Saturday, February 18, 2012

Elections, Deficits, and Debts - Addendum

It appears that the Drummond Report has confirmed my observations on the precarious state of Ontario's finances.  Drummond manages to give a rather sanitary glimpse into McGuinty's debt saturation policies of the his previous two terms.  However, Drummond does not fully delve into the long term implications of how this unsustainable debt will cripple Ontario for generations.

Demographics are against Ontario.  New immigrants are choosing the West over Toronto.  The population is aging, putting additional strains on the delivery of health care services.  Fewer children mean larger legacy education costs per child.   As I have posted before - Ontario is using the Greek strategy of using short term debt at record low rates to finance this.  

Tax increases and strategic cuts - as outlined by Drummond, will not solve the problem.  The entire model of how government services and benefits are financed and provided will need to be addressed from first principles.  Long term - defined benefit pensions need to be phased out.  Retirement ages and  employee contributions will need to be increased while benefits will need to be decreased.  Even though the Ontario Teacher's Pension Plan (OTPP) is one of the best run plans in the world - they even admitted that they will have problems paying out benefits.  The plan inadvertently outlined the issues with defined benefits when it reported that they had over 40 pensioner over the age of 100 receiving benefits - people who have received a pension longer than they have worked.  

Politicians here are willfully negligent of what is happening with the PIIGs, thinking that it won't happen here.  Sorry, it is right around the corner.


Realist Theorist said...

I wonder what assumptions about annual rate of return (over, say, 20 years) are built into the typical Canadian pension plan.

Mitch said...

I can tell you that a lot of US public and private defined benefit plans are using unrealistic assumptions of 7.5-8.5% per annum - even though 30 year bonds are yielding 3%. OTPP, which I will assume is a proxy for most Canadian pension plans is around 7-7.5%.

Mitch said...

A lot of firms use optimistic rates of return in order to under-report their funding shortfalls. Here is a nutshell of how the Fed's ZIRP will kill defined benefits.

Most legacy defined benefit plans have generally more retirees or people near retirement than people in prime work years contributing to the plan. As a result of this reality - there are current funding requirement (current recipients) and immediate near term funding (the crop of baby boomers about to retire). This means the pension plan needs to have a heavier weighting on fixed income investments. With near zero interest rates - pension plans need additional fixed income to cover its current benefits, but needs to take a lot more risk with its other investments to make its 8% target return.

A lot of pension plans are heavy into hedge funds as a result, and pension plans also have a lot more volatility in order to make the shortfall.

Realist Theorist said...

Real cause for concern.

BTW. Not sure if you're familiar with the FPA fund. Their top honcho has a good piece here: