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The Canadian Model/Pension Accounting Episode

The Canadian Model/Pension Accounting Episode

Pension accounting is a cursed subject.

It’s a crucial one though. Because how do we know if a pension fund is doing well? Like, obviously we have to count the money and we have to figure out if it's enough money. But how are people actually doing that?

To answer this question, we needed to talk with someone who understood the politics of governance, investment processes, and actuarial sciences. Many of the people with credentials like that are afraid to go on anarchic podcasts like ours, because the subject matter is inherently somewhat controversial.

So we called Hugh O’Reilly, who was happy to wade into the discussion with characteristic Canadian politesse. He has loads of experience putting this knowledge into practice as the former CEO of OPTrust (One of Canada’s largest pension funds) as well as a pensions attorney.

We’ve excerpted a couple of choice quotes from him to get you excited. Here’s Hugh on the mechanics of setting an appropriate discount rate:

“the higher your discount rate, the lower the value of your liabilities, the less money you have to put into the plan. That's where it comes from. The way the discount rate is established, in theory, is— well, here's how the actuaries do it. They look firmly backward to predict the future.”

And here’s how he did it while he was working at OPTrust:

“In the investment world, there's this concept that returns will revert to the mean, so in good times, bad times could happen, and in bad times, good times would happen. So what we would do, is we would lower the discount rate as far — subject to actuarial principles and the rest of it — as we could to maintain the fully-funded status of the plan, but to preserve a margin such that in a bad year, you would be able to raise the discount rate, release the surplus that you had preserved by lowering the discount rate, and it would be keeping with investment theory, because returns to do go back up over time. And that way, you're protecting the members. Because the fundamental issue for members is, they don't care what you earn in a year. What they care is, are you going to keep your promise and will there be sufficient funds to pay me when I retire? 

Here’s the way he evaluates the health of other pensions:

“What's it's funded position? Is it fully-funded, is it underfunded, is it over-funded? And then second— and this is where the rubber hits the road on a going concern assumption— is, what's the discount rate? So if the plan is underfunded and has a high discount rate, you've got big problems. If it's underfinanced, got a low discount rate, you may have some room to maneuver. And in an ideal world, it's got a lower discount rate and it's fully funded.” 

And his take on why American pensions haven’t had the same successes as their neighbors to the north:

“So the issues you have in the US are one: politics. The legislatures, by and large, set the contribution rates, or the legislature asks for the government contribution to be as low as possible. That's problem number one. Problem number two: no independently governance. Problem number three: they’re not assessed in accordance with, I would argue, appropriate actuarial principles.”

And in closing, here’s what he’s working on building now:

“You need a new long-term asset class where the long-term investment strategy promotes innovation, promotes— this word's overused— but resilience, so that these companies can withstand the disruptive elements that are coming their way, that they invest in R&D, they invest in technology, they stay on top of it, they treat the people who work for them well”

As always, we took questions from our listeners at the end of the show. You can ask a question easily. Just email freemoney at gmail dot com with whatever’s on your mind.

  • Simple, a widely loved bank that provided its customers budgeting tools and other personal finance aids, announced it was shutting down last week for “business reasons.” Why is it so hard to make a good bank? 

  • If you were a software engineer, who wants to work somewhere that contributes to the world in a net positive way, where would you want to work right now (companies, not locations)?

  • In honor of Donald trump getting banned from Twitter, who would you bring back to Twitter (from getting banned or beyond the grave, etc)? 

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Free Money with Sloane and Ashby
Sloane Ortel and Ashby Monk explore what's holding the world back from investing in progress, answer the questions on the minds of people in the know, and deliver the Brooklyn-Bay Area consensus about institutional investing that you desperately crave.
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Sloane Ortel
Ashby Monk