Report on the Canada Pension Plan as at December 31, 2012, published in November 2013 by the Office of the Chief Actuary
  • Ministry’s Office of Economic Policy – Economic and Revenue Forecasting and Analysis Branch economic projection from 2015 – 2035 (developed July 2015)

The Economic Policy Branch within the Ministry manages and maintains a sophisticated demographic model that can produce long-term projections of the Ontario population.  The Ministry was the only source identified which could produce the required projection for a 75-year period with the further requirement to provide a sufficiently detailed projection for each age and sex.  In order to extend the projections beyond 75 years, WTW successfully reproduced the Ministry’s projection using the data and assumptions provided and then extrapolated the population projection to 2117.

The use of a 100 year projection period, as prescribed in the ORPP Act, means that the analysis covers a period that would outlast an age 18 entrant to the end of his/her life and the probable end of any last survivor benefits. 

To assess the sufficiency and appropriateness of the population projection data provided, WTW compared the Ministry Demographic Projection, including the underlying assumptions, to a series of other sources, including (as listed above), the CBoC, the C4SE, Statistics Canada Medium Projection and the CPP Actuarial Report.  In each case the comparisons showed that the projection from the Ministry was reasonably similar to the projection from the comparative source.

The projection of ORPP contributions and expenditures requires assumptions about the proportion of the workforce that will participate in the ORPP. To develop the projection of contributors, data were collected for the 2012 tax year to arrive at the proportion of the population who would have contributed to the ORPP in 2012 had it been in operation. Excluded from the population were:

  • People under age 18 and over age 69;
  • Federally regulated employees; and
  • Employees with a comparable workplace pension plan.

Exclusions were also made for self-employed income and any earnings in excess of $90,000.

In order to assess whether someone had a comparable workplace pension plan, the Ministry worked with the Financial Services Commission of Ontario to develop a list of registered pension plans and identified them as defined benefit (DB), defined contribution (DC), combination or other plans. Based on the plan registration number and the Pension Adjustment (PA) reported on each T4, the member was assumed to be in a comparable plan if:

  • For a DB plan, the ratio of the PA divided by employment income (limited to $135,000) is greater than 4%; or
  • For a DC plan, the ratio of the PA to employment income (limited to $135,000) is greater than or equal to 8%.

Based on this 2012 data, WTW arrived at a 2012 ORPP participation rate for each age and sex, as well as an overall 2012 ORPP participation rate. For each year of the projection, WTW determined a preliminary ORPP participation rate for each age and sex, weighted by the projected working-age population in that year. Then, for each year of the projection, they determined a calibration factor based on the labour force participation rate for the year that satisfied the following equation:

preliminary ORPP
participation rate
× calibration
factor
= labour force
participation rate
× ORPP participation
factor

The labour force participation rate was assumed to be 65.5% in 2018, grading down at 0.30% per year to 58.0% in 2043. WTW arrived at their best estimate assumption for the labour force participation rate with reference to the C4SE Forecast, the CBoC Forecast, the CPP Actuarial Report assumptions and input from the Ministry on trends related to labour force participation.

Within the sensitivity analysis, projections were also done using a labour force participation rate of 65.5% in 2018, grading down at 0.25% per year to 60.0% (Low-Cost alternative) and a labour force participation rate of 65.5% in 2018, grading down at 0.35% per year to 55.0% (High-Cost alternative).

The AFR also showed the Asset to Expenditure Ratio (A/E Ratio) for all scenarios in 2050, 2075 and 2100.

The results are seen in the following table.

Labour force participation Sustainable
Contribution Rate
A/E Ratio - 2050 A/E Ratio - 2075 A/E Ratio - 2100
Low-Cost 3.78% 44.2 27.7 25.6
Best-Estimate 3.78% 44.0 27.4 25.5
High-Cost 3.78% 43.7 27.0 25.2

The above table illustrates that changes in the labour force participation rates tested have a negligible effect on the cost of the plan and no effect on sustainability.

Observations

We have the following observations:

  • As the ORPP had not yet been established at the time the AFR was produced, the actuaries had to rely on demographic information and assumptions supplied by the Ministry.
  • The actuaries also contacted other Departments and Agencies such as the CRA, Statistics Canada and the Ministry’s Economic Policy Branch, and with external agencies such as the Conference Board of Canada and the Centre for Spatial Economics (C4SE).  All of this helped in developing and validating the assumptions used.
  • As a result, the actuaries appear to have had access to the data required.
  • The data are extensive and appear to be reasonably complete.
  • The data were tested for reasonableness and any deficiencies were resolved before the data were used.

Opinion on Data

Based on the observations noted above, in our opinion, the actuaries had access to the data required to perform the projections, and they completed such relevant tests and analysis on the data as might be expected.

SECTION 4. ACTUARIAL ASSUMPTIONS AND METHODS

In this Section, we address the following question:

“Are the actuarial assumptions and methods reasonable for use in completing the Actuarial Funding Report?”

Methods

In setting actuarial assumptions, most actuaries look back in time, and also look forward, to make an estimate of future assumptions.  For the forward-looking part of the process, the actuary builds a model that incorporates the details of the benefit, contribution and investment elements of the plan and reflects the expected behaviour of the factors that determine the year-by-year development of the benefit costs and the contribution and investment income.  The model for a plan as complex as the ORPP is necessarily complex itself.  Given the time constraints, WTW used one projection module created by an outside source.   

We understand that WTW went to great efforts to acquire a detailed knowledge of this module. Going forward, we recommend that a valuation model be created by the designated actuary to achieve maximum flexibility and transparency.

Another issue worthy of note is the use of an Open Group evaluation.  This was used both for the Balance Sheet and for the funding analysis. If a Social Security system is to be either Pay-As-You-Go (PAYG) or Partially Funded (as is the CPP) then there is a high level of agreement amongst Social Security actuaries that an Open Group valuation is the correct methodology.  If a plan is meant to be Sustainably-Funded like the ORPP, then either an Open Group or Closed Group valuation is acceptable. 

According to ISAP 2, Section 2.42:

“For fully funded SSPs (that is, where accrued liabilities are intended to be funded over the participants’ working years), the analysis should use a closed group methodology, under which only current participants are considered, with or without their assumed future benefit accruals. However, if the actuary judges an alternative approach to be more appropriate, that approach should be used with justification communicated in the report.”

Since the ORPP is a Sustainably-Funded plan with no intention of intergenerational subsidies, based on ISAP 2, WTW is permitted to use a methodology other than Closed Group.  We are very comfortable with their choice of Open Group and have no objections to that.  However, there may be other agencies and institutions (e.g., International Public Sector Accounting Standards Board and the IMF) that may raise concerns in the future.  As actuaries, we are more concerned about the sustainability of the plan versus the day-to-day level of pre-funding and we find comfort in the 100-year indication of sustainability.  An Open Group valuation is also consistent with the methodology selected by the Office the Chief Actuary in its determination of the permanent funding rate in respect of recent changes to the CPP that increased or added new benefits.

Assumptions

The assumptions incorporated into the model for a particular actuarial review reflect the actuary’s judgement, based on an interpretation of past experience and the available evidence about the likely course of future experience. 

The nature of the actuarial process is to make projections (not predictions) about the future based on the evidence available and then to review them periodically.  Where appropriate, the actuary makes “mid-course changes” to the assumptions as the emerging experience of the plan deviates from the previous assumptions and the expectations for likely future experience change.

The assumptions are intended to apply over the long-term future, so the actuary will normally give substantial weight to long-term historical data.  However, where the actuary judges that more recent data for a particular assumption indicate a shift or a trend that is likely to continue for the long-term future, the actuary will recognize that shift or trend in the assumption. 

The results of the actuarial process at any given time do not yield a “right” answer but should lie somewhere within a range that can be regarded as “reasonable”.  All assumptions used can be described as “best-estimate”, such that adverse or favourable deviations of actual future experience from each of those assumptions are about equally likely.  This is consistent with the goal of there being no intergenerational inequities (subsidies from one generation to another).

The major actuarial assumptions in the AFR can be conveniently divided into two categories: 

  • “demographic” assumptions that deal with changes in the covered population (for example, fertility, migration and Mortality rates) and events (for example, death and retirement) that trigger the starting or stopping of benefit payments or contributions, and
  • “economic” assumptions that deal with such issues as employment, wages, prices and returns on investment. 

Demographic Assumptions

The chosen demographic assumptions were as follows:

Total Fertility Rate:  The total fertility rate chosen for the population projections was 1.57 children per female in 2015, increasing to 1.60 children per female starting in 2030 with 105.5 male births per 100.0 female births. 

Within the sensitivity analysis, projections were also done using a total fertility rate of 1.90 children per female (Low-Cost alternative) and 1.30 children per female (High-Cost alternative).

The results are seen in the following table.

Ultimate Total
Fertility Rate from 2030
Sustainable
Contribution Rate
A/E Ratio - 2050 A/E Ratio - 2075 A/E Ratio - 2100
Low-Cost (1.90) 3.75% 44.6 29.4 27.3
Best-Estimate (1.60) 3.78% 44.0 27.4 25.5
High-Cost (1.30) 3.81% 43.4 25.5 23.6

The above table illustrates that changes in fertility tested have a relatively small effect on the cost of the plan.  However, all the individual sensitivity test results should be interpreted with caution.  Readers should form their own opinion about the plausibility of the Low-Cost and High-Cost assumptions.  Moreover, they should assume that changes in parameters are not likely to occur in isolation.  For example, a radical change in fertility rates would likely be accompanied by other changes that would mitigate their impact (for example, changes in average ages at retirement, levels of immigration or labour force participation rates). 

Opinion on Total Fertility Rate

In our opinion, the fertility assumption was reasonable.

Mortality:  The mortality assumptions used (Ministry Demographic Projection until 2090 and extrapolated thereafter) resulted in the following age 65 life expectancies:

Year Male Female
2015 21.2 years 23.4 years
2030 23.4 25
2060 25.2 26.3
2090 26.1 26.9

Future mortality rates were projected by using estimates of age-specific future mortality improvement rates.  The underlying age-specific mortality improvement rates were compared to those used in the 26th CPP Actuarial Report and were deemed to be appropriate although the resulting mortality rates were generally lower than the corresponding projected mortality rates used for the CPP Report (ratios of 0.54 to 1.01).  This difference would lead to higher costs being shown for the ORPP than under the CPP mortality assumptions.  Further, in the Ministry Demographic Projection, male and female mortality rates converge while for the CPP Report, the male and female mortality rates improve at the same rate (so do not converge).

The resulting rates were also compared to the new Canadian Pensioners’ Mortality Tables (CIA CPM Tables).  We note that there are differences in results since the CPM Tables are based on participants in Canadian pension plans and do not consider the mortality experience of workers not in pension plans.  Further for both the CPP and CPM Table assumptions, the data are cross-Canada data, not purely Ontario.

It is implicit in these assumptions that there will be no shocks affecting future life expectancies, either positively (for example, a major advance in the treatment of heart disease or cancer) or negatively (for example, an outbreak of a serious infectious disease).

In the sensitivity analysis, projections were also performed using mortality rates that result in an age 65 life expectancy in 2060 of 23.2 years for males and 24.3 years for females (Low-Cost alternative) and mortality rates that result in an age 65 life expectancy in 2060 of 27.2 years for males and 28.3 years for females (High-Cost alternative).

In the Low-Cost mortality alternative, the Sustainable Contribution Rate (best estimate being 3.78%) became 3.57% and in the High-Cost alternative, it became 3.99%.

The test results may be summarized as follows:

Life Expectancy
at Age 65 in 2060
Sustainable
Contribution Rate
A/E Ratio - 2050 A/E Ratio - 2075 A/E Ratio - 2100
Low-Cost (M 23.2, F 24.3) 3.57% 45.3 30.1 31.1
Best-Estimate (M 25.2, F  26.3) 3.78% 44.0 27.4 25.5
High-Cost (M 27.2, F 28.3) 3.99% 42.8 25.2 20.8

The above table illustrates that the changes in the mortality assumption tested have the third most significant effect on the cost of the plan.

Opinion on Mortality

In our opinion, the mortality assumption was reasonable.

Net Migration:  Data from Statistics Canada show that the rate of net annual migration to Canada since 1998 (assuming no annual net increase in the number of non-permanent residents) has varied from a low of 0.39% of the population to a high of 0.68%.  Variations in the earlier years of the 20th century were much more extreme.  Migration varies from year to year in response to demographic, economic, social and political changes.  Over 2010 to 2012, the average net migration rate for Canada was 0.63% of the population (assuming no annual net increase in the number of non-permanent residents).  Net migration rates for Ontario would be even more volatile.

The net migration assumption adopted for the ORPP (Ontario population) was 0.7% of population per year.  This seems logical since the fertility rate is not high enough for the population to replace itself internally. 

In the sensitivity analysis, projections were also done using a net migration rate equal to 125% of the Best-Estimate assumption (Low-Cost alternative) and 75% of the Best-Estimate assumption (High-Cost alternative).

The test results may be summarized as follows:

Average Annual
Net Migration Rate
Sustainable
Contribution Rate
A/E Ratio - 2050 A/E Ratio - 2075 A/E Ratio - 2100
Low-Cost (125% of Best-Estimate) 3.78% 45.1 28.5 26.6
Best-Estimate (0.70%) 3.78% 44.0 27.4 25.5
High-Cost (75% of Best-Estimate) 3.80% 42.8 26.3 24.1

The above table illustrates that changes in migration rates tested have a relatively small effect on the cost of the plan.

Opinion on Net Migration

In our opinion, the net migration assumption was reasonable.

Retirement Incidence:  Retirement incidence is a key assumption that determines when members are assumed to cease contributing to the ORPP and begin collecting their pension. As there is no historical experience to rely upon in setting this assumption, WTW assumed that members would retire from the ORPP concurrent with their retirement from the CPP.

Retirement under the ORPP is permitted as early as age 60 and no later than age 70. Unreduced pensions are payable at age 65 and pensions are actuarially increased or reduced to the extent that retirement is deferred beyond age 65 or taken earlier than age 65.

Male spouses are assumed to be three years older than female spouses and 70% are assumed to elect an actuarially reduced joint and survivor pension, where 60% of the pension is payable to spouse upon the member’s death.

The rates used in WTW’s projections are as follows:

Retirement Incidence Probability
Age Males Females
60 34.00% 38.00%
61 6.00% 6.00%
62 5.00% 5.00%
63 4.00% 4.00%
64 4.00% 4.00%
65 40.60% 39.20%
66 1.20% 0.90%
67 1.10% 0.60%
68 1.10% 0.60%
69 1.00% 0.60%
70 2.00% 1.10%
  100.00% 100.00%

No sensitivity testing was performed on the retirement assumption. Due to the actuarial adjustments in place for earlier or later retirements, we expect that the results would not be materially sensitive to changes in this assumption.

Opinion on Retirement Incidence

In our opinion, the retirement incidence assumption was reasonable.

Economic Assumptions

The key economic assumptions used in the ORPP projections are price inflation, wage growth, real rate of investment return on ORPP assets and investment management expenses. While WTW expresses an opinion on the price inflation and real wage growth assumptions used in their projections, they do not opine on the appropriateness of the real rate of investment return assumption nor do they opine on the investment management expense assumption. The values for these last two assumptions were decided upon by the Ministry and assigned to WTW for the AFR. We did not review the Ministry’s assumptions in the context of this report. However, we do note that these are critical assumptions and recommend that once the details are known about the ORPP’s investment strategy, the analysis in the AFR should be updated, including appropriate sensitivity testing which should consider the level of risk inherent in the investment strategy.

Price Inflation: Under the ORPP Act, pensions in payment are to be indexed with inflation, subject to certain changes that may be required to ensure plan sustainability. In line with the Bank of Canada target inflation rate of 2% per year, WTW has assumed that price inflation will be 2% for all years in the projection period.

WTW compared the price inflation assumption to four other data sources: the Ministry Economic Projection, the C4SE Forecast, the CBoC Forecast and the assumed price inflation rates used in the 26th CPP valuation report. With the exception of the Ministry’s projection, for years after 2023, the C4SE and CBoC Forecasts and the CPP report assume inflation rates above 2.0%.

In the sensitivity analysis, projections were also done using price inflation of 2.5% for the Low-Cost alternative and 1.5% for the High-Cost alternative.

The test results may be summarized as follows:

Price Inflation Sustainable
Contribution Rate
A/E Ratio - 2050 A/E Ratio - 2075 A/E Ratio - 2100
Low-Cost (2.5%) 3.73% 45.1 28.5 27.2
Best-Estimate (2.0%) 3.78% 44.0 27.4 25.5
High-Cost (1.5%) 3.85% 42.8 26.3 23.6

The above table illustrates that changes in the price inflation rate tested have a relatively small effect on the cost of the plan.

Opinion on Price Inflation

In our opinion, the price inflation assumption was reasonable.

Real Wage Growth: Real wage growth represents the growth in nominal wages over inflation and is impacted by productivity of the workforce, changes in the composition of labour and broader economic trends. For the purpose of the projections, WTW used a real wage growth assumption that varies between 0.8% and 1.3% for years prior to 2032 and then remains at 1.1% from 2033 onward.

WTW compared the real wage growth assumption to four other data sources: the Ministry Economic Projection, the C4SE Forecast, the CBoC Forecast and the assumed real wage growth used in the 26th CPP valuation report. While not the same for every year in the projection prior to 2033, the real wage growth assumption lines up closely to the Ministry’s projection and to the C4SE Forecast. For projection years 2033 and beyond, the real wage growth assumption remains unchanged at 1.1%.

In the sensitivity analysis, projections were also performed using a real wage growth assumption that is 0.50% less than the Best-Estimate assumption (Low-Cost alternative) and 0.50% greater than the Best-Estimate assumption (High-Cost alternative).

The test results may be summarized as follows:

Real Wage Growth Sustainable
Contribution Rate
A/E Ratio - 2050 A/E Ratio - 2075 A/E Ratio - 2100
Low-Cost (-0.5%) 3.54% 44.7 30.1 31.8
Best-Estimate 3.78% 44.0 27.4 25.5
High-Cost (+0.5%) 4.07% 43.1 25.1 20.6

The above table illustrates that the changes in the real wage growth tested have the second most significant effect on the cost of the plan.

Opinion on Real Wage Growth

In our opinion, the real wage growth assumption was reasonable.

Other Assumptions

Operational Costs: The ORPP AC is not yet fully operational and has not finalized its selection of administration providers. The Ministry has provided WTW with the assumption for operational costs, which is $150 per year for each active contributor for years 2018-2027, reducing to $100 per year thereafter, plus $50 per year for each pensioner/beneficiary. WTW makes no opinion on the appropriateness of this assumption.  

In the sensitivity analysis, projections were also done using operational costs that were 75% of the Best-Estimate assumption for the Low-Cost alternative and 150% of the Best-Estimate assumption for the High-Cost alternative.

The test results may be summarized as follows:

Operational Costs Sustainable
Contribution Rate
A/E Ratio - 2050 A/E Ratio - 2075 A/E Ratio - 2100
Low-Cost (75%) 3.72% 46.7 29.1 27.8
Best-Estimate 3.78% 44.0 27.4 25.5
High-Cost (150%) 3.92% 39.0 24.2 20.9

The table illustrates that changes in the operational cost tested have a relatively small effect on the cost of the plan.

We did not review the Ministry’s operational cost assumption in the context of this report.

Opinion on Methods and Assumptions

In our opinion, the actuarial methods used in completing the AFR were reasonable and the assumptions selected by Willis Towers Watson were also reasonable, both individually and in the aggregate.

SECTION 5. OTHER ISSUES

The AFR reported on the sensitivity analysis performed on eight of the most important model variables.  However, the sensitivity analysis had a significant limitation in that it did not show the likelihood of a particular scenario—it only shows the impact.  Thus the values chosen for the sensitivity analysis were chosen in a deterministic fashion.  The scenarios tested were not “worst” case or “best” case.  Each was constructed to show a meaningful variation from the corresponding Best-Estimate assumption used for the projection.  

In the real world, adverse deviations will not happen to only one variable.  It is quite possible for several factors to produce adverse or positive experience at the same time.  Thus, WTW did a sensitivity test where the three most important model variables:  real investment returns, real wage growth and mortality, all varied together in a Low-Cost and High-Cost alternative. We note that the combined High-Cost scenario results were slightly worse in aggregate than the sum of the High-Cost scenarios individually. This suggests there may be some additional interaction risk, which supports the need for stochastic analysis in the future, where these interactions could be built into the stochastic model and produce results that better capture these interactions (and the associated probabilities).

One can see from the sensitivity analysis that there are a number of potential real world situations where the Sustainable Contribution Rate Differential would be large enough to cause the Automatic Adjustments to occur.  This seems highly probable in the long run.

The government expressed its desire that the ORPP provide intergenerational (one generation to another) and intragenerational equity (within a given generation).   To test ORPP in this regard, WTW determined and compared the Internal Rate of Return (IRR) that each group of members is expected to earn from the ORPP.  The IRR analysis is based on a projection of future contributions and benefits for the group.

It is not the intention of the ORPP nor any social security program for members to receive a value exactly equal to one’s own contributions (and employer’s).  Rather, the degree of intergenerational and intragenerational equity should be reasonable.  To demonstrate the degree of intergenerational equity, the AFR shows Internal Rates of Return by defined Cohort Groups.  The IRR for the members who enter at the youngest ages (5.11%) is approximately 22 basis points lower than the overall average for the ORPP (5.33%).  However, these members should expect to receive the largest number of dollars in pension payment from the ORPP.  The members who are expected to get the higher IRRs will get lower benefits because of their shorter periods of participation.  The results are similar to those one would expect from any new defined benefit pension plan.

WTW also tested for intragenerational equity and found that while the IRR increases with the entry age into the ORPP, once the initial Ontario population enters the ORPP, very few members enter at the higher ages, since this will generally occur only through net migration.  Members who first enter the ORPP at older ages tend to have smaller pensions payable.  Overall, WTW found little concern with respect to either intergenerational or intragenerational equity issues.  We concur.

SECTION 6. RECOMMENDATIONS

We make the following Recommendations for future Actuarial Valuations of the ORPP:

Recommendation 1: Once the ORPP Administration Corporation (the “ORPP AC”) has completed its development of an investment strategy for the ORPP assets, the results of the preliminary projections should be updated using a best estimate real rate of investment return assumption that appropriately reflects this strategy.   In addition, the sensitivities around the real rate of investment return assumption could incorporate stochastic analysis once there is more visibility on the investment strategy with the goal of gaining greater insight on risk.

Recommendation 2: We recommend that the sensitivity analysis for all key variables apply a stochastic element based on the historic frequency distribution of the noted variable, as is the case with the CPP sensitivity analysis.

Recommendation 3: In the future, we recommend that a valuation model be created by the designated actuary to achieve maximum flexibility and transparency.

SECTION 7. SIGNATURES

This report has been prepared in accordance with accepted actuarial practice in Canada, and is respectfully submitted on June 30, 2016 by

Christopher G. Brisebois, FCIA FSA CFA

Robert L. Brown, FCIA FSA ACAS

Jill M. Wagman, FSA, FCIA