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The Department's Oversight System for Alberta's Public Sector Pension Plans

 

SUMMARY

Why we did this audit

We started this project in 2011 because of concerns expressed by elected officials, the media and the public about the financial health of Alberta’s public sector pension plans. As part of our audit planning, we met with those involved in Alberta’s public sector pension system, including plan board members, officials from the department and others. We needed to understand:

  • the roles and responsibilities of the various entities within Alberta’s public sector pension plan system
  • the risk management systems used

During our audit planning, we decided to focus the scope of our audit on assessing the adequacy of systems used to manage risks within Alberta’s public sector pension plans. We did this because the sector did not appear to have well functioning risk management processes that made use of clearly articulated objectives for the plans, with clear targets and tolerances for the costs of the plans. We also chose to focus our audit on the department’s systems because of its role of supporting the Minister of Finance, who is the trustee and administrator of the plans. The department supports the minister through the development of public sector pension legislation and policy.

In September 2012 the minister asked plan boards to consult with stakeholders about the sustainability of the plans and to submit proposals to ensure the plans continue to be affordable, sustainable and offer secure benefits. The department asked us to consider adding a second objective to our audit, which focused on assessing the adequacy of the department’s sustainability review support processes. We agreed to the department’s request.

We knew the sustainability review would not be complete by the time we had finished our audit. However, we wanted to provide the department with timely recommendations on areas where its sustainability review support processes could be improved. This would allow the department time to evaluate our recommendations and consider necessary actions to enhance its processes. We examined the department’s sustainability review support processes up to July 2013. We formally provided our report to the department in December 2013.

What we examined

We audited the Department of Treasury Board and Finance’s systems to monitor and evaluate the performance and sustainability of the following Alberta public sector pension plans:

  • Local Authorities Pension Plan (LAPP)
  • Management Employees Pension Plan (MEPP)
  • Public Service Pension Plan (PSPP)
  • Special Forces Pension Plan (SFPP)

What we found

Pension plans are facing funding challenges—Alberta’s public sector pension plans have significant unfunded liabilities and contribution rates that have risen to levels where some employers and employees do not want to pay more. At December 31, 2012 those unfunded liabilities totalled $7.4 billion. Unfunded liabilities, simply put, are the amount of money needed to be put into the plans today to fully support promises made to retirees and current employees for services already provided. Unfunded liabilities do not include amounts required to pay for benefits related to future service.

To fix the plans—The minister needs to ensure plan benefits are secure and commensurate with an

affordable and available amount of funding from both employees and employers.

Alberta pension plans not unique—These plans are not unique. Many other defined benefit plans face the same problem: they have significant unfunded liabilities and they risk having insufficient assets to meet their obligations unless they change something. Recent experience has shown that actual plan costs are much higher than the estimated costs originally used to set contribution levels.

The plans’ objectives and tolerances for risk have not been clearly articulated by the plans’ sponsor. Therefore, it is unclear whether the plans are meeting their objectives or operating within sustainable tolerances for risk. The plans are facing significant funding challenges and these plans are a significant cost to employers and employees. Therefore, a process to review the risks and costs facing the plans is necessary.

Better tools available to manage risk—The plans have used traditional pension industry methods to manage risk, primarily by spreading the effects of bad experience across contribution rates over a long time. But these methods allow the risks and costs of defined benefit plans to accumulate and be less transparent to stakeholders. Defined benefit pension plans are starting to use better tools and strategies to assess and mitigate their risks. With proper standards and guidance, Alberta’s public sector pension plans can use these risk management techniques to increase the likelihood that the plans are sufficiently funded to meet their obligations and costs do not become more than plan sponsors can afford.

Who should pay to fix the plans—This is a key question and the options are limited. Employers, funded typically by taxpayers, can pay higher contributions to the plans. In exceptional circumstances former employees may be asked to receive reduced benefits. Current and future employees can pay higher contributions and take lower benefits. It’s hard to reform pension plans that owe a lot of money to former and current employees. Current and future employees help pay these costs, but they likely won’t want to contribute more to plans that will pay them less benefits than their predecessors receive when they retire.

Inconsistent monitoring and evaluation—To varying degrees, the pension plan boards have implemented risk management systems. However, no one organization has clear responsibility to coordinate and monitor the performance of the plans or take a consolidated approach to managing risk. The department has managed risk to some extent by providing policy support to the minister, who is the trustee and administrator of the plans. Our audit focused on the department’s processes, which are designed for its primary role in providing policy support and advice to the minister.

Sustainability review—The department has completed significant research and analysis on plan design, governance and sustainability risks as part of its review. This analysis supported the advice provided to the minister. The department’s review covered a sufficient range of the relevant issues but the depth of analysis on some issues was constrained by the time limits for the review.

The department’s options for reform were also constrained by the existence of significant unfunded liabilities for past service that need to be funded. An option used in the private sector to manage pension risk is the conversion of defined benefit pension plans to defined contribution pension plans. This option was considered by the department in its analysis but was not pursued because of the existence of significant unfunded liabilities that are being paid for jointly by the contributions of employers and current employees. If the defined benefit plans were changed to defined contribution plans, it would be more likely that employers would have to pay a much larger share of the current unfunded liabilities than they are currently paying under the existing joint funding model.

Why this is important to Albertans

The financial health and design of Alberta’s public sector pension plans can affect the government’s and other plan employers’ ability to cost effectively deliver public services, attract and retain quality employees and provide a level of benefit security for plan members. Albertans need to know if Alberta’s public sector pension plans are sustainable. The plans face retirees who are living longer and low interest rates resulting in large unfunded liabilities. The minister and department need performance measurement systems to help them assess whether the plans are continuing to meet their objectives.

The promissory relationship between employers and employees created by defined benefit pension plans makes it difficult to change plan benefits once established. Therefore, it is important to properly cost plan benefits and assess the likelihood that they can be funded at a contribution rate acceptable to the sponsors while withstanding risks. Otherwise, the sponsors may bear a higher cost than intended or beneficiaries may receive less than promised. The first and most important step in managing risk in defined benefit pension plans is to only make promises that have a high probability of being able to be kept. Even so, not all risks can reasonably be foreseen and there will be times when plans experience circumstances that take them beyond the tolerances they were designed to withstand.

Our recommendations are intended to help ensure that each plan’s objectives and tolerances for its cost and funding components are clearly articulated. Clear objectives and risk tolerances will help the minister and department monitor plan performance. They will also help all stakeholders reach a consensus about what to do when a plan exceeds its tolerances. This should prompt timely responses to such risks as they arise. Furthermore, an improved approach to pension risk management should make it clear in advance who will bear which risks and costs when plans exceed their tolerances.

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