The Evolution of the Canadian Pension Model Practical Lessons for Building World-class Pension Organizations © 2017 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. 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VII Executive Summary...........................................................................................................................IX Section 1: Context Who this Report is for..........................................................................................................................1 Why Study the Canadian Pension Model? .....................................................................................1 Defining the Canadian Pension Model............................................................................................. 2 The Canadian Retirement System .................................................................................................3 Section 2: Origins of the Canadian Pension Model Ontario’s Public Pension Reforms and Ontario Teachers’ Pension Plan.................................. 7 Reforming the Canada Pension Plan and the Establishment of CPPIB...................................9 What Accounts for the Emergence of the Canadian Model? ..................................................10 Section 3: Fund Case Studies Overview.............................................................................................................................................. 13 AIMCo Case Study............................................................................................................................. 15 Independent governance and multiclient asset manager.................................................................. 16 Attracting top talent......................................................................................................................................... 18 CDPQ Case Study.............................................................................................................................. 19 Dual mandate........................................................................................................................................................21 Infrastructure investing at CDPQ................................................................................................................22 CDPQ Infra.............................................................................................................................................................22 Lessons from the global financial crisis.....................................................................................................23 HOOPP Case Study...........................................................................................................................24 History and evolution........................................................................................................................................24 Governance model..............................................................................................................................................24 Liability-driven investing..................................................................................................................................26 Current outlook....................................................................................................................................................28 OPTrust Case Study......................................................................................................................... 28 An evolving governance model..................................................................................................................... 30 Investment strategy: From asset allocation to risk allocation .......................................................32 Section 4: Framework for the Evolution of Pension Organizations Framework..........................................................................................................................................37 Phase 1: Pre-reform entity............................................................................................................................. 38 Phase 2: A solid foundation........................................................................................................................... 38 Phase 3: Independent, professional entity with strong governance............................................. 38 TABLE OF CONTENTS | V Phase 4: Mature, sophisticated entity...................................................................................................... 39 Navigating the Evolution of a Pension Organization................................................................ 39 Section 5: Practical Lessons Learned from the Canadian Experience Overview............................................................................................................................................. 43 Governance..........................................................................................................................................44 Governance principle 1: Independence........................................................................................................44 Governance principle 2: Leadership............................................................................................................ 46 Governance principle 3: Accountability and transparency................................................................ 47 People and Organization................................................................................................................. 48 People and organization principle 1: Top talent and integrity.......................................................... 48 People and organization principle 2: Competitive pay........................................................................49 Investments....................................................................................................................................... 50 Investment principle 1: Comparative advantage.................................................................................. 50 Investment principle 2: In-house management .....................................................................................51 Investment principle 3: Geographic and asset-class diversification..............................................52 Investment principle 4: Risk and liabilities management...................................................................54 Administration.................................................................................................................................. 55 Administration principle 1: Client-focused orientation........................................................................55 Administration principle 2: Modern technology.................................................................................... 56 Administration principle 3: High-quality communications and education.................................57 Plan Design and Funding................................................................................................................. 58 Plan design and funding principle 1: Sponsors with scale and mission alignment................. 58 Plan design and funding principle 2: Realistic assumptions ........................................................... 60 Plan design and funding principle 3: Risk sharing and prudent funding .................................... 61 Regulatory and Public Policy Environment................................................................................. 62 Regulatory and public policy principle 1: Trust and autonomy........................................................62 Regulatory and public policy principle 2: Robust regulatory regime............................................ 63 Regulatory and public policy principle 3: Good governance ........................................................... 64 Section 6: The Future of the Canadian Model: Challenges and Opportunities Ahead Challenge 1: Lower expected returns and interest rates.....................................................................67 Challenge 2: Demographics and the changing workforce..................................................................67 Challenge 3: Pension inequality....................................................................................................................67 Challenge 4: Complexity and other challenges of growth................................................................. 68 Challenge 5: Value-for-money scrutiny.................................................................................................... 68 Challenge 6: Regulatory environment....................................................................................................... 69 Challenge 7: Preparation for the next crisis............................................................................................ 69 VI | THE EVOLUTION OF THE CANADIAN PENSION MODEL Opportunities for Partnerships with Emerging Economies to Enhance Retirement Security.............................................................................................................................................70 Appendix A: List of Interviewees....................................................................................................72 Endnotes..............................................................................................................................................74 List of Figures Figure ES.1: Building a world-class pension organization (Lessons from Canada)..............X Figure ES.2: Four-phase framework for the evolution of pension organizations................XII Figure 1.1: Assets under management for the top 10 Canadian pension funds have more than tripled since 2003....................................................................................................................1 Figure 1.2: The three pillars of the Canadian retirement income system.............................. 4 Figure 1.3: Recently agreed-upon enhancement to Canada Pension Plan benefits............5 Figure 2.1: Key moments in the evolution of the Canadian model........................................... 7 Figure 3.1: Asset mix of select Canadian pension funds.......................................................... 14 Figure 3.2: Assets under management for the top 10 Canadian pension funds have more than tripled since 2003...................................................................................................... 15 Figure 3.3: Key moments in AIMCo’s evolution.......................................................................... 17 Figure 3.4: AIMCo: notable assets and recent transactions................................................... 17 Figure 3.5: Profile: CDPQ................................................................................................................ 20 Figure 3.6: Key moments in CDPQ’s evolution.......................................................................... 20 Figure 3.7: CDPQ: notable assets and recent transactions.................................................... 21 Figure 3.8: Profile: HOOPP..............................................................................................................24 Figure 3.9: Key moments in HOOPP’s evolution....................................................................... 25 Figure 3.10: HOOPP implements its LDI strategy through a two-part portfolio................27 Figure 3.11: HOOPP: notable assets and recent transactions............................................... 28 Figure 3.12: Profile: OPTrust.......................................................................................................... 29 Figure 3.13: Key moments in OPTrust’s evolution.................................................................... 30 Figure 3.14: OPTrust: notable assets and recent transactions............................................. 32 Figure 3.15: Member-Driven Investing focuses on keeping the plan in balance................. 33 Figure 3.16: OPTrust’s investment governance has shifted to enable the MDI strategy........................................................................................................................................... 35 Figure 5.2: Asset mix for Canadian pension funds has diversified over time (CDPQ and OTPP examples).............................................................................................................................. 53 Figure 5.3: Asset allocation by geography of select Canadian pension funds (2016 figures).................................................................................................................................. 53 Figure 5.4: Discount rates of select Canadian pension plans (Rates are in nominal terms, including inflation, based on most recent annual reports)..................................... 60 TABLE OF CONTENTS | VII Acknowledgments I t has been a privilege to collaborate with the World Bank and a wide range of leaders in the Canadian pension community to develop this case study. In preparing this study, we have benefited from the support and assistance of many organizations and people. First, we would like to acknowledge the generous Finally, we are thankful to the many World Bank support of five Canadian partners who provided Group professionals with whom we have been both financial and intellectual support for this fortunate to collaborate in preparing this study. project: the Alberta Investment Management In particular, William Price and Fiona Stewart of Corporation (AIMCo), the Caisse de dépôt et de the Finance and Markets Global Practice played placement du Québec (CDPQ), the Healthcare of essential roles in initiating and championing the Ontario Pension Plan (HOOPP), OPTrust, and the study, while offering helpful guidance about how to government of Ontario. adapt the lessons from the Canadian experience to the context of emerging economies. Second, we are grateful to the 25 pension professionals and experts who shared their deep Alex Mazer and Jonathan Weisstub, insights and experience with us through interviews Founding Partners, Common Wealth conducted to inform this study. A number of these Mahmood Nanji, interviewees, as well as other leaders in the pension Associate Deputy Minister, community, greatly enhanced the report by taking Ontario Ministry of Finance the time to review and provide thoughtful comments on earlier drafts. September 2017 Toronto, Canada ACKNOWLEDGMENTS | IX Executive Summary C anada is home to some of the world’s most admired and successful public pension organizations. This was not always the case. As recently as the mid 1980s, many Canadian public pensions were invested largely or entirely in domestic government bonds, were funded primarily on a pay-as-you- go basis, lacked independent governance, and were administered in an outdated and error-prone fashion. Over the past three decades, a “Canadian model” of public pension has emerged that combines independent governance, professional in-house investment management, scale, and extensive geographic and asset-class diversification. This report aims to document the emergence and evolution of this Canadian model, distilling practical lessons for stakeholders in emerging economies working to improve their pension arrangements and retirement systems. Although a growing body of literature exists on the Canadian model of pension organization, this report is unique in two respects: its emphasis on the evolutionary journey of Canadian pension organizations (as opposed to their current state) and its in-depth focus on Canadian pension funds that have received less attention than some of their peers. Methodology third parties, including experts or panels to consult This report was a collaboration between World stakeholders and make recommendations, have Bank staff, four participating Canadian pension sometimes proved to be a useful step in building funds (AIMCo, CDPQ, HOOPP, and OPTrust), the stakeholder trust and consensus in the early stages government of Ontario, and Common Wealth, a of the reform process. Toronto-based retirement security firm. The report Success in building a world-class pension is based on structured interviews that Common organization can be seen as a continuous cycle Wealth, together with a senior Ontario government consisting of three elements (see figure ES.1): official, conducted with 25 leaders in the Canadian (1), the building and maintenance of trust among pension field, including current and former pension a diverse range of relevant pension stakeholders; fund board chairs, trustees, chief executive officers (2) adherence to a set of pension design and (CEOs), and executive team members; pension management principles that cut across a variety of experts and advisers; and government officials.1 pension disciplines, including governance, people These interviews were supplemented with a review and organization, investment, administration, plan of relevant academic and “gray” literature. design and funding, and regulation and public policy; and (3) results-focused execution that puts Key lessons the principles into practice on a day-to-day basis The success of the Canadian model can be and delivers superior results. attributed to collaborations between diverse stakeholders—labor, government, business, and Strong, independent governance is perhaps the finance—in which each stakeholder performs the most important element of the Canadian model. role best suited to its expertise, and where there is Canadian pension organizations are governed to alignment around the shared interest of serving plan run as high-performing, arm’s-length entities that beneficiaries. Maintaining the buy-in and shared meet high standards of transparency, accountability, vision of these diverse stakeholders was critical and ethical conduct. Key steps to achieving not only during the founding stage of Canadian good governance include careful attention to the pension organizations, but also at each phase of organization’s constituting documents (for example, the organization’s evolution. The importance of framework legislation, sponsorship agreement), a stable, supportive stakeholder coalition should selecting a strong, independent-minded chair for not be underestimated. Government-appointed the founding or reform phase of the organization EXECUTIVE SUMMARY | XI Figure ES.1: Building a world-class pension organization (Lessons from Canada) St k hold r trust D si n nd m n m nt principl s Structures, processes, and leadership that build and maintain trust among relevant pension stakeholders Plan members • Align interests around • Independence Unions the best outcomes for Governance • Leadership Employers plan members • Accountability and transparency Stakeholder Government Trust- • Continuous and respectful engagement landscape Regulators building among relevant Plan trustees principles stakeholders • Each stakeholder People and • Top talent and integrity Plan managers organization • Competitive pay Service providers performs its highest and best function Market participants according to competencies • Comparative advantage Investments • In-house management • Diversification • Managed risks and liabilities • Client-focused orientation Stakeholder Design and trust management Administration • Modern technology Virtuous principles • High-quality communications and circle of trust education and performance • Sponsors with scale and mission Plan design and alignment funding • Realistic assumptions Execution • Risk sharing and prudent funding • Trust and autonomy Regulation and • Robust regulatory regime Living the principles on a day-to-day public policy basis and delivering superior results • Good governance encouraged over meaningful periods of time using a rigorous, transparent process, and organizations and has enabled them to avoid establishing a track record of independent decision distractions from political factors or activities making early in the life of the organization. The ancillary to the core goal. board, and especially the chair, should be willing Many of Canada’s top pension organizations to push back against potential infringements on the were quite unsophisticated as little as 20–30 years organization’s independence. Trust that is earned ago. The same organizations that today are regarded and maintained among the key stakeholders as as global leaders had little to no independent they work together goes a long way to building this governance, lacked investment diversification, independence. operated under strict investment limits, suffered Singularity of purpose is critical. Canadian from significant administrative errors and poor pension organizations are designed to be run like member service, and were considerably smaller in businesses, with a focus on delivering retirement terms of assets under management. The progress security for plan members. This focus has provided Canadian funds have been able to make over critical mission clarity to Canadian pension the past several decades should be a source of XII | THE EVOLUTION OF THE CANADIAN PENSION MODEL encouragement to emerging economies seeking to market circumstances, pension stakeholders in modernize their pension systems. emerging economies are also likely to face local conditions that will influence their pension design Despite this progress, the evolution of Canadian and management choices. The diverse experience pension organizations has taken time. Building a of exemplars of the “Canadian model” may be world-class organization can take decades, even in helpful to these stakeholders in choosing a path a global financial center such as Toronto. Earning toward improvement that best fits their unique local the trust of governments, the private sector, and circumstances. sponsoring organizations can be a slow, iterative process. By taking a phased approach to reform and A high-level, four-phase framework for the continuous improvement, stakeholders can achieve evolution of pension organizations has been a more realistic view of what is possible when and developed based on the Canadian experience (see of what to focus on at each stage. figure ES.2). The transition from phase 1 (“pre- reform entity”) to phase 2 (“a solid foundation”) The Canadian model could not have emerged is especially critical and deserves attention from without the leadership of certain key pension stakeholders in emerging economies. The individuals. Sound processes and design are framework also suggests an integrated approach to necessary but insufficient to build strong pension pension management and design, in which gradual institutions. They must be supplemented by the progress is made in each of the key elements of strong, ethical leadership of individual government running and overseeing a pension organization— officials, board members, union leaders, and including governance, investments, administration, pension and investment professionals. Building people and organization, plan design and funding, and continuously improving Canadian pension and the regulatory and public policy environment— organizations has required significant persistence and these elements are kept in alignment. through ups, downs, and unforeseen circumstances. Had these individuals not prioritized doing the right The quality of the people involved in Canadian thing in the long term over doing the comfortable pension organizations, has been a key driver thing in the short term, the Canadian model would of success. Talent—at the board, management, not have been born. and service-provider levels—is critical. Canadian pension funds recruit globally and provide Canadian pension organizations have not competitive, performance-based compensation to followed a straight path in their development. attract top-notch personnel. Integrity and the ability The Canadian model includes significant variation to navigate both the public and private sectors in organizational structure, investment approach, have also been distinguishing characteristics of and governance. The model’s evolution includes high-impact Canadian public pension leaders. missteps and course corrections along the way. For pension organizations located outside major Rather than offering a singular blueprint to follow, financial centers, a focus on long-term talent the Canadian experience offers a diversity of development is especially important. design choices within a broader set of principles. While experts disagree on the relative merits of The success drivers underlying the Canadian these design choices, the perfect pension should model are highly interrelated. This report identifies not become the enemy of the good pension. Just a set of principle-based lessons from the Canadian as the organizations profiled in this report were experience across the following six categories: shaped by external political, economic, and governance; people and organization; investments; EXECUTIVE SUMMARY | XIII Figure ES.2: Four-phase framework for the evolution of pension organizations 1 2 3 4 Independent, Mature, sophisticated Pre-reform entity A solid foundation professional entity with entity strong governance • Part of government—no • Reform strategy in place • Independent governance • Mature independent real independence or • Stakeholder buy-in to governance model Governance arm’s-length oversight reform • Earning trust of government and private sector • Low expertise or • Developing in-house staff • Ability to attract • Ability to attract global experience in external • External hires to fill gaps qualified professionals top talent People and best practice organization • Developing skills for • Strong program to • Ability to develop top • Limited procurement external sourcing develop internal talent quality internal expertise skills • Little diversification— • Begin to diversify • Diversified investments • Highly diversified T pic l ch r ct ristics sometimes 100% in investment • Increasingly competent investments Investment nonmarketed • Begin to build in-house investment • Sophisticated in-house government debentures investment expertise capabilities investment teams and 100% domestic • Inefficient and ineffective • Major administrative • Competent plan • Professional plan plan administration errors corrected administration administration Administration • Investment in systems to • Modern technology • Significant errors reduce costs and • Strong client service • Poor member service improve service • Pay-as-you-go or • Realistic understanding • Improved funding • Assets and liabilities well Plan design limited funding of liabilities • Realistic understanding balanced and funding • Little clarity on liabilities • Active dialogue on plan of assets and liabilities • Funding is sustainable sustainability • Sustainable funding target • Outdated or legacy • Updated legislation • Modern legislative • Proactive improvements legislation • Some investment framework in legislation and Regulation and regulation public policy • Strict investment limits freedom • Limited investment • Little political will for reform restrictions • No investment limits administration; plan design and funding; and facilitated by the stable, defined-benefit nature of regulatory and public policy environment. Yet few the pension plan designs that Canadian pension of these lessons can be seen in isolation from the managers are charged with administering. others. For example, Canadian funds are distinctive The “founding” stage of a new or reformed in their ability to invest directly in alternative asset pension organization can be the most critical. classes such as infrastructure, real estate, and private This report describes the stage as the transition equity. Yet this ability to invest directly requires a from a “pre-reform entity”—often a fully or number of conditions to be in place: (1) the right partially pay-as-you-go pension model that is sponsoring organizations and membership base to part of government, lacks diversification, and has provide sufficient scale; (2) the right governance inefficient and ineffective plan administration— structure to oversee a complex investment program; to a “solid foundation” in which key stakeholder (3) the organizational culture and compensation buy into a reform strategy, trust is being earned model to attract a talented in-house investment with both the public and private sectors, and major team; and (4) the long-term patient capital that is XIV | THE EVOLUTION OF THE CANADIAN PENSION MODEL administrative mistakes have been corrected. Challenges ahead Investments of time, energy, and resources in Despite their success to date, Canadian public this founding stage are likely to pay considerable pension funds face challenges ahead. These dividends in the years and decades that follow. challenges, many of which are similar to those The work during this stage can be thought of as a faced by pension organizations around the world, combination of developing pension management will shape Canadian pension organizations fundamentals and skillfully navigating a series of over the coming 5 to 10 years and will require diverse stakeholder relationships with government, continued innovation, leadership, and change at a plan sponsors, and the business community. management, governance, and public-policy level. Governments and the regulatory environment Seven challenges stand out: played a key role in creating the right environment • Lower expected returns and interest rates, over for Canadian public pension funds to succeed. the long term, will make it more difficult to Although Canadian pension funds tend to operate meet pension promises on a sustainable basis. independently from government today, the right This “low for longer” environment is leading government action and regulatory environment has funds to seek new investment strategies for been critical to the funds’ evolution. Framework achieving the required risk-adjusted returns. legislation, independent board appointments, increasingly hands-off investment rules, and • Pension plans are maturing, with active plan reforms to pension standards rules all are examples members supporting a rising number of retired of government action that helped facilitate the plan members. This too is putting pressure on emergence of the Canadian model. plan sustainability and raising questions of intergenerational equity. Plans are responding Canada’s investment in building top-performing by making plan design changes and seeking pension organizations has paid dividends. The new sources of membership. country’s top 10 public pension organizations now manage over $1.2 trillion in net assets, employ • The gap between those who have a good thousands of highly qualified professionals, and pension and those who do not is growing. compete for investment opportunities around the Many worry about a simmering “pension globe on behalf of Canadian pension beneficiaries. envy.” Governments have responded by The success of early adopters of the “Canadian enhancing public pension programs, including model” is also leading to expansion of that model the Canada Pension Plan. Some pension funds within Canada, including a recent enhancement are exploring plans to offer their services to to the Canada Pension Plan and ongoing reforms new constituencies. to improve the governance and management • The growth of Canadian pension organizations of public pensions across the country. A recent confers significant economies of scale but also analysis estimates that public pension funds using creates additional complexity as funds expand the “Canadian model” have added additional into new geographies and asset classes and value, relative to other comparable global funds, compete globally for attractive investment of $4.2 billion annually over the past 10 years.2 opportunities. Staying focused on comparative Canadian public pensions have also managed to advantage and seeking partnerships are two avoid the funding crises and the crippling impact ways that pension funds are navigating this on government budgets that have been seen with complexity. public pensions in other jurisdictions. EXECUTIVE SUMMARY | XV • As they grow, Canadian funds are likely to investment and funding risk. They have also face increasing scrutiny and thus need to sought to build more proactive relationships continuously demonstrate value for money. with governments and regulators to avoid knee- Continuing to build trust with governments, key jerk reactions to future crises. stakeholders, and the public and maintaining strong accountability, transparency, and ethics Opportunities for collaboration measures will be crucial in responding to this with emerging economies scrutiny. Deeper collaboration between Canadian pension • The regulatory environment presents two funds and pension stakeholders in emerging challenges. First, Canada’s regulatory economies could be of mutual benefit. It could environment remains fragmented, and its enable Canadian funds to build local knowledge and existing regulators have not always kept up partnerships to assist them in investing in emerging with the increasing sophistication of Canadian economies, and it could help emerging economy pension funds. Second, the global regulatory stakeholders to incorporate the most relevant, environment, particularly in the wake of the practical lessons from the Canadian experience into 2008–9 global financial crisis, has become a program for reform and continuous improvement. more complex and uncertain. Such collaboration could take the form of exchange programs, secondments, participation in capacity- • The next major market downturn or financial building engagements (including World Bank– crisis will test the investment strategies and sponsored projects), joint ventures, or formal governance models of Canadian pension funds. partnerships between Canadian pension institutions Since the global financial crisis, Canadian and pension institutions in emerging markets. funds have increased their focus on managing XVI | THE EVOLUTION OF THE CANADIAN PENSION MODEL EXECUTIVE SUMMARY | XVII Section 1 Context Who this Report is for T his report is for those with a stake in building better pension institutions. Its primary audience is the wide range of stakeholders in emerging economies that wish to deliver retirement security in a more efficient and sustainable manner. The report is designed to support and enhance the World Bank’s extensive capacity-building work with these stakeholders. Such stakeholders include governments, regulators, pension managers, central banks, labor leaders, pension trustees and governors, Social Security administrators, and private-market participants that support pensions and retirement systems. This report is intended to offer a practical guide for these stakeholders, both individually and collectively, to assist them on their journey toward better pension systems. We hope the report will also be useful for a including those as financially sophisticated as New similarly broad range of stakeholders in developed York City, have looked to the Canadian approach economies, including in Canada itself. We believe as a blueprint for pension reform. Delegations from the Canadian experience, and the leaders who every continent frequently travel to Canada to learn contributed to it, can offer much to anyone involved from the country’s top public pension organizations. in the task of delivering retirement security through Although not the largest in the world, Canadian pension plans or similar vehicles. public pension funds feature prominently in global rankings and constitute a large portion of Why study the Canadian Canadian retirement-specific assets. According to Pension Model? a 2015 Boston Consulting Group study, “Investing Canada’s largest public pension funds have attracted for Canada on the World Stage,” eight Canadian considerable attention in recent years. Global pension funds ranked in the top 100 global funds by publications such as the Economist3, Fortune4, and size and three of the funds were in the top 20.6 The the Financial Times5 have highlighted the unique 10 largest Canadian public pension funds manage approach and success of these growing public assets of over $1.2 trillion.7 The net assets of these pension institutions. Jurisdictions around the world, pension funds tripled between 2003 and 2015, including the period of the global financial crisis.8 Figure 1.1: Assets under management for the top 10 Canadian pension funds have more than tripled since 2003 Net assets under management ($ billion) 1400 1200 1000 1214 800 600 400 200 354 0 2003 2005 2007 2009 2011 2013 2015 Section 1: CONTEXT | 1 The case for studying the “Canadian model” Board (CPPIB). Less known and documented are is founded not only on the reputation and size the stories of other high-performing Canadian of Canadian pension plans. It is also rooted in pension organizations, including the four evidence. profiled in this case study: Alberta Investment Management Corporation (AIMCo), the Caisse The performance of Canadian pension institutions de dépôt et de placement du Québec (CDPQ), has been strong. Two Canadian pension funds— HOOPP (Healthcare of Ontario Pension Plan), and Ontario Teachers’ Pension Plan (OTPP) and the OPTrust, which administers the Ontario Public Healthcare of Ontario Pension Plan (HOOPP)—have Service Employees Union pension plan. Further, recently ranked first among global peers for their much of the documentation on the Canadian 10-year net investment performance, according to pension model focuses on current characteristics of CEM Benchmarking. Canadian pension funds have Canadian funds, including sophisticated programs also contributed to respectable ranking for Canada in to invest directly in alternative asset classes such the Melbourne Mercer Global Pension Index, which as private equity and infrastructure, rather than in 2016 ranked the Canadian pension system 8th on the origins and evolutionary path of these among 27 developed countries, giving the system institutions. Although studying the current state a high score for integrity and above-average scores of Canadian pension institutions can be useful, for for adequacy and sustainability. A recent analysis emerging economy stakeholders it is likely more by pension expert Keith Ambachtsheer and CEM instructive to go back further in time and examine Benchmarking estimates that public pension funds how these institutions were founded and how using the “Canadian model” have added additional they evolved. With this in mind, the study that value, relative to other comparable global funds, of follows provides an in-depth look at the evolution $4.2 billion annually over the past 10 years.9 of several Canadian pension funds and endeavors The core characteristics of the Canadian pension to offer lessons for emerging economies seeking model, articulated in more detail in the next section, to improve their retirement systems and public have been demonstrated to improve performance. pension institutions. Strong, independent governance is often cited by experts as a driver of outperformance.10 In- Defining the Canadian house investment management tends to result in improved returns after taking costs into account.11 Pension Model Pension portfolios that are highly diversified by What is the “Canadian pension model”? There both geography and asset class tend to achieve is no universally accepted definition, aside from better results.12 Pension funds with sufficient scale the fact that it nearly always refers to Canada’s are able to drive down costs and obtain access to larger public pension funds. This study defines the differentiated investment opportunities, improving Canadian model as a public pension plan or public investment outcomes.13 asset manager that is typically defined-benefit, has at least one public sector sponsor or sponsors, and Academics, scholars, practitioners, pension has the following characteristics: experts, and research institutes have produced seminal pieces on the Canadian pension system • Independent governance. This is perhaps and pension funds.14 While the literature on the primary characteristic of the Canadian Canadian pension funds is growing, much of it pension model. Although many of the public has focused on larger, better-known funds such pension funds have government as a sponsor as OTPP and the Canada Pension Plan Investment or contributor, funds operate at arm’s length of 2 | THE EVOLUTION OF THE CANADIAN PENSION MODEL governments and sponsors and are overseen by applicable to plans in the private sector and with independent boards that have a fiduciary duty defined-contribution or target-benefit plan designs. to the plan members and operate within strong accountability and transparency frameworks. The Canadian Retirement • Scale. Assets under management exceed $10 System billion and are often significantly higher. Canada has had a long history of improving • In-house management by professionals. retirement income security for its citizens. Canadian funds have evolved to have a Workplace pension plans provided by employers significant portion of their investment can be traced back to the middle of the 19th management, pension administration, or both century. Then, in 1919, the federal government performed by in-house professionals who introduced income tax legislation to encourage receive competitive compensation. implementation of workplace pension plans. Concerned with increasing poverty rates among • Diversification. Canadian pension funds are seniors, the federal government began to introduce highly diversified by both geography and broad-based retirement programs in the early asset class, including a significant allocation 1950s with Old Age Security (OAS), a tax- to alternative asset classes such as real supported income-assistance program for seniors. estate, private equity, and infrastructure and In 1966, the Canadian government established the significant direct investments in such asset Canada Pension Plan and the Québec government classes. According to a recently released established the Québec Pension Plan, contributory study by PwC, Canadian pension funds have programs intended to supplement OAS. In 1967, a higher exposure to alternatives than large the Canadian government created the Guaranteed pension funds in Australia, the Netherlands, Income Supplement (GIS), a targeted tax-supported the Nordic countries, the United Kingdom, program for lower-income seniors. Since then, and the United States.15 significant reforms have been made to the retirement • Talent. Through a combination of a compelling income system to ensure that Canadians have mission, competitive compensation, and adequate income in retirement to enjoy the same intellectually stimulating work, Canadian standard of living as when they were working and pension institutions have been successful in to secure the sustainability of existing programs. attracting and retaining top talent from around As in most member countries of the Organisation the world at both the board and management for Economic Co-operation and Development, levels. Canada’s retirement income system can be • Long time horizon. Canadian pension funds characterized in terms of three main components or are long-term investors able to withstand short- “pillars” (see figure 1.2). Pillar I provides a basic term market volatility. income guarantee for seniors through two publicly financed programs, OAS and GIS. OAS is paid at age Pension organizations or systems need not share all 65 to Canadians who meet residency requirements. the characteristics of their Canadian counterparts The maximum annual benefit is $6,800 (2016). to benefit from the lessons in this report. Although For those with earnings greater than $73,800 Canada’s most successful pension organizations (2016), OAS benefits are reduced and eventually tend to be in the public sector and have defined- eliminated. GIS is an income-tested program that benefit plan designs, their lessons are also provides additional income to seniors who reside Section 1: CONTEXT | 3 in Canada and live in lower-income households. These are contributory plans that require a To be eligible for GIS benefits, which assist about combined employer-employee contribution of 9.9 one-third of Canadian seniors, individuals must be percent (10.5 percent for QPP) of earnings between receiving OAS benefits. The maximum annual GIS $3,500 and the year’s maximum pension earnings benefit is approximately $9,300 (2016) for a single ($56,900 in 2016), shared on a 50/50 basis. These senior and $12,300 (2016) for senior couples. plans aim to replace 25 percent of pensionable The GIS benefit is reduced by 50 cents for every earnings, and the benefits are portable throughout dollar of retirement income received from sources Canada and can be drawn at age 65. They can other than OAS. Seniors no longer qualify for GIS also be drawn earlier and or later using reduced or when their annual income in retirement exceeds increased payment formulas. The maximum annual approximately $17,300 (2016) for single people retirement benefit from CPP/QPP is approximately and approximately $22,800 (2016) for couples. $13,000 (2016) annually. Pillar II includes the Canada Pension Plan (CPP) and Pillar III of the Canadian system consists of Québec Pension Plan (QPP), which are mandatory workplace pensions and private savings plans earnings-related programs for the employed and that allow for additional earnings replacement in self-employed in Canada and Québec. CPP and QPP retirement. These include registered pension plans provide a range of benefits including retirement, (RPPs) with an employer, union, or other sponsor; survivor, and disability benefits, as well as benefits individual or group Registered Retirement Savings for children of deceased and disabled contributors. Plans (RRSPs); and, since 2009, Tax-Free Savings Figure 1.2: The three pillars of the Canadian retirement income system Canadian retirement income system Pillar I Pillar II Pillar III • Old Age Security • Canada Pension Plan • Workplace pension plans • Guaranteed Income • Québec Pension Plan Defined benefit Programs Supplement Defined contribution • Other government funded (including PRPPs) programs (such as Spouses • Tax-assisted private savings Allowance) (such as RRSPs, TFSAs) • Paid from general revenues • Mandatory and universal • Voluntary Characteristics • Based on income, age, coverage • Privately administered years of residence • Earnings based • Minimum standards set • Partially prefunded in each province and federally based on employment sector Note: PRPP = Pooled Registered Pension Plan; RRSP = Registered Retirement Savings Plan; TFSA = tax-free savings account. 4 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Accounts (TFSAs). All of these vehicles offer has ended up winning the day. Until June 2016, favorable tax treatment. Ontario was set to implement a new mandatory pension plan, the Ontario Retirement Pension Although the retirement income system has Plan, which was expected to cover more than 4 generally served Canadians well in reducing million participants and provide up to $13,500 the poverty levels of seniors, concern has been annually in additional income to contributing growing in recent years about the system’s future members at retirement. Ontario’s efforts to effectiveness. As in many countries, workplace implement a provincial government-sponsored pension coverage, particularly in the private sector, pension arrangement played a significant role has steadily declined over recent decades. Further, in catalyzing an agreement between the federal a number of studies, including those commissioned government and the provinces and territories. In a by federal and provincial governments, have deal that was nearly a decade in the making, the shown that a significant minority of Canadians are Canada Pension Plan will be enhanced effective not on track to maintain their standard of living in 2019 to provide members up to an additional 8.3 retirement.16 percent in replacement income or approximately Against this backdrop, Canada has experienced a $12,000 annually. Under the enhanced CPP, which vigorous policy debate over nearly a decade about will see both employee and employer contributions what actions government should take to address the increase, a worker contributing to the national plan retirement adequacy and coverage challenge. The for 40 years would receive almost $25,000 annually expansion of mandatory public pension programs (figure 1.3). Figure 1.3: Recently agreed-upon enhancement to Canada Pension Plan benefits 33% CPP+ phase 1 2019–23 Replacement rate 25% CPP+ phase 2 Current CPP 2024–25 ~55 ~83 Earnings ($ thousands) (in 2025) Note: CPP = Canada Pension Plan. Section 1: CONTEXT | 5 Section 2 Origins of the Canadian Pension Model T he Canadian model of public pension organization has its origins in the 1980s and 1990s. The model arguably began in Ontario and then spread across the country. In the mid 1980s, larger Canadian public pension The late 1980s kicked off a period of significant organizations took a variety of forms. A number reforms to Canada’s public pension organizations. of large public pension organizations—including There were two major inflection points: first, the HOOPP, Ontario Municipal Employees Retirement Ontario reforms that led to the creation of OTPP; System (OMERS), and CDPQ—were already and second, the reforms to the CPP and the creation investing in markets and were in a process of of CPPIB (figure 2.1). diversifying their portfolios. Other organizations, including the organizations that would later become Ontario’s Public Pension OTPP and OPTrust, were invested entirely in nonmarketable government debentures and had no Reforms and Ontario true independence from government. The Canada Teachers’ Pension Plan Pension Plan was set up as a largely pay-as-you-go The late 1980s was a period of intensive pension plan, and provinces were entitled to use the CPP as reform in Ontario. In 1987, the provincial a captive source of borrowing.17 government reformed its pension benefit standards Figure 2.1: Key moments in the evolution of the Canadian model Emergence of a uniquely Canadian pension model 2016 1963 1966 1990 1999 CPP OMERS • CPP created OTPP • bcIMC created benefits created • QPP created created • PSPIB created enhanced 1960 1970 1980 1990 2000 2010 1960 1965 1995 1997 2008 2017 HOOPP CDPQ • OPTrust • CPPIB created AIMCo Investment created created created • CPP premiums created Management raised Corp of Ontario launched Note: OMERS = Ontario Municipal Employees Retirement System; HOOPP = Healthcare of Ontario Pension Plan; CDPQ = Caisse de depot et placement du Québec; CPP = Canada Pension Plan; QPP = Québec Pension Plan; OTPP = Ontario Teachers’ Pension Plan; CPPIB = Canada Pension Plan Investment Board; bcIMC = British Columbia Investment Management Corporation; PSPIB = Public Sector Pension Investment Board; AIMCo = Alberta Investment Management Corporation. Section 2: ORIGINS OF THE CANADIAN PENSION MODEL | 7 legislation, modernizing rules and introducing These recommendations eventually led to the additional member protections. The government transformation of teachers’ and public servants’ then turned its attention to public sector pension pensions in Ontario into three professional pension plans, with a focus on the pensions of teachers and organizations: OTPP, OPTrust, and the Ontario public servants. These pensions were run on a partial Pension Board. The first of these to be formed, and pay-as-you-go model in which indexation was not the organization most often credited as pioneering prefunded. The government became concerned the Canadian public pension model, was OTPP. that these public sector pensions could become an Several key steps were involved in establishing insurmountable fiscal burden on government unless OTPP as an arm’s-length, professional pension they were reformed. Public sector pensions had organization. First, the government introduced also become a contentious political issue and were legislation that created OTPP as an independent the impetus for protest and intense political debate institution, including providing for an arm’s-length during that era.18 board. Second, a sponsorship agreement was The government began by commissioning three negotiated between the teachers’ unions and the expert reports—one on the investment of public government. Third, the government appointed a sector pension funds (the Rowan Report), one on respected former governor of the Bank of Canada the financing of pensions for teachers and public (the country’s independent central bank), Gerald servants (the Coward Report), and, following Bouey, to serve as the founding chair for the new the first two reports, a third report synthesizing organization. In accepting the role, Bouey insisted stakeholder consultations on the two previous that the new organization be run independently reports and recommending a path forward (the Slater from government.20 Fourth, through a professional, Report). The Rowan Report recommended setting arm’s-length selection process, the new board chose up public sector pension funds as arm’s-length actuary and insurance executive Claude Lamoureux entities independent of government and allowing to serve as the plan’s founding CEO. Lamoureux those entities to diversify their portfolios by envisioned a pension plan run “like a business.” investing in markets. The Coward Report identified He moved quickly to hire an experienced executive multibillion-dollar unfunded liabilities in Ontario’s team (including CIO Robert Bertram), invest public pension arrangements and recommended a more of the plan’s assets in public equities, and transition from a partial pay-as-you-go plan to a modernize the plan’s administration and member fully funded pension-financing model. The Slater service, which were outdated and riddled with Report identified sufficient stakeholder consensus errors, and a frequent source of complaints from to move forward with pension reforms that would plan members.21 move the plans in the following direction:19 OTPP made several other pathbreaking moves • Joint trusteeship and governance following its founding years, including direct investing in private equity and infrastructure and • Joint sharing of risks and rewards between the acquiring real estate subsidiary Cadillac Fairview. government and plan members With over $175 billion in net assets, over 1,000 • Investment of the plan’s funds in the market employees, a fully funded status, and a 10.1 percent annualized rate of return since 1990, OTPP is now • Arm’s-length organizations that would operate well known globally as one of the world’s leading independent of government pension organizations.22 8 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Reforming the Canada minister of finance. The legislation allows the minister to establish a nominating committee to Pension Plan and the advise on board appointments, and the process Establishment of CPPIB also involves consultation with provincial finance ministers given the role of provinces as joint In the mid 1990s, Canada’s federal and provincial stewards of the CPP.25 Only the Governor in governments successfully passed a series of Council may remove a director for cause. reforms to the CPP. The reforms were catalyzed by mounting evidence that the CPP was becoming • A single mandate to maximize long-term, risk- unsustainable. The plan’s modest reserve fund was adjusted returns on CPP assets running out, and its investments were restricted to • Accountability and transparency measures nonmarketable federal and provincial government including regular public reporting debt. Concerns about intergenerational inequity— heavy subsidies from younger generations to A nominating committee was formed to seek out older generations—were mounting. A 1995 report the CPPIB’s initial board directors. Gail Cook- from the chief actuary of Canada found that the Bennett, a management consultant, economist, and CPP would run out of funds within 20 years if no experienced board member who had previously reforms were made. The mid-1990s reforms to the served on the OTPP board, was selected as the CPP put the plan on a sustainable footing by raising chair. In the early days, Cook-Bennett said, the contribution rates and reducing benefits. They also board put considerable emphasis on codifying the resulted in the creation of CPPIB, an arm’s-length values of the organization: “We spent a lot of time professional investment organization tasked with on transparency, openness, and values, including investing the CPP’s assets. The remarkable story developing a code of conduct. This very, very of how 11 governments came together to achieve careful work by the governance committee served these reforms has been well documented by Bruce as an ideal foundation for the organization.”26 Little in his book Fixing the Future: How Canada’s In those early days, CPPIB also focused heavily Usually Fractious Governments Worked Together on earning the confidence of both the public and to Rescue the Canada Pension Plan.23 private sectors. Building a strong reputation across sectors was crucial, Cook-Bennett said, because Part of the reform agreed to by Canada’s federal many were skeptical that the organization would be and provincial governments was to create an truly arm’s-length.27 independent investment organization to manage the CPP’s assets. Examples of other public sector CPPIB received its first injection of funds—a funds that had recently moved to this type of model, cheque for $12 million—in 1999. Based on the especially OTPP, helped give policy makers comfort organization’s structural comparative advantages— that such a model could work. The organization long-term horizon, scale, and certainty of assets— created by CPPIB’s founding legislation had the the board determined that it could add value following features, which continue to this day: through active investment management. Initially, regulation restricted CPPIB to passive investments • Joint oversight shared between the federal in domestic equities, but the government lifted this government and the governments of Canada’s restriction shortly after the organization’s inception. provinces CPPIB made its first private-market investments in • A board whose directors are appointed by Governor 2001 and its first commitments to real estate and in Council24 on the recommendation of the federal infrastructure in 2003.28 Section 2: ORIGINS OF THE CANADIAN PENSION MODEL | 9 Today CPPIB manages $317 billion, employs • Leaders in both the public policy and pension nearly 1,400 professionals in eight offices around and investment spheres were able to harness the globe, and has a highly diversified investment these crises and create an opportunity to build program that includes public equities, fixed income, world-class organizations and enact sensible real estate, infrastructure, private equities, and pension reforms. credit investments. CPPIB has earned a reputation • Both the Ontario reforms and the CPP reforms as a best-in-class investment organization and is in the mid-1990s involved extensive public, frequently studied by governments and pension expert, and stakeholder consultation to and investment professionals from around the build alignment around a vision for reform. world, as evidenced by CPPIB’s recent partnership What could have been polarizing political with China around issues of pensions and aging.29 issues became the subject of collaborative, As with OTPP, CPPIB’s story and approach to constructive work among diverse leaders and governance and investment have been thoroughly stakeholders. documented elsewhere.30 • As we will see in greater detail from the case What Accounts for the studies, the experience and success of first- mover “Canadian model” institutions helped Emergence of the Canadian establish the necessary stakeholder comfort Model? to create more such institutions, eventually Why did the Canadian model emerge in the first building a vibrant pension and public place? The preceding origin story leads to the investment “ecosystem” in Canada. following observations: • A pension funding/fiscal crisis was the core motivation behind the creation of the reformed Ontario public sector funds, including OTPP, and the creation of the CPPIB. 10 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Section 2: ORIGINS OF THE CANADIAN PENSION MODEL | 11 Section 3 Fund Case Studies T his section profiles four different examples of the Canadian pension model: AIMCo, CDPQ, HOOPP, and OPTrust. The case studies in this section highlight the similarities and differences among examples of the Canadian model. Perhaps most important, they emphasize the variety of ways in which pension organizations employing variations of the Canadian model have evolved. Overview The four organizations profiled share the chief by both asset class and geography. Each has characteristics of the Canadian model, as defined decreased its “home bias” over time. earlier in this report. • Talent. Each of the organizations has • Independence. All four operate at arm’s length demonstrated the ability to attract and retain from government. Both key strategic decisions world-class pension professionals and has put a and day-to-day operational decisions are great deal of emphasis on building a long-term made by independent boards and management pipeline of talent. teams. This does not mean, however, that • Long time horizon. All four funds profiled the organizations operate in isolation from view themselves as long-term investors. government. As we will see from the case Their main client base consists of members studies, government has a role to play with of defined-benefit pension plans in the public respect to each of the funds, which themselves sector, giving them the contribution certainty to are public sector organizations. invest for the long term. • Scale. All four have assets under management Despite the common characteristics among the four exceeding $15 billion, allowing them to make funds profiled, they also have important differences direct investments and build talented, in-house between them. Key areas of differentiation include teams that smaller pension organizations the following: would be unable to build. Collectively, the four organizations manage about $460 billion • Size. The largest of the four organizations, in assets, while supporting the pensions of CDPQ, has over 10 times the net assets under roughly 6 million members.31 management of the smallest organization, OPTrust ($271 billion vs. $19 billion). • In-house management by professionals. Collectively, the four organizations manage the • Mission and mandate. CDPQ and AIMCo are majority of their assets in-house as opposed to focused strictly on asset management, whereas through external managers. All four provide HOOPP and OPTrust serve as integrated pension their in-house professionals with compensation delivery organizations, managing both the assets that is intended to be competitive with the and the liability side of the balance sheet. The private sector. Each of the four organizations organizations also differ in their investment also makes significant direct investments in mandates. AIMCo focuses on maximizing long- external asset classes, including infrastructure, term return on risk.32 HOOPP’s and OPTrust’s real estate, and private equity, although not all investment goals focus on paying pensions of the funds participate in every one of these or liability management. CDPQ has a dual asset classes. investment mandate: it seeks both to maximize return on capital and to contribute to Québec’s • Diversification. Each of the four funds has an economic development.33 investment portfolio that is highly diversified Section 3: FUND CASE STUDIES | 13 • Asset allocation. While each of the funds later became part of what is understood to employs a highly diversified portfolio, their constitute the Canadian model. These include approach to asset allocation and portfolio pooling assets (HOOPP was established as a construction varies considerably. HOOPP’s multiemployer plan for the Ontario hospital portfolio is more heavily weighted to fixed sector from the very beginning), investing in income than the other funds profiled. Whereas certain alternative asset classes (CDPQ began CDPQ and OPTrust are putting increasing investing in private equity in 1971 and acquired emphasis on investments in emerging markets its first office building in 1980), and establishing investments (for example, CDPQ recently independence from government (despite the opened an office in India), AIMCo and HOOPP fact that its employees are in the public sector, have largely kept their investment efforts to HOOPP has always operated as a private plan, developed markets (for example, HOOPP and the government has never been a sponsor has no employees outside Toronto). Whereas of the plan). By contrast. AIMCo and OPTrust CDPQ, AIMCo, and OPTrust have invested are newer entities. OPTrust recently marked significantly in infrastructure, HOOPP has its 20th anniversary and AIMCo is less than a stayed away from infrastructure as an asset decade old. The reasons each organization was class, although it does make some direct formed also vary. CDPQ’s founding was rooted investments in real estate and private equity. in local economic development and economic independence for Québec. HOOPP was • History and origins. CDPQ and HOOPP are founded as a private initiative of the Ontario over half a century old and have had more time Hospital Association to achieve efficiencies and to mature as organizations. Both have been pension portability within the sector. OPTrust influenced by, and have evolved as a result was formed out of a union sponsor’s desire to of, the emergence of a distinctly “Canadian” have a shared say in how its members’ pension model of pension plan in the 1990s. However, plan was managed. AIMCo was founded in an they also predated that model by a significant effort to bring efficiencies to Alberta’s pension amount of time and were instituting some and public asset management. procedures well before the 1990s that Figure 3.1: Asset mix of select Canadian pension funds 100% 4% 5% 11% 8% 90% 80% 28% 41% 30% 70% 37% Infrastructure 60% Real estate 50% 36% Fixed income 40% 35% 54% 30% 36% Public equities 20% 15% Private equity 13% 10% 11% 11% 13% 5% 7% 0% 14 | THE EVOLUTION OF THE CANADIAN PENSION MODEL The four funds were chosen for review in this study financial crisis presented its share of challenges, but for two main reasons. First, the variation among almost a decade later AIMCo appears to be thriving. them will, we hope, make their experiences relevant AIMCo manages over $100 billion in total assets, to a wide range of global pension stakeholders, with pension assets account for almost 60 percent who themselves operate with a wide variety of of the total assets, or approximately $60 billion, aspirations and constraints. Readers will be able making the organization the eighth largest public to choose the examples most relevant to their pension asset manager in Canada.34 AIMCo situations, considering local conditions, assets, has over 400 employees in four offices with its and political dynamics (see figure 3.1). Second, as headquarters in Edmonton and satellite offices in noted earlier, the four funds profiled here have been Toronto, London, and Luxembourg. studied less than more well-known examples of the Canadian model such as OTPP and CPPIB, whose AIMCo invests on behalf of 32 separate Alberta- approach and evolution have been well documented based public entities, including public sector in both academic and nonacademic literature. pension plans, the Alberta Heritage Savings Trust Fund (a resource revenue savings fund), AIMCo Case Study endowments, government funds, and other special- purpose funds. Each of these entities has unique Established in 2008, AIMCo is among the newest circumstances and investment-return requirements. public pension managers in Canada. Building the This, in turn, affords AIMCo the opportunity to new crown corporation a few months before the manage multiple client relationships. See figure 3.2. Figure 3.2: Assets under management for the top 10 Canadian pension funds have more than tripled since 2003 Overview Governance Investment • Established in 2008 • Established by an act of the Alberta Legislature as Assets • Manages investments of 32 clients, including a Crown corporation public sector pension funds, • 11-member board, all $100 billion endowment funds, and independent directors government funds, appointed by Alberta including the Alberta government Annualized return since Heritage Fund • By legislation, board inception (8 years) • ~60% of investments are members must have on behalf of Alberta public sector pension plans experience in investment management, finance, 8.6% accounting, or law, or have served as an executive or director with a large, publicly traded company Section 3: FUND CASE STUDIES | 15 AIMCo is a global investor with an active board as the bedrock of supporting a world-class management investment strategy aimed at generating organization. Indeed, Uebelein identified the quality long-term sustainable returns. Since 2009, it has of the board as a critical factor in providing comfort generated average annual returns of 8.6 percent. that AIMCo has and would continue to aspire to be Expressed differently, since 2009, $49 billion of world class in orientation.36 AIMCo’s growth can be attributed to growth from The creation of AIMCo emerged from the Capelle its net investment returns, $4.2 billion of which was Report commissioned by the Alberta Finance “value added” over and above relevant benchmarks Department in 2005 (see figure 3.3). The report (net of expenses). A significant portion of its examined various governance and organizational investments—nearly a quarter of its portfolio—is options and ultimately recommended that to achieve allocated to illiquid markets, including infrastructure, “investment excellence,” it was important to move private equity, and real estate. the investment management function outside To be effective in active management, AIMCo’s government and establish a separate arm’s-length CEO Kevin Uebelein believes there are five key corporation. In 2007, the government moved forward prerequisites: (1) people and tools; (2) low cost; (3) with the creation of the corporation highlighting appropriate risking taking; (3) stable/ patient capital; that the goal was to improve governance, increase and (5) proper incentives. Complementing these flexibility, and generate opportunities for greater requirements are two essential “enablers”—scale investment returns by 25 to 100 basis points (0.25 and good governance—and two “advantages”— percent to 1 percent) for Alberta’s various funds. reasonable regulation and cooperation and risk To ensure that the Corporation would achieve the sharing among public sector funds.35 desired results, the government appointed a blue ribbon board with directors from both within and Independent governance and outside Alberta. One of the most important decisions multiclient asset manager that the government made was to appoint former The governance of public sector pension funds in Toronto Dominion Bank CEO Charlie Baillie as its Alberta can be described as both centralized and first chair. Baillie was trusted by the government, distributed. The minister of finance is technically the and there was confidence that he would be able to owner or trustee of most of AIMCo’s clients. AIMCo manage the delicate governance structure. By all manages the assets, and all functions related to the accounts, that was a successful choice. administration of benefits are delegated to the Alberta Pension Services Corporation. In addition, pension AIMCo was created by the Alberta Investment clients such as the Alberta Local Authorities Pension Management Corporation Act as a board- Plan Corporation and other organizations provide governed provincial corporation. Under the act, the strategic guidance for the pension plans, including corporation’s budget is approved by the government setting the investment policy and guidelines. and it is audited by the auditor general. This would Chris Brown, president and CEO of Alberta Local give the appearance of limited autonomy. However, Authorities Pension Plan Corporation, AIMCo’s since its inception, AIMCo has acted at arm’s largest client, noted that three elements are critical length from the government while recognizing to making all of this work: (1) a strong board; (2) the importance of the role of the government’s an understanding of the need for client service; and oversight. This oversight, according to all of those (3) AIMCo’s independence from the government. interviewed, has not affected investment decisions, Uebelein underscored the importance of a strong recruitment of senior executives, compensation frameworks, or other operational matters. 16 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Figure 3.3: Key moments in AIMCo’s evolution 2009 2010/11 2017 Opens office Builds in- • AUM xc ds in Toronto house $100 billion for investment 32 cli nts capacity • Op ns offic in Lux mbour 2005 2010 2015 2005 2008 2014 2015 Capelle Report • AIMCo Office opens Managing recommends established in London, assets for independent • First CEO UK 31 clients investment management hired organization Figure 3.4: AIMCo: notable assets and recent transactions Yorkdale Shopping Autopista Central, Chile Centre, Toronto Vue Entertainment, UK • 2011 investment, 50% stake • Partnership with • 2013 investment Oxford Properties Group • Part of consortium led • World’s largest cinema by Abertis • Two major expansions chain; operations underway to add throughout Europe, • Infrastructure (Spanish 600,000 sq ft to existing focus in United Kingdom, corporation) 61-km, 1.4 million footprint Germany and Poland six-lane private highway in Santiago • 50% partner with • Active management for OMERS on $1.5 billion transaction five years; sold in 2016 for $1.5 billion Section 3: FUND CASE STUDIES | 17 While the focus of AIMCo in the early days was to Attracting top talent improve investment performance, today a broader Before the creation of AIMCo, Alberta’s pension approach engages AIMCo’s clients more actively in funds were managed by a dedicated unit (Investment investment decisions. Under Uebelein’s leadership, Management Division) within the Alberta Ministry AIMCo has adopted a “Client First” philosophy, of Finance. Although the ministry did an admirable which he describes as “working to build a constant, job of managing a sizeable portfolio of assets over multifaceted dialogue with our clients, creating several years, it was thought that salaries needed optimal transparency to them regarding what we to go up to attract and retain the best talent and are doing and affording us with the best possible that step required the organization to be removed understanding of their needs and opinions.”37 from government, according to Lowell Epp, More concretely, this means developing stronger assistant deputy minister, Alberta Treasury Board relationships between AIMCo and its clients and and Finance (who brings the perspective of 16 having AIMCo’s investment teams work more years of government service).40 An added benefit closely with their clients to develop appropriate of removing the organization from government investment portfolios that consider the risk and return was that AIMCo no longer needed to compete for characteristics so that they can meet those targets. resources with other government priorities, a change As AIMCo’s Chief Investment Officer Dale that enabled it to make proper investments in new MacMaster points out, although this is the right information technology systems and operations. thing to do, the challenge that a multiclient asset To become a world-class institutional investor, manager faces is developing an appropriate asset AIMCo recognized from the outset that it would need allocation given the different investment strategies to have a team of top talent with global experience. of its clients. Interestingly, MacMaster notes that This remains a priority today. Attracting top talent AIMCo’s clients are increasingly looking for less is commonly understood to be a critical element volatile, more illiquid, longer-duration investment to building an effective in-house capacity that is strategies, a preference that has led AIMCo to create expected to generate superior returns at lower cost. strategies to support those client demands.38 AIMCo has always felt comfortable investing in Alberta and AIMCo has deployed several strategies to attract, in the past several years has benefited from Alberta’s retain, and develop talent. First, for its senior enjoying the highest growth rate in Canada. Key executive positions and particularly for the CEO drivers of investment success that MacMaster position, the board, with the assistance of external highlighted were to (1) focus on recruiting high- advisers, has conducted a global search to find performing, creative, entrepreneurial staff; (2) the best and most suitable candidate. This was the maintain a client-centric approach; (3) approach its case in the hiring its first CEO, Leo de Bever, who work with humility; (4) build investment programs had extensive experience with Victorian Funds (particularly in public equities) that allow access to Management Corporation, Manulife, and OTPP. It cheap “beta,” largely through thoughtful in-house was also true in the recruitment of the current CEO, management; (5) have the discipline to do some Uebelein, who also has extensive global investment direct investing in alternative asset classes first in and executive experience. Uebelein noted that their “own backyard” before extending over time moving from Boston to Edmonton was not to the United States, Europe, and elsewhere; and something that he had envisioned, but the unique (6) maintain the longevity of both strategy and the opportunity to lead a world-class institutional senior management teams of various investment investor was most appealing to him.41 Importantly, verticals.39 as Epp observed, there has been no interference by 18 | THE EVOLUTION OF THE CANADIAN PENSION MODEL the government of Alberta in the selection of either learn from more experienced professionals. Indeed, the first or the second CEO of AIMCo.42 he identified the growth of its own “farm team” as critical to achieving “sustainable alpha returns.”43 Second, AIMCo has put into place a competitive This approach appears to be paying dividends. compensation structure that enables it to recruit and retain top investment, corporate, and operating professionals who are capable of managing and CDPQ Case Study delivering a superior risk-adjusted return on the CDPQ was established in 1965 by an act of the $100 billion of client assets under management. The Québec National Assembly (figures 3.5 and 3.6). corporation’s compensation philosophy follows Initially created to manage the funds of the Québec six key principles: (1) alignment with vision; (2) Pension Plan, it has since been entrusted with pay based on performance; (3) sustained, long- managing the funds of other public pension and term performance; (4) fairness based on market- insurance plans too. competitive context; (5) incentives provided for Today, CDPQ has 41 clients (called “depositors”) successful active investment management; and (6) and $271 billion in assets under management, qualitative measures for performance. The financial making it the second-largest public pension fund elements of the compensation program include base manager in the country, after CPPIB. Eight of the salary, annual incentive plan, long-term incentive 41 depositors make up 97 percent of CDPQ’s assets plan, special long-term incentive plan, restricted under management. Depositors are responsible for fund units, contributory pension plan, and health plan administration (collecting contributions and and medical benefits. paying benefits), while CDPQ is entrusted with Third, the fund has been successful in retaining investing depositor funds, in accordance with a key talent within executive and investment defined investment policy that details risk tolerance, teams. This stability has been invaluable not the investment horizon, and a benchmark portfolio. only from a corporate knowledge perspective CDPQ also offers advisory services to clients. but also in developing a positive and integrated CDPQ’s initial investing approach was entirely organizational culture. focused on bonds. The fund started to invest in Finally, being headquartered in a city—Edmonton— public equities in 1967 and created a private equity that is not a major financial center presents its share portfolio in 1971. Through the 1970s and 1980s, of challenges for recruiting top talent in a fiercely CDPQ continued to diversify its holdings, entering competitive industry. AIMCo has addressed this global equity and real estate markets (figures 3.6 challenge through two creative approaches. It and 3.7). The 1990s saw further diversification of has actively reached out to Alberta and Canadian CDPQ’s real estate investments and a legislative expats who have spent several years overseas change allowing CDPQ to increase its allotment to and who may be interested in returning home to equities from 40 percent to 70 percent. In the late consider joining AIMCo and contributing to its 1990s, CDPQ became one of the first Canadian mandate. In addition, Uebelein has continued to pension funds to invest in infrastructure by investing support a “grow your own” approach of developing in the Highway 407 toll road in Ontario. As noted the next generation of leadership talent within the earlier, over the past several years, CDPQ has been organization by providing them with opportunities increasing its investments in emerging markets. to work in different and more complex areas and to Section 3: FUND CASE STUDIES | 19 Figure 3.5: Profile: CDPQ Ov rvi w Gov rn nc Inv stm nt • Established in 1965 to • Established by an act of manage funds of the Québec’s National Assembly Québec Pension Plan Ass ts • Board can have up to • Eventually expanded to 15 members, two-thirds of whom must be $270.7 billion manage funds of other public pension and independent insurance plans • Board members are appointed by Québec 5- r r turn • Serves 41 depositors government, in • Dual mandate to maximize consultation with the board 10.2% returns and contribute to Québec’s economic growth • Board establishes a profile of expertise and experience required for independent directors Figure 3.6: Key moments in CDPQ’s evolution 1970–73 1980–83 1999 2005 Entrusted to First First major Second major manage funds of international infrastructure infrastructure other public investments in investment investments pension and public and (in toll highway) (in international insurance plans private equities airports) 1960 1970 1980 1990 2000 2010 1965 1971 1990 1996 2016 CDPQ Establishes Acquisition of Largest real Launch of established by private equity Ivanhoé estate owner in CDPQ Infra, Québec National portfolio to Cambridge as Québec, to play role in Assembly invest in Québec real estate second-largest public-private companies subsidiary in Canada infrastructure partnerships 20 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Figure 3.7: CDPQ: notable assets and recent transactions Tr ns rid, Austr li Stu v s nt Town/P t r Rés u él ctriqu Coop r Vill , N w York Cit métropolit in, Montr l • 2015 investment with consortium • 2015 investment, $5.3 billion • Proposed project • Owner and operator of • Partnered with Blackstone • 27-station, 67km light electricity transmission rail transit line crossing in network of the State of • 56-building residential Montreal New South Wales complex in Manhattan with 11,200 apartments • 4th-largest automated • Total value of transportation system in AUD 10.3 billion, CDPQ • 5,000 below-market the world share 24.99% (10.3 billion) apartments will be protected for 20 years; rents capped • CDPQ investment of • Consortium partners are for further 1,400 apartments $2.7 billion (51%), partnering Australian investors, with governments of Québec United Arab Emirates • Agreement with city for and Canada, with expected fund, and a global income qualification for 8–9% unlevered return infrastructure firm rent-protected units • CDPQ portfolio in • Projected to add $3.7 billion to Québec’s gross domestic Australia includes Port of product and create 34,000 Brisbane and an office jobs tower in Sydney Dual mandate Notably, CDPQ uses the same return criteria CDPQ is unique among Canadian pension funds across all its investment portfolios, including its for its dual mandate: to both maximize returns and Québec investments, and does not set specific contribute to Québec’s economic development. targets or percentages for investments in Québec. CDPQ’s approach to investing in Québec The government of Québec has access to its own comprises three themes: (1) investments in the economic development agency, which is separate growth and globalization of small, medium, and and apart from CDPQ, should it wish to directly large corporations; (2) investments in innovative make investments in the province that are not tied companies and ecosystems and the next generation to financial returns. As stated by Robert Tessier, of entrepreneurs; and (3) high-impact real estate chair of CDPQ’s board, “We don’t see a conflict and infrastructure projects. between our two mandates. Our investments in Québec perform well. Québec companies know us Although some have argued that an economic well, they know CDPQ will be here for the long development mandate could interfere with a pension term, and that makes us a first choice as investors.”44 fund’s independence, CDPQ operates at arm’s length from government (a principle enshrined in its According to Michael Sabia, CEO of CDPQ, “We founding legislation) and CDPQ’s performance has use our expertise and networks to support the generally matched that of its peers, including a 10.2 growth of medium-sizes businesses, accelerating percent average annual return for the past five years. their success and expansion beyond Québec. Both Section 3: FUND CASE STUDIES | 21 our depositors and Québec businesses benefit from time and energy recruiting a team of infrastructure our investments in the Québec economy. That’s why experts to build its portfolio. Another crucial generating returns and contributing to Québec’s success factor has been finding the right partners economic development go hand in hand.”45 for long-term investments. Not surprisingly, CDPQ has become a specialist Macky Tall, CDPQ’s executive vice president of in Québec business investing. By focusing on its infrastructure and CEO of CDPQ Infra, offers the home, CDPQ has developed a deep understanding following advice to emerging economy pension of all the business players in the province and is funds looking to invest in infrastructure:46 able to identify (and get access to) the best deals • Develop strong in-house teams that can understand for its depositors. CDPQ has developed a good the drivers of value and regulatory risk. reputation as a long-term, growth-seeking investor. • Find partners with strong local and sector Infrastructure investing at knowledge who can create value from an CDPQ operational perspective. Starting in 1999, CDPQ became one of the first • Take a long-term macroeconomic perspective Canadian pension funds to invest in infrastructure on the countries you invest in. assets, with the purchase of a toll highway in Ontario. In 2005, CDPQ followed up with • Ensure there is a stable and transparent investments in several international airports. Since framework for private investment. CDPQ refocused on long-term investing in the real economy—a priority for Sabia, the current CEO— CDPQ Infra infrastructure investments have more than doubled, To deepen CDPQ’s investments in infrastructure from $5.8 billion in 2011 to a $15 billion portfolio assets, CDPQ created a new subsidiary, CDPQ today that includes ports; airports; highways; wind Infra, in 2015. farms; oil, gas, and electricity transmission and CDPQ Infra is a unique, vertically integrated distribution systems; water distribution systems; model for investing in and operating greenfield and passenger transportation systems. Notable infrastructure worldwide. The value chain begins infrastructure assets include the Eurostar high- with a government identifying certain infrastructure speed train service, container ports in Australia needs. CDPQ identifies projects that meet its and Canada, Heathrow Airport, a $2.8-billion commercial criteria, submits a proposal to the coinvestment consortium platform in Mexico, and government, and then assumes full responsibility a natural gas pipeline network in the United States. for the project, including design, build, financing, This emphasis has resulted in greater asset maintenance, and operations. CDPQ Infra may in diversification, both geographically and by sector. turn decide to syndicate the financing. In particular, CDPQ has increased exposure to the The partnership aims to generate value for both United States and Australia, as well as to public parties, allowing governments to move significant service infrastructure, targeting assets that build infrastructure projects off their balance sheets while productivity and strengthen a nation’s ability to giving CDPQ an opportunity to invest in commercial supply global goods and services. projects that generate returns for depositors. CDPQ’s infrastructure program is 100 percent The first project proposed by CDPQ Infra is the direct, and the organization has spent considerable Réseau électrique métropolitain, a 67-kilometer 22 | THE EVOLUTION OF THE CANADIAN PENSION MODEL light-rail transport system running through the weights. CDPQ began converting its portfolios to greater Montreal area, connecting several suburbs this approach in 2012 and targets having 80 percent and the airport through the downtown of the city. of its assets managed in this style. The estimated cost of the project is $6 billion, and This investment mindset has been complemented CDPQ Infra has proposed a CDPQ investment of 51 by a new approach to recruiting and development, percent, with the remaining shares owned equally with CDPQ hiring experienced operators who between the Québec and federal governments. bring a deep understanding of their fields to the CDPQ Infra estimates a return on the investment of investment process. between 8 percent and 9 percent. Another key lesson from the global financial crisis Lessons from the global financial has been the need to break down the silos across crisis different asset classes that, in the run-up to the During the global financial crisis, CDPQ suffered financial crisis, magnified CDPQ’s risk exposure. heavy losses, which led to a significant amount of Today, risk staff is embedded across all verticals public attention being focused on CDPQ. and deals as an integrated risk function, highly integrated in the investment decision-making Two key lessons emerged from this episode: the process. need to better manage risk and the importance of proactively managing CDPQ’s relationships with Reflecting this approach, CDPQ has transformed stakeholders. As explained by Jean Michel, executive its investment committee into an “investment- vice president for depositors and total portfolio, “We risk committee” that encourages debate between had created silos in different asset classes. … One the investment and risk teams. CDPQ has also of the side effects of the silos was that everyone was reevaluated its approach to measuring risk, shifting increasing risk at the same time.”47 from a focus on shorter-term volatility to an understanding of core strengths and weaknesses As part of significant changes to CDPQ’s and of the financial and nonfinancial risk factors investment process, Sabia was appointed the new that could lead to permanent loss of capital. CEO in 2009. With significant experience as an executive in two industrial companies, Sabia began In the aftermath of the global financial crisis, CDPQ to reorient CDPQ toward a business owner mindset has focused more on managing the expectations focused on long-term investing to reduce risk. of various stakeholders, doing proactive work to ensure they have a stronger understanding of Key to this new approach was broadening the focus CDPQ’s strategies, especially during inevitable of investment teams beyond financial statements periods of downturn. Michel explains the dangers and analysis and having them develop an in- of failing to manage such expectations: “In the depth understanding of business fundamentals— past, we have made changes and reconsidered our and the sources of long-term value creation—in strategies during down markets, and that can lead to their respective industries. As a result, CDPQ has instability. We are doing our best to avoid this kind reoriented to invest more in assets rooted in the “real of problem in the future, managing expectations economy” and away from synthetic instruments and and [doing] proactive work to gain trust.”48 financial engineering. CDPQ now invests from a bottom-up approach, investing much more heavily As Sabia puts it, “The world right now has a lot across a smaller number of equities rather than of risk, geopolitically, in particular, and we will starting with an index and increasing or decreasing continue to build a portfolio that we call an ‘all- terrain’ portfolio. We’re looking for stability.”49 Section 3: FUND CASE STUDIES | 23 HOOPP Case Study HOOPP’s two most significant evolutions arguably occurred during the 1990s and the prefinancial History and evolution crisis period of the 2000s. The evolution during the HOOPP was established in 1960 by the Ontario 1990s transformed HOOPP’s governance structure, Hospital Association (OHA) with the goal of whereas the evolution during the 2000s transformed offering a uniform, portable pension to all hospital HOOPP’s investment program (figure 3.9). workers in Ontario (figure 3.8). Before HOOPP was created, Ontario hospitals varied in the retirement Governance model arrangements offered to their employees. Some In 1993, HOOPP became a jointly sponsored offered no retirement plan whatsoever. At its pension plan, an entity that was truly independent inception in 1960, HOOPP was one of Canada’s from its sponsoring organizations. It transitioned first multiemployer pension plans, with 71 from an organization that was sponsored solely by employers, fewer than 10,000 members, and $9 an employer association, the OHA, to one that was million in assets. During its first 33 years, the plan also sponsored by four major unions in the Ontario was overseen solely by the OHA through a board health care sector: the Ontario Nurses’ Association, of trustees, originally operating as part of the OHA. the Canadian Union of Public Employees, the The plan evolved incrementally during this phase, Ontario Public Service Employees Union, and the gradually building a team that could oversee the Service Employees International Union. plan and beginning to bring investments in house. According to Dan Anderson, a HOOPP union- The HOOPP fund topped the $1 billion mark in side trustee and vice-chair who has been involved 1980 and, by the early 1990s, had reached nearly with the plan’s governance since 1989, a number $8 billion. of factors precipitated HOOPP’s transition to joint sponsorship and governance:50 Figure 3.8: Profile: HOOPP Ov rvi w Gov rn nc Inv stm nt nd fundin • Established in 1960 by • 1993 Agreement and the Ontario Hospital Declaration of Trust allowed Ass ts Association (OHA) for a joint governance between the OHA and the $70.4 billion • Became a jointly sponsored four union settlors and jointly governed plan in 1993 • Board composed of 16 members, 8 appointed 10- r r turn • Over 321,000 members by OHA and 2 appointed by across more than 500 hospital each of 4 union settlors and health care employers 9.08% provincewide • Governance can only be changed with unanimous • Defined benefit plan consent of the five sponsoring organizations Fund d st tus 122% 24 | THE EVOLUTION OF THE CANADIAN PENSION MODEL • Reforms to pension standards legislation in the late single plan CEO, responsible for all aspects of plan 1980s had created a provision for joint governance. management, reporting to a single board of trustees. • The health care unions launched a complaint to the Today, HOOPP’s governance structure has the pension regulator demanding joint governance. following characteristics: • The provincial government’s desire to • The board of trustees has 16 members—8 achieve sectorwide agreements to constrain appointed by the Ontario Hospital Association compensation created a greater willingness and 2 each appointed by the four sponsoring to negotiate a joint governance agreement, unions. Neither the union-appointed trustees HOOPP’s Agreement and Declaration of Trust. nor the management-appointed trustees represent a majority on the board, and so every • HOOPP’s plan document contained a critical decision must represent at least some agreement provision—the “contribution corridor”—which between trustees appointed by both labor and provided both certainty and perceived fairness the Ontario Hospital Association. In the case on both sides about contribution rates and how of a deadlock, there is a dispute resolution benefit enhancements would be funded provision whereby the Chief Justice of Ontario In addition to the move to joint sponsorship, the would appoint a 17th trustee who would break 1990s also saw HOOPP move to an integrated the tie. The provision has never been used.51 management structure. Previously, HOOPP’s • The board members represent a mix of administration had been managed separately from backgrounds, including hospital administration, its investments. Each side of HOOPP’s balance labor relations, asset management, and sheet had its own manager and governance structure. business. Today, the board is a hybrid model During the 1990s the organization transitioned to a Figure 3.9: Key moments in HOOPP’s evolution 1980 2006 2014 Plan assets Flexible Top 10-year returns surpass indexation for global peer $1 billion introduced group (CEM Benchmarking) 1960 1970 1980 1990 2000 2010 1960 1993 2003 2010 2016 HOOPP founded Adopt Begin Return to Part-time by Ontario independent, transitioning surplus employees Hospital Association jointly sponsored to liability- position post– eligible to join model driven investing financial crisis immediately Section 3: FUND CASE STUDIES | 25 that combines pension-specific expertise with decisions together, including having to agree expertise in the sponsoring organizations and on such potentially contentious issues as how their members. to deal with a plan deficit, what to do with a plan surplus, and whether to make indexation • The fundamental governance structure can be contingent on plan performance. changed only with the unanimous consent of the five sponsoring organizations. • The plan’s strong performance has created a sense of shared success and pride in the plan.55 • The board is unicameral, meaning it has responsibility for both plan management • Perceived political and regulatory threats to the (administration, investments) and plan design plan have served as a unifying force, leading (contributions, benefits, funding). This is both union and Ontario Hospital Association unusual within the Canadian model. When the sponsors to rally in the plan’s defense.56 plan has a surplus or deficit, the trustees must decide what, if any, changes should be made to Liability-driven investing benefits, contributions, or plan assumptions HOOPP’s governance evolution during the 1990s was followed by a transformation of its investment The plan is set up as a private trust, governed by trust program in the 2000s. The crux of this change was law principles, and was not created by legislation. a shift toward liability-driven investing (LDI). An Several of the interviewees for this case study early adopter of LDI, HOOPP has now embedded indicated the governance of HOOPP has been very a focus on liabilities throughout its investment highly consensual between labor- and Ontario program and investment governance. Hospital Association–appointed trustees.52 This is HOOPP’s journey toward a liability-driven approach especially noteworthy given that the demand for joint began around the time of the dot-com crash of the governance had originated in an adversarial context: early 2000s. “We went from a big surplus to being the threat of litigation by the unions. Asked what materially underfunded in less than two years,” said factors had contributed to this culture of consensus, CEO Jim Keohane, who led HOOPP’s transition to interviewees pointed to several key elements: LDI. “Both sides of our balance sheet moved against • The plan defined itself as an independent us—equities crashed and interest rates dropped. We business with a single mission: delivering on the realized that the disconnect between our assets and pension promise. This has helped focus the board liabilities was one of the biggest risks to the plan.”57 and management team on a singular objective. The management team began assessing the main risks to the plan’s funded status. • The plan’s structure as a private trust encourages board members to bring a fiduciary perspective, Employing stress tests and other analyses, rather than a labor- or management-side management identified three main risks: equity outlook, to their HOOPP work.53 risk, inflation risk, and interest-rate risk. The board concluded that the plan had both too much equity • HOOPP’s founding chair, Cliff Nordal, although risk and too much inflation risk. In 2007, the plan appointed by the employer sponsor, was seen took action to reduce these two risks. The fund’s as fair-minded by the union side and not there equity weighting was decreased by 30 percent, solely to advance employer interests.54 and this capital was redeployed in real estate, • The unicameral structure of the board means real-return bonds, and nominal bonds.58 During that board members must come to plan design this transition, HOOPP moved from a 60 percent 26 | THE EVOLUTION OF THE CANADIAN PENSION MODEL equities/40 percent fixed-income allocation to a to return to a surplus position by 2010 without 46 percent/54 percent allocation. The move to increasing contribution rates. liability-driven investing also increased HOOPP’s HOOPP has since deepened its approach to liability- use of derivatives, including futures contracts, driven investing. Material changes have included options, and swaps, to help the plan manage risk these two strategies: and increase value-added returns (figure 3.10). • The HOOPP fund has been divided into two “People often think of LDI as a full hedge of the separate portfolios: a “return-seeking” portfolio liabilities,” said Marlene Puffer, HOOPP trustee and a “liability hedge” portfolio. Largely and asset-liability management committee chair. derivatives based, the return-seeking portfolio “But that’s not what it means at HOOPP. We are comprises public equities, private equity, looking for ways to get paid by the market to corporate credit, a long-term option strategy, reduce risk.”59 and a variety of other return-seeking strategies. HOOPP weathered the global financial crisis The liability-hedge portfolio includes short- better than most pension plans, losing 12 percent term assets, nominal bonds, real-return bonds, in 2008 compared with the 15–25 percent losses and real estate. that other large pension funds sustained during that • Investment policies and procedures have year. The plan avoided exposure to U.S. subprime been reoriented to focus on an LDI approach, mortgages and to nonbank-issued asset-backed framing the policies in terms of a risk budget commercial paper. HOOPP’s timely reduction of and risk appetite, rather than a more traditional its equities allocation by 14 percentage points in asset-weight-based approach. The board has an 2007 protected roughly $2 billion in asset value. asset-liability management committee, not an Thanks to these decisions, and to its positive- investment committee. funded status before the crisis, HOOPP was able Figure 3.10: HOOPP implements its LDI strategy through a two-part portfolio Public Largely equities Short-term derivatives based Private equity Nominal bonds Corporate credit Liability Return- hedge seeking portfolio portfolio Real return Bonds Long-term option strategy Real estate Other return seeking strategies Section 3: FUND CASE STUDIES | 27 Figure 3.11: HOOPP: notable assets and recent transactions M rin G t w , Kl ss C pit l V ncouv r 32 Old Slip, N w York Cit • 2012 investment • 2016 investment • 2015 investment • Venture capital fund focused • Mixed-used development in • $198 million interest in on enterprise software and South Vancouver $645 million investment e-commerce companies • Direct public transit by RXR Realty • $50 million fund size integration • 1.2 million sq ft office • 240k sq ft multistory retail, tower, Class A • Focus on Toronto, Montreal and Vancouver 250,000 sq ft office building, • Lower Manhattan 460 residential homes, • Fund invests $2 million– LEED Gold • Built in 1987; recently $10 million of equity per renovated transaction • Partnered with PCI (developer) and Triovest (advisory) • Targets proven high-growth technology businesses Current outlook OPTrust Case Study Today, HOOPP serves over 321,000 members, OPTrust is the 14th largest pension fund in Canada manages over $70 billion in net assets, and has with assets under management of $19 billion a funded status of 122 percent. It is the pension supporting approximately 90,000 members. provider for over 500 employers in health care in Although OPTrust is relatively new—just over 20 Ontario. HOOPP has built a large in-house team years old—its roots can be traced back to the Public of several hundred professionals, all of whom are Service Superannuation Fund (and subsequently the housed within a new HOOPP-owned office tower Public Service Pension Plan), which was created in in downtown Toronto. Unlike other plans profiled 1920. The plan was spun off into a separate entity here, HOOPP has not yet opened an office outside in the mid -990s, a few years after the creation of Canada. HOOPP’s scale has allowed it to keep OTPP. costs to 19 basis points for investments and 30 basis points overall. HOOPP has also delivered The plan was established by a trust agreement by very strong annualized investment performance its two sponsors, the government of Ontario and the of above 9 percent over the past 20 years. In 2014 Ontario Public Service Employees Union (OPSEU) CEM Benchmarking recognized HOOPP for in late 1994, and OPTrust became operational in having the highest 10-year net returns of 124 global 1995. The plan’s creation was rooted in OPSEU’s peer funds.60 See figure 3.11 for examples of recent longstanding desire to have a greater say over its transactions. members’ pensions.61 It was spurred into reality 28 | THE EVOLUTION OF THE CANADIAN PENSION MODEL through a high-stakes labor negotiation between sponsors in January 2013, OPTrust has been able to public sector unions and the government during a expand its membership by admitting certain classes time of fiscal restraint. The government put a jointly of employees whose employers deliver a public trusteed pension plan on the negotiating table as a service or perform a public function. concession to OPSEU, and the union accepted.62 OPTrust is a global investor with offices in Toronto, The plan’s governance structure was modeled London, and Sydney. Its investment mandate from the HOOPP Agreement and Declaration of focuses on achieving the investment returns needed Trust. As noted earlier, HOOPP had adopted an to fund members’ and retirees’ pensions decades independent, jointly sponsored model in 1993 and into the future. OPTrust views itself as a long-term OPSEU, also a sponsor of HOOPP, was familiar investor, and this is reflected in its asset allocation. with that governance framework. The plan/fund It diversifies across asset classes and different was created to provide members and pensioners a geographies to achieve its objectives. This approach say in their plan through a joint trusteeship. The aims to generate the funding target return over joint sponsorship means that OPTrust members and a long-term horizon, while avoiding substantial the Ontario government share equally in the plan’s/ negative returns in the short term. fund’s financial risks and rewards. See figures 3.12 Along with strong governance and long-term and 3.13. sustainability, another key priority for OPTrust Today, the majority of OPTrust members are is service excellence. The organization has been current and former employees of the Ontario public recognized for its personalized and proactive service, including several government agencies. service in helping members make informed As a result of an agreement reached between the decisions about their pensions. This has resulted Figure 3.12: Profile: OPTrust Ov rvi w Gov rn nc Inv stm nt nd fundin • Established in 1995 • Established as a joint Ass ts trusteeship of the • Administers the OPSEU government of Ontario (Ontario Public Sector and the Ontario Public $19 billion Employees Union) Service Employees Union Pension Plan • 10-member board, with • 90,000 members 5 members appointed by 10- r r turn each organization • Defined-benefit plan 6.2% Fund d st tus 110% Section 3: FUND CASE STUDIES | 29 Figure 3.13: Key moments in OPTrust’s evolution 2001 2006 2011 2013 Investment Private Markets First CEO Sydney office division is (private equity hired opened established and with internal infrastructure) capabilities Group established 1990 1995 2000 2005 2010 2015 1995 2000 2004 2010 2015 OPTrust OPTrust assets Real Estate London office Member- becomes fully reach Group opened driven operational $10 billion established investment strategy launched in consistent strong overall member satisfaction An evolving governance model ratings. To ensure the high quality of service, in OPTrust’s governance structure has evolved 2016 OPTrust embarked on a multiphase project differently from that of most pension funds. The to upgrade its pension administration system and governance model, especially in the plan’s early enhance its web capabilities. years, has been tightly linked to a key reason for Among Canadian pension plans, OPTrust has the plan’s founding: the union sponsor’s desire for a distinguished itself as an active participant in greater say in how its members’ pensions were being public policy debates and broader industry issues, managed. The ability to negotiate and establish the advocating on matters such as retirement security organization in less than one year reflected a strong policy, responsible investing, and climate change. commitment by OPSEU leadership to create a plan It also has a keen interest in investing and forming for its members at a time when sentiment for joint partnerships in emerging markets. trusteeship was gaining political support. This commitment instilled a more hands-on approach Over the past decade, OPTrust has undertaken by the board of trustees in the initial years and has significant changes to both its governance structure shaped and distinguished the organization from and investment philosophy and strategy. This may other jointly sponsored pension plans. be the result of the natural evolution of a relatively young pension plan. More important, though, the OPTrust is governed by a 10-member board of fundamental changes have arguably made OPTrust a trustees, five of whom are appointed by OPSEU more effective, stronger, and more sustainable plan. and five by the Ontario government. While the sponsors are responsible for the plan (including 30 | THE EVOLUTION OF THE CANADIAN PENSION MODEL any changes to the benefit structure or contribution Another unique aspect of OPTrust’s governance rates), the board of trustees is the plan administrator is that, when it was established in 1995, the board and is responsible for the overall administration of adopted a management structure that included two the plan and the management of the assets. senior executives—the chief administration officer (CAO) and the chief investment officer (CIO)—at The board carries out its work through four the head of the organization. Rather than have one standing committees: the governance and chief executive officer accountable to the board, administration committee; the audit, finance, and the CAO and CIO were independently accountable risk committee; the investment committee; and the to the board.  The board effectively assumed the human resources and compensation committee. role of the CEO with the support of the two senior The standing committees operate under prescribed executives and the rest of the management team. terms of reference and report to the board on matters The board also retained the services of expert within their mandate. In addition, the board has advisers such as legal counsel, actuarial support, an established an adjudication panel to review matter investment adviser, and a compensation adviser. of dispute between plan members and pensioners and management regarding eligibility, benefit The two-part senior management structure was entitlements, or other pension-related rights issues intended to serve as a check and balance in the under the plan.   system, so that no single individual could control all aspects of the operation. It was also a system that From the outset, the sponsors made a conscious recognized the diverse business activities within decision to have a jointly trusteed model of the pension plan—administration and investment governance with each sponsor appointing five management—with a view to giving equal weight members and with the board serving as the to each.  plan administrator, owing a fiduciary duty to the plan members. Unlike the boards of some Around the time of the global financial crisis, there other Canadian funds, the OPTrust board has was considerable discussion about the governance been primarily a representational board. The structure and, in particular, the relationship government sponsor has tended to appoint between the board and management. The board a mix of senior civil service executives and retained a consultant to review the governance retired executives with pension, investment, structure and propose options, including a model financial, and administration experience. OPSEU with a single CEO accountable to the board. After has tended to appoint active and retired public an in-depth search, in April 2011 the board hired service employees with different backgrounds its first CEO.  Although the initial transition to and experience in the Ontario public service. this model proved difficult, OPTrust now appears to have struck the right balance between board In more recent years, a greater emphasis has been and management responsibilities, in the process placed on selecting board members with specific alleviating considerable pressure on the board skill sets to manage the significant size of the that resulted from having to do everything from fund, the complexity of investment strategy, the oversight to day-to-day management. OPTrust importance of technology for administration, President and CEO Hugh O’Reilly, then the board’s and the delicate relationships that need to be legal counsel, said that the absence of a CEO proved managed. OPTrust’s experience demonstrates that, to be a real challenge during a time of crisis such as if done properly, a representational board can add in 2008–9.63 significant value to a fund. Section 3: FUND CASE STUDIES | 31 OPTrust’s governance model has continued to investment strategies. The fund’s asset allocation has evolve. The board has been delegated to the CEO remained relatively stable over the years with the broad management responsibilities that include largest change being in investments in alternatives managing day-to-day affairs while the board sets (real estate, infrastructure, and private equity). Even the strategic direction and carries out oversight and relative to the other major Canadian public pension monitoring responsibilities. The board approves plans, OPTrust has a high portion of its total assets in the structure of the executive team, which the CEO alternative assets (38 percent). is responsible for appointing. Further, the CEO OPTrust’s alternative asset investments include is accountable for the delegated portfolios. The class “A” buildings in Toronto, a shopping center board sets the compensation framework with the in Hawaii, intermodal freight transportation CEO recommending annual payments within the services in Newfoundland and Labrador, and approved mandate. infrastructure investments such as toll roads and passenger rail transport in eight member countries Investment strategy: From asset of the Organisation for Economic Co-operation and allocation to risk allocation Development. To execute its investment strategy, Since its inception, OPTrust has generated an average OPTrust has built an extensive team of investment annual investment return of 8.4 percent, exceeding professionals and has established a strong presence the fund’s long-term target rate of return of 6.15 in London and Sydney. The fund combines robust percent. Asset allocation has been a primary driver internal investment capacity with a roster of of the fund’s long-term investment performance, external managers to generate a risk-adjusted return and OPTrust is diversified across asset classes and that protects its members (figure 3.14). Figure 3.14: OPTrust: notable assets and recent transactions Infr REIT Glob lvi D nt lCorp • $2 billion market cap public • Portfolio of 28 infrastructure • Leading dental practice REIT with portfolio of concessions across management company electricity assets across 8 OECD countries in Canada Texas • Assets include toll roads and • 200 locations, 3,500 staff, • Portfolio includes power lines, tunnels and passenger and 2 million patient substations, transmission rail transport visits per year towers, distribution poles, transformers, and other • Manages design, build, related property assets financing, maintenance, and operations • All assets are leased to a single regulated utility • Expansion planned to New Mexico and Arizona Note: REIT = real estate investment trust; OECD = Organisation for Economic Co-operation and Development; 32 | THE EVOLUTION OF THE CANADIAN PENSION MODEL As a long-term investor, OPTrust has prioritized By the end of 2015, OPTrust adopted a new responsible investing. The fund acknowledges investment strategy framework called Member- the relevance of material environmental, social, Driven Investing or “MDI” (figure 3.15). As and governance (ESG) factors to investment O’Reilly explains, the aim of this strategy is “to performance and to the health and stability of change the conversation” away from a narrow markets. Accordingly, the fund has integrated ESG focus on investment returns to a focus on pension considerations into its investment beliefs, policies, certainty, contribution stability, and sustainability and strategies. This emphasis on responsible for plan members. According to O’Reilly, this investing has earned OPTrust top ratings from the is a fundamental shift from “asset allocator to Principles for Responsible Investment initiative. risk allocator” and more significantly from being an asset manager to being an effective “pension In 2015, OPTrust embarked on a yearlong process management organization.” To this end, the fund to establish a new framework that better aligned even changed the name of its year-end report from its investment activities with the interests of its an annual report to a “funded status report.”64   members, consistent with its mission of paying pensions today and preserving pensions for The board and management believe that the primary tomorrow. It examined the best practices of many goal for the plan membership is to improve plan leading organizations intent on adopting leading- certainty, namely for members to know that they edge pension management thinking. The impetus will receive the pensions that they are counting on for this reflection and review was a rapidly and having the confidence that the contribution rates changing environment driven by challenges of they pay and the benefits they receive will remain as demographic maturity, volatile investment markets, stable as possible over a long period. To achieve plan and persistent low interest rates, and the resulting certainty requires the balancing of two objectives: downward pressure of expected investment returns. sustainability (generating sufficient returns to Figure 3.15: Member-Driven Investing focuses on keeping the plan in balance Ass ts Li biliti s Inv stm nt R turns B n fits Contributions Section 3: FUND CASE STUDIES | 33 keep the plan fully funded) and stability (keeping uncorrelated value-added, by using its differentiated contributions and benefits as stable as possible skills and relationships to take advantage of market over the long term). In practical terms, the mandate inefficiencies (such as informational asymmetry, requires that OPTrust maintain a regulatory funded structural or regulatory constraints, and behavioral ratio between 95 percent and 110 percent. biases). The portfolio construction process aims to allocate risk efficiently between these “beta” and The implementation of MDI also represents a more “alpha” components. fundamental philosophical and practical shift for OPTrust. In the past, the fund’s investment activities To more effectively allocate risk, OPTrust were driven through the lens of asset management, employs leverage, including borrowing to buy where the focus was on delivering excess rates of government bonds, which helps offset the impact return, often above what the actuaries required, to of interest rate fluctuations on the plan’s liabilities. deliver on the pension promise. This often meant Internationalization of certain investment taking on greater risk. In shifting to a pension capabilities is another risk-allocation tool that management organization, the members’ interest OPTrust is implementing as part of its MDI is paramount with a priority on fully funded status strategy. By internalizing certain trading activities and stability in contribution and benefit levels. that were previously outsourced, OPTrust believes This philosophical shift has been driven in part by it can better manage liquidity, gather better market OPTrust’s increasing maturity as a plan: its active- intelligence, increase potential for value-add, and member-to-retiree ratio was 1.3 in 2015, down from reduce costs. 12.8 in 1995 at the plan’s inception. To ensure the effective implementation of MDI, Risk management and efficiency are central to the OPTrust also realigned its governance framework MDI strategy. OPTrust’s investment philosophy (figure 3.16). In moving from an asset management defines risk broadly. Risk is more than just market organization focused on adding incremental return volatility. It is about risk to the plan’s funded status, to a pension management organization concerned encompassing both quantifiable risks such as with efficient risk allocation and providing flexibility funding risk, drawdown risk, market risk, tail risk, on setting asset class benchmarks, the board uses liquidity risk, and counterparty risk, as well as more three key policy documents to hold management qualitative risks such as operational risk, key-man accountable: (1) a passive reference portfolio, (2) risk, ESG risk, and reputational risk. MDI places a set of total fund performance metrics, and (3) a a premium on efficient allocation of risk and on risk appetite statement. OPTrust has also readjusted earning risk-adjusted returns at the total fund level. the compensation policies for its investment team to align these with funded status. Portfolio construction under MDI begins by building “the most risk efficient portfolio with OPTrust’s shift to MDI is significant for the the risk diversification that is appropriate for the organization. It will likely take three to five years to prevailing market environment.”65 This allows fully assess the impact of the new approach. the fund to achieve a desirable mix of “beta” exposures. To this, OPTrust seeks to add “alpha,” or 34 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Figure 3.16: OPTrust’s investment governance has shifted to enable the MDI strategy Curr nt Gov rn nc N w Gov rn nc • P ssiv R f r nc • Polic Ass t Mix • Add Portfolio • Actu l Portfolio- Incr m nt l Effici nt Risk Alloc tion • Ass t Cl ss B nchm rks R turn • Tot l Fund • Risk App tit St t m nt P rform nc • Ass t Cl ss nd Str t M trics B nchm rks • Risk App tit St t m nt Bo rd of Trust s M n m nt Bo rd of M n m nt Trust s Ass t M n m nt Or ni tion P nsion M n m nt Or ni tion Section 3: FUND CASE STUDIES | 35 Section 4 Framework for the Evolution of Pension Organizations E ach of the funds examined as part of this case study evolved in a unique way. There are many paths, in other words, toward achieving the “Canadian model” of public pension fund. Yet certain patterns emerge from studying the evolution of various Canadian funds. To capture some of these common patterns, and also to help pension stakeholders in emerging economies think about the evolution of their own pension organizations, we have developed a simplified framework for the evolution of pension organizations. Not all Canadian pension funds have followed this framework exactly. Nevertheless, we believe it provides a useful heuristic for thinking about the evolution and continuous improvement of pension organizations, in both developed and developing economies.  Framework The framework is meant to chart the journey The framework, summarized in figure 4.1, breaks of a pension organization—either a pension the evolution of pension organizations into four asset manager or an integrated pension delivery phases:  organization (including both assets/investments and • Phase 1: Pre-reform entity liabilities/administration). Note that the framework • Phase 2: A solid foundation is chiefly concerned with the evolution of an • Phase 3: Independent, professional entity with existing organization. However, the framework strong governance could also serve as a useful guide for the creation of • Phase 4: Mature, sophisticated entity new pension organizations.  Figure 4.1: Four-phase framework for the evolution of pension organizations 1 2 3 4 Independent, Mature, sophisticated Pre-reform entity A solid foundation professional entity with entity strong governance • Part of government—no • Reform strategy in place • Independent governance • Mature independent real independence or • Stakeholder buy-in to reform governance model Governance arm’s-length oversight • Earning trust of government and private sector • Low expertise or • Developing in-house staff • Ability to attract qualified • Ability to attract global People and experience in external • External hires to fill gaps professionals top talent organization best practice • Developing skills for • Strong program to • Ability to develop top • Limited procurement skills external sourcing develop internal talent quality internal expertise • Little diversification— • Begin to diversify • Diversified investments • Highly diversified T pic l ch r ct ristics sometimes 100% in investment Increasingly competent investments Investment nonmarketed in-house investment government debentures • Begin to build investment • Sophisticated in-house expertise capabilities investment teams and 100% domestic • Inefficient and ineffective • Major administrative • Competent plan • Professional plan plan administration errors corrected administration administration Administration • Investment in systems to • Significant errors • Modern technology reduce costs and • Poor member service improve service • Strong client service • Pay-as-you-go or limited • Realistic understanding • Improved funding • Assets and liabilities well Plan design funding of liabilities • Realistic understanding balanced and funding • Little clarity on liabilities • Active dialogue on plan of assets and liabilities • Funding is sustainable sustainability • Sustainable funding target • Outdated or legacy • Updated legislation • Modern legislative • Proactive improvements legislation framework in legislation and Regulation and • Some investment public policy • Strict investment limits freedom • Limited investment regulation • Little political will for restrictions • No investment limits reform Section 4: FRAMEWORK FOR THE EVOLUTION OF PENSION ORGANIZATIONS | 37 Phase 1: Pre-reform entity including poor member data, transaction processing This phase describes what some of Canada’s leading backlogs, or errors in pension calculations.  public sector pension organizations were like before an active period of reform in the 1980s and 1990s. Phase 3: Independent, For instance, as of the 1980s, the organizations that professional entity with strong are today known as OTPP and OPTrust were governance • 100 percent invested in nonmarketable By this phase, a truly professional, independent government debentures; pension organization is in place. The governance • Partially pay-as-you-go; and model is established and has successfully asserted • Run largely by government employees. its independence from government or sponsor influence in a number of real-life scenarios. The Until the mid 1990s, the Canada Pension Plan was organization will have made the transition from pay- run in a similar manner. Pension funds at this stage as-you-go or partially pay-as-you-go to prefunded, are not really professional pension organizations. meaning it will have built up a base of assets to They are run more like government programs.  enable it to meet future liabilities in a sustainable manner. A diversified investment program will At this stage, there is no clear path toward reform or have been established, including broad exposure to aligned stakeholder will to engage in such reform. equity markets.  One of the key insights from this study is that much of the work in transitioning from this phase to the At this point the organization will have begun next phase in the framework has to do with building to build strong internal investment capabilities, stakeholder consensus around a vision for reform.  including the ability to perform core investment activities such as investment strategy, asset Phase 2: A solid foundation allocation, and portfolio construction. The Reaching this second phase means that the reform organization should have a strong sense of its of the pension organization is well underway. A comparative advantage relative to other investors, strategy is in place to improve the organization, and of where it believes it can add value through including a vision for how the organization will active investment management. The team may have evolve over the medium and long term. Key chosen to manage some asset classes—or portions stakeholders, including the government, labor, of asset classes—in house rather than through and employer groups, are largely aligned around a external managers. However, it is expected that the shared vision for the future of the organization. The organization may continue to rely substantially on organization has recruited some very good people external managers in this phase.  including, crucially, the initial board chair and To the extent the organization is involved in perhaps the initial CEO. Through its people and its pension administration, that function will have actions, it will have begun to win the confidence of reached a competent level, with levels of member stakeholders in both the public and private sectors. satisfaction rising and per-member costs becoming The organization will have begun transitioning more competitive. Finally, the organization will be its investments away from a purely fixed-income seen as an attractive place to work for pension and portfolio to a portfolio with broader market exposure. investment professionals and will have established Finally, but certainly not least important, the a track record of recruiting and retaining talented organization will have corrected—or be on the road people from the investment management industry to correcting—its major administrative problems, and the pension field.  38 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Phase 4: Mature, sophisticated By this stage, the legislative and regulatory environment will have evolved to grant pension entity organizations more autonomy and flexibility, as This mature phase is the one in which many large the organizations grow in capability, improve their Canadian public sector pension funds, including the governance, and build trust with government and funds profiled in this case study, find themselves regulatory officials. today. Reaching this stage does not mean that improvements are not still possible. As we will see in a subsequent section, executives at the helm of Navigating the Evolution of a Canadian pension funds see significant challenges Pension Organization and opportunities ahead.  Moving through these phases and becoming a By this phase, the governance model for the highly functioning pension organization is far from pension fund will have evolved to a point that is inevitable. For the Canadian funds profiled in this both independent and well suited to the unique case study, navigating each transition required characteristics of the fund in question. For some leadership, innovation, and a willingness to learn organizations, such as OTPP, CPPIB, and AIMCo, from mistakes. The next section aims to document that has meant a strong emphasis on, or even an some of the lessons learned from the evolutionary explicit requirement for, appointing board members journey of each of these funds, including specific with professional and business experience. For lessons for governance, investments, administration, other organizations, such as HOOPP and OPTrust, plan design and funding, organization, and the that has meant creating hybrid boards that aim to regulatory and public-policy environment. Before balance such experience with knowledge of the moving on, however, it is worth making a few plan’s membership and its sponsoring organizations. general observations on the evolutionary framework previously laid out.  The investment programs in this phase have become highly diversified both by geography and • Evolution of pension organizations takes by asset class. By this phase we can expect the time. HOOPP is over 50 years old and continues majority of investments to be managed by in-house to change. OPTrust recently celebrated its 20th teams, although funds usually continue to maintain anniversary and has only recently begun the partnerships with external managers to complement process of bringing public-markets investments in-house capabilities. To the extent the fund invests in house. AIMCo (not yet a decade old), its in alternative asset classes, such investment will pension plan clients, and its government often occur directly rather than through funds.   shareholder have in recent years examined new approaches to pension governance. CDPQ, over Plan administration, by this phase, will have moved half a century old, recently underwent major from merely competent to truly professional, changes in its investment strategy and has begun including employing modern technology and to invest directly in new markets, including an finding new ways to serve members.  increasing focus on emerging markets. A mature, sophisticated pension organization is seen • Considerable variation appears within each as a very attractive place to work, with competitive phase. There are as many differences among compensation, a high-performance culture, and exemplars of the “Canadian model” of pension interesting, meaningful work that makes it possible plan as there are similarities. This includes to attract and retain talent not only locally but also both differences in the paths Canadian pension on a global scale.  Section 4: FRAMEWORK FOR THE EVOLUTION OF PENSION ORGANIZATIONS | 39 organizations took toward their destination pension organizations have been successful and differences in their current characteristics. has been their ability to build and maintain a Thus, the features of each phase of evolution consensus around a particular model of pension in this framework have been kept deliberately governance and management among a broad broad. For instance, for investments, rather group of stakeholders. These stakeholders than referring to a specific asset allocation or include elected officials of different partisan asset class, we refer to the broad principles of affiliations, civil servants, regulators, labor diversification and in-house capability. CDPQ, leaders, the financial services sector, and for instance, places significant emphasis on the broader business community. Although infrastructure investment, whereas HOOPP building such consensus is particularly critical does not invest in infrastructure.  during the early stages of reform—the transition from phase 1 to phase 2—the importance of • Maintaining stakeholder buy-in is crucial at maintaining and strengthening the consensus each phase. Lack of stakeholder and political as the organization evolves should not be will is often cited as a major obstacle to pension underestimated or taken for granted.  reform. One of the reasons that Canadian 40 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Section 4: FRAMEWORK FOR THE EVOLUTION OF PENSION ORGANIZATIONS | 41 Section 5 Practical Lessons Learned from the Canadian Experience W hat can be learned from the experience of Canada’s more successful public pension organizations? Drawing on the history of the Canadian model, and the specific examples of the evolution of Canadian pension organizations described earlier, this section aims to distill practical lessons for pension stakeholders in emerging economies. We believe that at least a portion of these lessons will be relevant to a wide range of stakeholders, from government officials to regulators to pension fund trustees to pension administrators to labor leaders to private industry. The goal here is not to provide a specific blueprint to agree on a vision and to collaborate in a way in for the ideal pension organization. The optimal which each stakeholder does what it does best and approach will necessarily vary depending on local respects the strengths of the other stakeholders. conditions, including the characteristics of the In Canada, this approach has created unusual stakeholders, assets, and constraints. Rather, our partnerships between labor unions, governments, objective is to provide a set of principles that, if employer associations, business people, and followed, are likely to drive better retirement financial services professionals—groups that often outcomes and better-performing pension find themselves on the opposite side of issues organizations. or negotiations. If there has been one critical precondition to the success of the Canadian model, Further, and equally important, we aim to review we would argue that it has been the collaborative a variety of strategies and tactics that Canadian and mutually respectful nature of these unusual organizations have used to put these principles into partnerships. The shared mission of delivering the practice. We place the greatest emphasis on the first best possible retirement security value for every three phases of the framework for the evolution of pension plan member, of meeting the pension pension organizations described in the previous promise, allowed these “strange bedfellows” to section because we believe that these earlier phases align in a form of division of labor that has created are likely to be of greater relevance to audiences in considerable value for millions of Canadians. emerging economies. Without this alignment and division of labor, the governance models, investment programs, and Overview strong performance of the Canadian funds would The principles and lessons detailed in this section not have been possible. (See figure 5.1.) are grouped into six categories: (1) governance; If one accepts this argument about the core (2) investments; (3) administration; (4) plan design lesson regarding the evolution of the Canadian and funding; (5) regulatory and public policy pension model, then the implications for emerging environment; and (6) organization and people. economies should be more optimistic than Each of these categories, on its own, is an important pessimistic. Building these kinds of partnerships driver of performance for pension organizations. among diverse stakeholder constituencies is One of the overarching lessons from the Canadian challenging. In Canada, it has taken many years, experience is the importance of thinking of pension has included many missteps and failures, has organizations in an integrated fashion, one in required extraordinary leadership from certain key which the categories listed align and work together individuals in each of the stakeholder groups, and to produce the best possible outcomes.66 How do remains a work in progress that requires ongoing integration and alignment occur? It is not just a maintenance and continuous improvement. On matter of thinking in the right way. It is also a matter the other hand, there is nothing unique to Canada of getting a diverse range of powerful stakeholders about these partnerships. Other countries, such as Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 43 Figure 5.1: Building a world-class pension organization (Lessons from Canada) St k hold r trust D si n nd m n m nt principl s Structures, processes, and leadership that build and maintain trust among relevant pension stakeholders Plan members • Align interests around • Independence Unions the best outcomes for Governance • Leadership Employers plan members • Accountability and transparency Stakeholder Government Trust- • Continuous and respectful engagement landscape Regulators building among relevant Plan trustees principles stakeholders • Each stakeholder People and • Top talent and integrity Plan managers organization • Competitive pay Service providers performs its highest and best function Market participants according to competencies • Comparative advantage Investments • In-house management • Diversification • Managed risks and liabilities • Client-focused orientation Stakeholder Design and trust management Administration • Modern technology Virtuous principles • High-quality communications and circle of trust education and performance • Sponsors with scale and mission Plan design and alignment funding • Realistic assumptions Execution • Risk sharing and prudent funding • Trust and autonomy Regulation and • Robust regulatory regime Living the principles on a day-to-day public policy basis and delivering superior results • Good governance encouraged over meaningful periods of time Germany or the Netherlands, are better known than Canada for their collaboration among government, Governance labor, and business. While Canada has a strong In our interviews and our review of the relevant financial services sector, particularly in Toronto, literature, governance came up again and again other developed countries are better known for their as perhaps the single most important factor in the depth in this field. And while luck and circumstances success of the Canadian model of pension fund. certainly played a role in the emergence of the Three aspects of the governance of the Canadian Canadian model— including very favorable market model have been particularly important. conditions during the 1990s when many of the funds diversified their investment programs—a Governance principle 1: number of the conditions that led to the creation of Independence Canadian plans can be replicated outside Canada Independence is perhaps the most important with the right leadership, people, processes, and governance principle. What does independence vision. mean? Chiefly, it means that the pension organization can make decisions based solely 44 | THE EVOLUTION OF THE CANADIAN PENSION MODEL on its mission—whether that is an investment- between the pension organization and its political oriented mission (CDPQ, AIMCo) or a retirement- stakeholders. We discuss this dialogue in a more security-oriented mission (HOOPP, OPTrust). granular fashion later as part of the lessons regarding This independence implies the ability to make the regulatory and public policy environment. decisions without political interference and without Independence of the pension organization is realized pressure or incentives to serve stakeholder interests through both structure and through day-to-day or pursue goals that conflict with or distract from human decisions and actions. The formal, structural their core mission. “Depoliticized governance” is enablers of independence, in the Canadian context, how pension expert Keith Ambachtsheer puts it.67 have included the following: OTPP founding CEO Claude Lamoureux calls it “run like a business,” a phrase that remains • Legislation. Many Canadian pension embedded in OTPP’s self-description.68 A third organizations (including CPPIB, OTPP, way of expressing this concept is in the idea that AIMCo, CDPQ, and OPTrust) are creations pension organizations exist at arm’s length from of framework legislation.71 Such legislation both government and the sponsoring organizations, enshrines the independence of the organization including labor unions and employers. “The miracle from government, both by providing for of the Canadian model,” Ambachtsheer said, “has specific processes and structures (such as the been the willingness of politicians and labor leaders organization’s mission, board appointment to step aside.”69 process, and exemption of the organization from government budgeting and procurement Independence from politics does not mean complete rules), and through the very fact of legislation, isolation from political forces or actors. To the which can make it more difficult for future contrary: the relationship between independent governments to interfere with the organization’s pension organizations and the political entities that structure and governance for short-term political create, help govern, and regulate them is an ongoing gain. In the case of the Canada Pension Plan one. After all, each of the pension organizations (including CPPIB), the framework legislation profiled in this report is a public entity, even if is quasiconstitutional in the sense that any each operates in ways that are more common to amendment requires the consent of not only the the private sector. A set of specific and facilitating federal legislature, but also the legislatures of political conditions helped create the Canadian two-thirds of the provinces representing two- model of pension organization and have helped it thirds of the Canadian population.72 Dodge calls evolve and improve over time. this framework legislation “the basic operating Former Bank of Canada governor David Dodge rules to keep the government hands-off and frames this idea in terms of trust.70 Trust is a give the organization the ability to run well.”73 precondition for independence. Political actors, • Board appointments. A strong board member and the public they serve, will be reluctant to grant appointment process is a critical element of autonomy to an organization unless they trust that ensuring independent board members. This organization to deliver against its stated mission process sometimes involves the use of a and ultimately act in the public interest. Trust, and nominating committee—a group of outside therefore independence, is not granted all at once, experts whose sole job is to recommend when an organization is founded, but instead must qualified candidates for the board. Whether be earned over time. Independence, in other words, or not a nominating committee is involved, requires a continual and constructive dialogue the boards and management teams of all Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 45 organizations profiled provide advice to the fund, and provided those professionals do sponsoring or appointing organizations on a good job in pursuing the mission assigned board appointments, including (1) using a to them, it is critically important that fund detailed skills matrix that identifies the needs of executives and board members protect those the board and any gaps currently existing and professionals from interference and allow them (2) retaining specialized recruiting firms that the appropriate autonomy. This autonomy can can help create and vet a pipeline of qualified be achieved through structured processes, such candidates for sponsoring or appointing as written and transparent rules governing organizations to consider. These board the approval of investments, which often appointment tactics are relevant regardless limit board or senior executive approval of of whether the organization uses a more investment decisions to those exceeding a professional board model or a hybrid model particular threshold of size or risk. that combines professional board members and more representative board members. Governance principle 2: • Track record of independent decision Leadership making. Independence gains meaning and “The most important thing for a pension credibility to the extent that organizations and organization,” Lamoureux said, “is the quality their leaders practice it in real-life situations of the people involved.”75 This is true at both the in which the organization is being subjected management level and at the board level. Lamoureux to external political pressure to do something observed, “Bad boards are the number one reason that may conflict with its stated mission. OTPP why pension plans fail.”76 Without great people, experienced this earlier in its existence. As without exemplary leadership from individuals Claude Lamoureux recounts it, the Teachers’ involved in building and running the organizations, plan was asked by the government of the day even the soundest and most thoughtful framework (also a sponsor of the Teachers’ plan) to invest legislation and governance structure will fail to in a new government-created vehicle that was produce superior outcomes and may even result in intended to promote economic development poor outcomes or worse. in the province. Whatever the program’s We delve into the issue of people and organization public-policy merits, Teachers’ management, in more detail in a dedicated section. However, it is including its CIO at the time, Robert Bertram, important to also emphasize the importance of people did not feel it was a good investment from and leadership as fundamental elements of pension a plan beneficiary viewpoint. Government governance. The following advice is in order: officials were invited to present the opportunity to the Teachers’ board. After the presentation, • Pick the right chair. Perhaps no decision the officials left the boardroom and Board is as critical to the success of a pension Chair Gerald Bouey asked Lamoureux what organization as the choice of the chairperson he wanted to do. Lamoureux said he did not for the founding or reform phase of the want to make the investment. “Next item,” was pension organization. This initial chair sets Bouey’s response.74 the tone for the organization, is the guardian of the organization’s independence, and leads • Protection for fund managers that allows the effort to hire a CEO and build a strong them to do their job. Once the organization board. This is the case both for the start-up of has recruited professionals to help administer a new organization and for the reform of an 46 | THE EVOLUTION OF THE CANADIAN PENSION MODEL existing organization, in which bringing in a characteristics, it should go without saying, are new board chair to oversee the reform process especially important for those occupying key can be critical in setting the right tone. From leadership positions, such as board members a people perspective, an excellent choice of and members of the senior executive team. founding chair can be leveraged dozens if not Integrity should therefore be embedded in the hundreds of times in terms of other quality hiring criteria for such key leaders, as well people who are attracted to the organization. as in the values and codes of conduct of the A poor choice of founding chair can have a organization. A professional, timely recruitment similar cascading effect, but in the opposite and appointment process for board members direction. “The choice of the first chair is is an important factor in attracting world- critical,” Ambachtsheer said. “He or she will class board members, who usually have many set the tone for the whole organization and will opportunities to serve on boards. Extended often be the person who can make or break the delays in the appointment process can mean organization’s independence.”77 Former Bank losing talent to other opportunities and are of Canada Governor Gerald Bouey, founding especially important to avoid in situations in chair of Ontario Teachers’, is often identified which government approval is required for as an example of an outstanding founding appointments. chairperson. Bouey’s daughter Kathy identifies two key qualities that she believes made her Governance principle 3: father a strong board chair: objectivity (“he Accountability and transparency felt an obligation, rooted in his public service, Accountability and transparency mechanisms are to provide the best, most objective advice in a critical tools for public pension organizations in studiously nonpartisan way”) and a sensitivity earning and maintaining the trust of stakeholders. to both the public and private sectors (“he was Such mechanisms should be built into the governance neither ‘of’ government nor ‘of’ the private of public pension organizations from the beginning. sector, but he deeply understood both”).78 CPPIB The accountability and transparency mechanisms founding chair Gail Cook-Bennett identifies that work best in a public pension context are not three critical characteristics: (1) sensitivity to necessarily the same as those traditionally applied in both the public and private sector; (2) courage, the public sector. Some would argue they are more including the ability to stand behind business akin to those applied to publicly traded companies, decisions in the face of political pressure; and though ideally without the same pressures to (3) a broad range of relevant experience.79 deliver short-term results. The optimal mechanisms • Solve for both talent and integrity. Public allow the public pension organizations to meet a pension organizations, to maintain the trust very high bar of accountability, transparency, and of the public, must meet very high standards ethical conduct, while also allowing room for them of conduct (see the later discussion of to run their affairs in an operationally independent accountability and transparency). Public manner, with a focus on long-term goals. Specific pension leaders, therefore, should meet a high mechanisms, tactics, and strategies for achieving standard not only of professional talent but these goals include also of integrity. A track record of honesty and • Robust public reporting. All major Canadian of doing the right thing under pressure can pension organizations profiled in this study be as important as an outstanding record of publish detailed annual reports. These reports professional skill and accomplishment. These Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 47 are publicly available—easily accessible on theme of people and organization relates not the organization’s websites—and are crafted only to employees, officers, and board members to communicate with a wide variety of of the organization itself, but also to the broader stakeholders, from plan members to employers, range of stakeholders and partners with which the sponsors, journalists, regulators, and private organization collaborates. The presence of people entities that do business or aspire to do of leadership, talent, and integrity at the plan business with the pension organizations. The sponsor and government levels can be critical on reports include audited financial statements issues of governance, plan design, regulation, and and, typically, a detailed section that includes public policy – each of which has been an important discussion and analysis by plan management. enabler of the Canadian model. • Codes of conduct. A publicly available code of conduct can be a key tool for pension People and organization organizations in establishing a culture of principle 1: Top talent and ethical conduct. These codes govern the integrity actions of employees, officers, and board Canadian public pension organizations have members of pension organizations. They deal been able to recruit and retain some of the best with issues such as conflicts of interest, gifts leaders in the pension and investment industry. and other benefits, personal trading activities, They now recruit globally for top positions. Over and personal and professional conduct. While the course of several decades, Canadian pension many organizations have codes of conduct, organizations have gone from being seen as Canadian pension organizations have treated relatively sleepy to being seen as highly desirable these documents as especially important, places to work, attractive because of their public foundational elements of their governance. mission, stimulating work, global orientation, and According to Cook-Bennett, CPPIB’s founding competitive pay. The organizations are highly board members were heavily involved in the selective in whom they hire and in which service detailed drafting of the organization’s code providers they work with, and they now have the of conduct, seeing it as a documentation of ability to work with the “A” teams of some of the CPPIB’s guiding values.80 CPPIB created best firms in the world. Lamoureux tried to set the an external conduct review adviser position, tone for this approach in the early days of OTPP, currently former Supreme Court Justice Frank insisting on hiring the external auditor that he Iacobucci, to provide confidential advice on regarded as the best in the country, even though issues related to the code of conduct and to other options cost less.81 report directly to the board chair. Jean Michel, executive vice president, depositors and total portfolio at CDPQ, identifies talent, People and Organization along with independent governance, as keys to Closely related to governance are the issues of the organization’s success over the years. “When people and organization. It can be argued that, if a hiring for a new position,” he said, “we adopt the pension organization has the right governance and mentality of ‘who’s the best person in the world?’ the right people, these two foundational aspects We want to compete with the best globally.”82 will create a high chance of achieving success in Recruiting talent can be more challenging for those the other elements of pension delivery, including funds that operate outside major financial centers. investments, administration, and funding. The This is the case for AIMCo, whose headquarters in 48 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Edmonton houses 90 percent of AIMCo’s employees. organizations. It typically involves a significant Because Edmonton has not traditionally been a performance-based component, tied to factors such major center for finance and asset management, as investment value added, member satisfaction, AIMCo has focused on building a “farm team” or funded status. It is regularly benchmarked of local talent, ensuring the next generation of against compensation elsewhere to ensure it leadership is in place for the organization. “We have remains competitive. The approach to pay taken a strong internship program,” AIMCo’s CIO Dale by Canadian funds means that Canadian internal MacMaster said. “We build talent from the bottom compensation costs are higher than those of funds up. It can be difficult to recruit people, but once they in some other countries (such as the United States). join they don’t leave, unlike the ‘revolving door’ However, such compensation also gives funds the phenomenon [in bigger financial centers]. Older ability to bring investment management and other workers are willing to come back from overseas. In functions in house, a tactic which tends to result in terms of recruitment, you need to be creative, but lower costs and better net performance.84 you can be successful.”83 Most Canadian pension organizations, particularly The Canadian talent pool for pension management those with more professional governance models, has grown as the funds themselves have grown. It also provide competitive pay for their board is now possible for senior pension and investment members, enabling them to compete with private talent to build diverse, global careers working sector boards for talent and helping ensure board for Canadian pension organizations. In recent members devote adequate time and attention to years, senior leadership of Canadian pension their governance duties. organizations have moved among the funds as they Increasing compensation for internal pension have grown. Former CPPIB CEO Mark Wiseman managers can be politically challenging. began his pension career at OTPP in private equity, Compensation levels for Canadian pension managers then moved to CPPIB’s private investments group have, on occasion, been subject to political scrutiny before becoming head of that organization. André and media controversy—for example, in the wake of Bourbonnais, CEO of PSP Investments, headed significant losses by Canadian pension funds during CPPIB’s private investments group before assuming the global financial crisis. The political challenge his current role. BC Investment Management associated with competitive in-house compensation Corporation CEO Gordon Fyfe previously served levels has been cited as a major obstacle to other as CEO of PSP Investments. jurisdictions wishing to adopt the Canadian model. Such in-house compensation levels, however, need People and organization to be seen in comparison with the alternative: fees to principle 2: Competitive pay external managers that are usually significantly higher, A key part of the Canadian model is that particularly for illiquid, alternative investments. organizations pay competitively, enabling them Government officials and regulators considering a to build professional internal teams and decrease shift to greater in-house expertise will likely require reliance on external service providers, particularly education on the costs and risks associated with an on the investment side. Though pay varies from outsourced model and on the potential cost savings organization to organization, it tends to follow and performance advantage associated with bringing a few general patterns. It is not subject to public investments in house. In the long run, the political sector compensation limits; exemption from these risk associated with uneconomic outsourcing may rules is often part of the enabling legislation of these be greater than that associated with higher in-house Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 49 compensation, because outsourcing ultimately costs deep understanding of their comparative advantage plan members and public treasuries and is likely to relative to the many other talented, sophisticated be subject to increasing scrutiny as the cost of asset institutional investors. “You can’t be world-class management becomes the topic of greater regulatory at everything,” AIMCo CEO Kevin Uebelein said. and public debate. “You need to be thoughtful about assessing in what functional areas you are truly outstanding.”88 Investments HOOPP CEO Jim Keohane put it this way: “We don’t believe that we can outsmart people. We look Unlike many institutional investors, many to our comparative advantage—what can we do well Canadian pension funds have demonstrated the that other people can’t or are unwilling to do?”89 ability to add after-cost value through active investment management.85 Recent analysis by Comparative advantages can exist at a number of Keith Ambachtsheer found that funds using the levels. CPPIB, for instance, sets out two categories “Canadian model” generated an average of 0.6 of comparative advantage:90 percent per year in after-cost value relative to a • Structural advantages—attributes inherent passive reference portfolio, compared with an in the structure of the pension fund, including average of 0.1 percent for global peer funds.86 long time horizon, scale, and certainty of assets Today, large Canadian pension funds are heavily diversified, active public investment managers with • Developed advantages—attributes that evolve large, sophisticated in-house teams. The funds are over time, including internal expertise, expert part of some of the most significant deals on the partners, and a risk-based, total-portfolio planet and are sought-after investment partners and approach sources of capital.87 Many large funds have opened Comparative advantage can exist at the asset- offices outside of North America, including some class or geographic level. CDPQ professionals, for funds that are building teams in emerging markets. example, talk about the organization’s comparative How did the funds get to this point? A number of advantage when it comes to investing in its home key principles help explain their evolution. province of Québec, where the fund has developed a very deep understanding of the economy, business Investment principle 1: community, and local deal flow.91 OPTrust has Comparative advantage developed a comparative advantage in midmarket Canadian pension funds have evolved their capacity infrastructure, often competing effectively for to do active investment management over time. A smaller deals that may not be of interest to larger critical question that has guided this journey is the funds. matter of comparative advantage. In an increasingly Some comparative advantages of Canadian funds competitive asset management environment, in are a function of plan design or policy features. which a greater and greater share of investors are The defined-benefit nature of the vast majority sophisticated institutional players, investors need a of Canadian public pension obligations gives significant edge over the competition if they wish to the Canadian funds stable, patient capital, which outperform. Individual and even many institutional enables them to invest directly in long-dated assets investors struggle to do better than market indices. such as infrastructure and real estate. The relatively The bar for value-adding active management is hands-off regulatory environment governing the therefore very high. Investors that wish to stand a investment of Canadian pension assets has also good chance of outperforming need to develop a enabled Canadian pension funds more leeway to 50 | THE EVOLUTION OF THE CANADIAN PENSION MODEL pursue new and innovative investment strategies Neil Petroff (who later became OTPP’s CIO) with less concern about regulatory intervention. in derivatives, and George Harrison and Jim This freedom has given Canadian funds a Leech (who later became CEO of OTPP) in comparative advantage relative to pension funds private equity.93 Similarly, Michael Nobrega in other jurisdictions and financial institutions that (who later became CEO of OMERS) was the operate under more prescriptive regulatory regimes. key person behind OMERS’s move to invest directly in infrastructure. Many funds began Investment principle 2: In-house the move to internal management with more management liquid investments such as public equities, In-house management is often cited as one of the then moved to in-house, direct investment in key characteristics of the Canadian model. Indeed, alternative asset classes at a later date. OPTrust roughly three-quarters of the assets of the top 10 has taken the opposite approach, building in- Canadian pension funds, across a range of asset house capability in private markets first and classes, are internally managed rather than managed moving to in-house management of public- by external asset managers.92 If properly executed, market investments more recently. The decision an internal management approach can lower costs, to bring a particular asset class in house needs allow access to more investment opportunities and to be based on a business case, tied to the deals, reduce principal-agent problems, and enable comparative advantage of the fund, and based the fund to play a more active role as an asset owner. on a realistic assessment of the fund’s scale In addition to these basic advantages, a number of and the pool of investment talent that the fund aspects of the Canadian funds’ evolution toward in- might realistically recruit. house management deserve emphasis: • Collaboration and coinvestment. Although • Phased approach to bringing assets in house. Canadian pension funds compete over some Canadian funds did not bring assets in house all elements, such as talent, their nonprofit at once. The process was gradual and in some structures and largely captive membership bases cases opportunistic. Most of the funds’ evolution create much more space for collaboration than toward in-house, direct investment began with would be possible in the competitive world of investments through funds before investments private sector asset management. The evolution were made alongside partners. Sometimes of the Canadian model, then, has created not just in-house teams were built from the ground a number of individual successful entities but up, as in the case of OMERS’s infrastructure also a collaborative public pension ecosystem subsidiary, OMERS Infrastructure. Sometimes that allows for the sharing of knowledge and they were acquired, as in OTPP’s entry into best practices, and also coinvestment, often direct real estate investment through the alongside Canadian peer plans. “The creation of acquisition of Cadillac Fairview. The decision an ecosystem has been important to the model’s to build capacity in a particular asset class success,” OPTrust CEO Hugh O’Reilly said. may be based around a particular person “Competition among the plans encouraged who is recruited to the investment team. innovation, while the first couple of funds set Lamoureux describes OTPP’s entry into new the tone for the system.”94 The coinvestment asset classes in terms of leadership by certain approach, which is common in asset classes key individuals, including Leo de Bever (who such as real estate and infrastructure, allows later became CEO of AIMCo) in infrastructure, funds to share investment risk on deals. It can Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 51 also result in lower diligence costs when funds Investment principle 3: work together to scrutinize potential investment opportunities. Canadian funds have also used Geographic and asset-class coinvestment as a way to enter and develop diversification expertise in new asset classes. Examples of Diversification is a basic principle of investment coinvestments by Canadian pension funds management, an essential tool for managing risk. include The story of the evolution of Canadian pension funds is in part a story of increasing diversification, • TMX (Canada). In 2012, CPPIB, AIMCo, both by geography and by asset class (figure 5.2). OTPP, and CDPQ led a consortium of “Canadian funds have not been afraid to change their investors to acquire the TMX Group Inc., asset mix,” former OMERS CEO Michael Nobrega which owns the Toronto Stock Exchange said. “They have continued to evolve. For OMERS among other assets. This consortium was the asset mix shift took 30 years.”96 As discussed put together in the wake of a bid by the earlier, some of the Canadian pension funds that are owner of the London Stock Exchange to now regarded as among the world’s most successful merge with TMX. were, less than three decades ago, invested 100 • Yorkdale Shopping Centre (Toronto, percent in nonmarketable government bonds. They Canada). OMERS and AIMCo are owners were less diversified than a typical retail investor of the fifth-largest shopping mall in Canada. —and far less diversified than many institutional investors around the world. These same funds • Chicago Skyway Toll Bridge (United are now investing in a wide range of geographic States). In 2015 CPPIB, OTPP, and OMERS markets and asset classes, many of which are not acquired the company that manages the accessible, at least not at a reasonable cost, to most Chicago Skyway toll road, a 12.5 kilometer retail investors or even many institutional investors. (7.8-mile) link between downtown Chicago and the city’s southeastern suburbs, for Each fund’s journey toward increasing diversification US$2.8 billion. has been unique. CDPQ and HOOPP, for instance, have been investing in equities since the 1960s. • Transelec (Chile). CPPIB, bcIMC, and CDPQ made its first international investments in the PSP Investments coinvested in the largest 1980s. By contrast, before OPTrust and OTPP were electricity transmission company in Chile. spun off as independent entities, their members’ • Technology as a key driver. An important but assets were invested entirely in nonmarketable sometimes overlooked component of in-house government debentures. management, particularly within a plan with Considering these differences, the diversification of sufficient size, is technology related. “In the Canadian funds has followed two broad themes: mid 2000s, we revamped all our investment operations, allowing us to do things many • Increasing investment in alternative, illiquid other plans can’t,” said HOOPP’s Keohane. asset classes. Canadian funds are well known “Technology is a big advantage of scale that for their exposure to alternative asset classes is often underestimated. We can do large such as real estate, infrastructure, and private technology projects that many other entities equity. Although increasing allocation to can’t.”95 Indeed, investment information alternatives has become a broader trend in more technology comprises a significant portion of recent years among institutional investors, the in-house teams of many Canadian plans Canadian funds began to follow this path Note: AUM = assets under management. 52 | THE EVOLUTION OF THE CANADIAN PENSION MODEL Figure 5.2: Asset mix for Canadian pension funds has diversified over time (CDPQ and OTPP examples) Asset type as a share of total AUM (%) 100% 90% Absolute Return 80% Commodities / 70% Natural Resources 60% Infrastructure 50% Real Estate 40% Fixed Income 30% Private Equity 20% Equities 10% 0% 1985 1995 2005 2010 2015 Pre 1992 1996 2000 2005 2015 Figure 5.3: Asset allocation by geography of select Canadian pension funds (2016 figures) 15% USA UK 31% 5% 41% USA 64% Canada Canada 14% Other 13% 6% 9% Europe Other Emerging 0 18% 0 22% USA USA Europe 0 8% 47% 73% Canada 7% Emerging 1% Other Canada 24% Other Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 53 relatively early, in the 1990s and early 2000s. emphasized that important preconditions—both Today, roughly one-third of the portfolios of internal and external to the plan—should be in the top 10 Canadian public pension funds are in place before such strategies become advisable. alternative asset classes.97 These preconditions include the true independence of the pension fund from sponsors and government, • Increasing international investment. a strong rule of law and regulatory framework, and Canadian funds have tended to decrease their a board and management team with the capability “home bias” over time and continue to do to properly oversee and execute the program.100 so, particularly in asset classes outside fixed income, which has tended to remain largely within Canada. For the top 10 Canadian Investment principle 4: Risk and pension funds, as of 2014, non-Canadian assets liabilities management comprised 77 percent of public equities, 28 Although many Canadian pension funds have percent of fixed income, 85 percent of private achieved strong after-cost returns, they do not see equity, 74 percent of real estate, and 39 percent the generation of investment return as their primary of real estate.98 To facilitate international purpose. Indeed, one of the key shifts over the years investments, particularly in private markets, in the investment approaches of the four funds most Canadian funds have opened international profiled here has been a greater emphasis on two offices over the years. OTPP has offices in Hong other factors: risk and liabilities. This shift, in some Kong SAR, China; New York, and London. cases, was accelerated by the 2008 financial crisis. OPTrust has offices in London and Sydney. These factors are now at the center of how these AIMCo recently opened a London office. organizations think about investments. Strategies CDPQ has offices in Washington, D.C.; New and tactics that these organizations have used to York, Mexico City, Paris, Singapore, Sydney, advance this goal include an effort to and Beijing, in addition to an office the fund • Develop a deep, integrated understanding opened in Delhi in 2016. CPPIB has offices in of the sources of risk to the fund or plan. New York; São Paulo; London; Luxembourg; HOOPP, one of the early adopters of liability- Mumbai; Hong Kong SAR, China; and Sydney. driven investing (LDI), began its transition to The trend toward international investment is this approach by assessing the major sources of likely to continue, especially given the limited risk to its funded status. It identified three main size of the Canadian market (figure 5.3). CDPQ, risks: equity risk, inflation risk, and interest-rate for instance, recently opened an office in India risk. Managing these risks to the plan’s funded and plans to increase its allocation to emerging status then became the basis of a revamped markets, with a focus on building on-the- investment strategy that focused on increasing ground knowledge and partnerships in priority the interest-rate and the inflation sensitivity of geographies.99 OPTrust, CPPIB, and OTPP are the plan and reducing the plan’s sensitivity to other examples of Canadian funds that have equity markets.101 identified emerging markets as priorities for future growth. • Orient investment governance around managing risks to funded status. HOOPP’s When discussing the implications of the increasing LDI approach, which has evolved over more sophistication of Canadian public pension than a decade, is now deeply embedded in the investment for emerging economies, interviewees plan’s investment governance. The board does 54 | THE EVOLUTION OF THE CANADIAN PENSION MODEL not have an investment committee; it has an Administration principle 1: asset-liability management committee whose mandate is aligned with the plan’s overall goal Client-focused orientation An important part of running a pension organization of achieving and maintaining fully funded like a business involves treating plan members like status. The plan’s investment policies and valued clients, aiming to deliver a high-quality procedures have been rewritten from scratch level of service. Lamoureux, the founding CEO and reframed to focus on liability management of Ontario Teachers’, identifies client service and risk budgets, now differing from more orientation as one of the key leadership qualities for traditional investment documents focused on pension professionals.104 This orientation comes, asset weights.102 OPTrust has also recently in part, from the kinds of people that a pension begun to shift to a similar type of approach, organization hires and the type of culture the which it calls “Member Driven Investment.” organization encourages. Client service orientation • Appoint a chief risk officer or equivalent. can also be fostered through a number of other Many Canadian pension organizations include tactics and approaches, including by the following. on their senior executive teams a person in • Measure and benchmark client satisfaction. charge of managing risk. The role of this person Canadian pension plans regularly survey and the function he or she oversees has grown their members and employers to gauge their in importance over time. “Risk has become level of satisfaction. These satisfaction levels much more integrated into our investment are treated as important business metrics, process,” CDPQ’s Jean Michel said. “The chief including in setting the compensation of the risk officer is at the same level as the chief pension professionals who work for these investment officer in the investment decision- plans. Benchmarking client satisfaction against making process.”103 global pension peers—and reporting the results in public annual reports—is a common practice Administration that Canadian plans use to hold themselves The pension administration functions of Canadian accountable and identify opportunities to pension organizations have received less attention deliver even better service to members. Firms than the investment functions. Administration such as CEM Benchmarking, a Toronto-based should not, however, be overlooked. For the company founded in 1990, help pension Canadian pension organizations that include organizations compare their performance and administrative functions (investment-only costs against global peers on the basis of a organizations such as AIMCo, CDPQ, and CPPIB standard set of metrics. do not have such functions), those functions have • Build strong in-house teams for front- improved considerably since the early days of line member and employer service. While those organizations. High-quality administration administrative functions of Canadian plans are is a major driver of increased member satisfaction. performed through a mix of in-house staff and Administrative mistakes can also have huge outsourcing, the front-line, client-facing service consequences for pension organizations and can is almost always performed by in-house teams result in costs of hundreds of millions of dollars, as that are fully dedicated to serving the clients a number of Canadian plans have learned. of the plan. These in-house teams are usually Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 55 highly trained on the client base and features organization as a whole, including at the senior of the plan, and their tenures with the plan are management and board levels. “Customer often much longer than those of a typical call service talent was one of the main reasons center or front-line client service employee. Claude Lamoureux was hired [as the first This longevity enables them to become experts CEO of OTPP],” Kathy Bouey recalled. in the plan and to enable member and employer “Better customer service was one of the main issues to be dealt with quickly and efficiently, motivations for the teachers’ unions to set up in a one-stop-shop type of approach. The client- OTPP as a separate business.”105 AIMCo’s focused mentality can manifest itself in the Uebelein, who previously had extensive client- physical offices of the pension organizations. facing experience at major private sector firms OPTrust’s offices, for example, include meeting Fidelity and Prudential, believes that there is a rooms that are reserved exclusively for plan special client-service obligation on Canadian members who want to talk to someone face-to- pension funds because of their largely face about their pension. captive client base. “When you have captive relationships, it is easy to view it as license to • Make it easy for employers. Larger Canadian behave the way you want to,” Uebelein said. public sector plans are usually multiemployer in “You need to change that attitudinally. You nature, meaning that the individual employers need to a meet a higher obligation because they that are part of the plan are not generally don’t have a Plan B.”106 themselves the sponsors of the plan but are rather participants in it. This creates value for the employer because it minimizes or removes Administration principle 2: legal liability and administrative responsibility Modern technology for running a pension plan, and it turns these Pension administration can be thought of as a duties over to an expert pension administrator combination of services and technology. Increasingly, and a fiduciary board. Pension organizations the technology element of administration—whether can create even more value for participating built in house, outsourced, or developed through employers by making the employer’s part a hybrid model—is essential and should not be of plan administration as easy as possible, overlooked. Strong technology choices can drive minimizing employer administrative burden down costs, improve client satisfaction, and reduce and developing a clear understanding of the errors. Poor technology choices can be enormously constraints and environment facing employers, expensive, confuse clients, and, perhaps most both large and small. Being client focused, problematically, compromise sensitive member then, involves attention not just to members of and employer data. The experience of Canadian the plan, but also to employers and their needs. plans offers two key practical lessons for emerging When employer service works well, it can economy stakeholders to keep in mind. significantly improve compliance (in the case • Tie technology to a vision for the of a mandatory plan) and member participation administration business. Ultimately, pension (in the case of a voluntary plan). administration technology is meant to serve • Hire people with talent for customer the business: the clients of the pension service. This tactic applies not just within plan. This point may seem obvious, but in the administrative function but within the complex technology products and projects, a 56 | THE EVOLUTION OF THE CANADIAN PENSION MODEL large disconnect often emerges between the Administration principle 3: High- technology and its business purpose. One tool that plans can use to avoid this disconnect is quality communications and to lay out a carefully articulated and thoughtful education vision or “target operating model” for the • Create in-person education teams. Despite administrative function before undertaking a major advances in technology, Canadian large technology purchase or build. This vision pension plans have developed and retained or model should integrate the technology several “high-touch” elements to their pension part of plan administration with the services administration. One such element, which element and should be geared toward the needs is common in Canadian plans, is teams of and preferences of the members and employers member and employer education staff. The who are the clients of the plan. chief function of these teams is to run in-person sessions for members and employers to explain • Fix administrative mistakes early. Before the features of the plan, to help guide clients entering a reform period (such as at phase 1 in through important decisions that they face with the framework laid out in the previous section), respect to the plan (such as when to retire), and pension organizations often suffer from major to answer any questions. Recently, these teams administrative problems. When professional have expanded beyond a technical education management first took over at Ontario function to begin educating members and Teachers’, Lamoureux said, the staff discovered employers about the fundamental value of the $500 million worth of mistakes and a backlog plan, and are even recruiting members who are of 10,000 letters.107 Fixing early administrative willing to serve as “ambassadors” of the plan. problems cost the plan $360 million, and the HOOPP, for example, not only engages 11,500 work to carry out this fix was done early.108 members annually for pension education, Brian Mills, the CEO and superintendent of but it has also built an ambassador program the Financial Services Commission of Ontario, comprised of over 4,000 plan members.112 Ontario’s pension regulator, recalls that OPTrust also recently launched an education similar administrative challenges were present program, called “People for Pensions,” that has when the Ontario Pension Board (which now a similar goal.113 manages $23 billion in assets) began to reform in the late 1980s and early 1990s.109 There was • Tailor communications products for a backlog of 22,000 cases; no one had checked different audiences. Over the years, Canadian whether the approximately 40,000 members in plans have moved toward more client-focused the plan were still alive (it turned out that 200 communications that are tailored to the needs of had died yet were still in the plan’s system); different audiences. In addition to their detailed there were violations of pension law and major annual reports, which can be over 100 pages data issues that cost $13 million to clean up.110 long and include detailed technical investment “You have to deal with data issues early,” Mills and funding information, plans have begun said. “That means spending the money to invest producing communication products targeted in systems.”111 to the needs of members and employers. Plans tend to produce a simple, short, visually Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 57 appealing member statement, a summary of the Second, the insights shared during our interviews key member-relevant parts of the annual report. lead us to believe that there are valuable plan Targeted employer communications, including design and funding lessons to be learned from both employer newsletters, also have become the positive and negative experiences of Canadian common. pension institutions. The Canadian model has its origins in plan design and funding issues of Plan Design and Funding sustainability and intergenerational equity. These were critical factors undergirding the creation Discussion of the Canadian model of pension of organizations such as OTPP and CPPIB. Plan plan tends to focus more on plan management design and funding issues are an integral part of the and governance than on plan design and funding. story of how the Canadian model evolved. Indeed, some experts argue that plan design and funding are not truly part of the model. “The Canadian model is about running a pension plan,” Plan design and funding actuary Malcolm Hamilton said. “It is not about principle 1: Sponsors with scale plan design or funding, which are often outside the and mission alignment control of boards.”114 As noted earlier, scale confers considerable advantages on a pension organization. It enables more There are some merits to this point of view, and activities on both the investment and administrative certainly the plan design and funding models of side to be brought in house, reducing costs and Canadian public sector plans have evolved over improving long-term alignment of interests. Scale recent years, especially since the global financial also enables organizations to make meaningful crisis, and remain works in progress. However, we investments in technology, helping improve both include plan design and funding considerations as pension administration and investment operations, part of the definition of the Canadian model, and as that smaller organizations would not be able to part of the lessons learned from that model, for two make. Governance can also benefit from scale, main reasons. because larger, more sophisticated funds often have First, although the plan design and funding models an advantage in attracting board members and in of Canadian funds may not be as distinctive as ensuring their boards are well supported. their approaches to investment and governance, It helps to ensure the fund has sponsoring they are interrelated with those other features. For organizations that have access to pools of example, the defined-benefit nature of most of the membership, capital, or both that will allow the underlying plans, with their predictable, locked-in organization to achieve meaningful scale over time. contributions, facilitate the stable, patient capital In the context of leading Canadian public funds, this necessary for the kind of investment programs that has tended to mean removing pension sponsorship the funds carry out.115 Further, the nature of the from the ambit of any particular employer and sponsoring organizations—typically governments, instead vesting that responsibility with larger, unions, and associations—foster (and may even aggregating organizations that include be necessary pre-conditions for) the scale, joint- governance, joint-risk-sharing, and members-first • Labor unions. Two of the organizations orientation that are core to the definition of the featured in this case study, OPTrust and Canadian model. HOOPP, have labor-union sponsors. OPTrust has a single labor-union sponsor. In HOOPP’s case, the five sponsors of the plan include four 58 | THE EVOLUTION OF THE CANADIAN PENSION MODEL public sector unions. Other leading Canadian and the Public Service Pension Investments, public pension organizations are also jointly also were initiated by governments. sponsored by labor unions, including OTPP, • Another advantage of those kinds of sponsoring OMERS, and major public sector pension organizations is portability. Many Canadian plans in British Columbia. According to public sector plans allow members to keep Jennifer Brown, a founding trustee of OPTrust their pension as they move from employer to and former chief pension officer at OMERS, a employer, so long as they remain within the union presence is “very important to the health same province and sector. of a pension program,” provided the union is able to carry out its role as sponsor without • Achieving the effective sponsorship of getting inappropriately involved in the day-to- organizations with this kind of reach was not day management of the operation.116 achieved overnight. Considerable effort was involved on the part of both governments • Associations. Industry, professional, or sector and the sponsoring organizations themselves. associations can play an important role as Sponsorship lessons include pension sponsors in offering access to a broad pool of employees and facilitating portability • Intensive engagement around the setup of within a sector or field. As noted in the HOOPP the organization. One of the preconditions case study, HOOPP began as an initiative to the setup of OTPP was the considerable of the Ontario Hospital Association, which engagement between the government and the represents the hospital sector and continues to Ontario Teachers’ Federation, an umbrella group be a sponsor of HOOPP. Other Canadian plans representing the four main teachers’ unions in also have involved associations as sponsors. Ontario.117 The government appointed a special For example, the Association of Municipalities adviser to consult with the key stakeholders, of Ontario, which represents all municipal including the labor unions.118 Considerable governments in the province of Ontario other time and effort were spent working out a than the city of Toronto, is one of the sponsors joint sponsorship agreement that would serve of OMERS. as a foundational document underlying the plan. Lamoureux credits the leadership of the • Governments. Most (though not all) of Ontario Teachers’ Federation for providing the Canada’s leading public pension organizations managers space to do what they do best. “They have involved government as a sponsor or made it clear they wanted us to do a good job,” initiator of the organization. CDPQ was he said.119 established by the government of Québec, which continues to appoint board members to oversee • Ongoing pension capacity building within the the organization. AIMCo was established sponsoring organization. Sponsoring a pension by the government of Alberta. OPTrust is plan is a significant undertaking that requires cosponsored by the government of Ontario, certain skills, knowledge, and organizational as is the Ontario Teachers’ Pension Plan. The state of mind. Although the arm’s-length aspect federal government and the 10 provincial of the Canadian pension model is designed to governments together share responsibility for minimize the sponsors’ role in the day-to-day overseeing CPPIB. Other large public pension running of the plan, sponsors nevertheless have asset managers, including the British Columbia certain responsibilities that continue even after Investment Management Corporation (bcIMC) the plan is set up. Obligations could include to Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 59 recruit, select, and educate board members; make Plan design and funding principle decisions around the design, funding, or basic governance model of the plan; communicate 2: Realistic assumptions The assumptions a pension plan makes about with membership about the benefits of the plan; expected investment returns, demographics, and respond to member inquiries about the plan; and working life have a critical effect on the plan’s interact with government, regulators, and other sustainability. One crucial assumption is the stakeholders around important issues facing the discount rate used by the plan. OTPP describes the plan. The union, association, and government importance of reasonable discount rates as follows: sponsors associated with Canadian pension organizations all have taken steps to improve their The discount rate must be realistic to avoid internal capacity to deal with these kinds of issues, masking plan funding issues that could impact including creating in-house pension specialists future generations of retirees and plan members. and retaining external expertise. Similarly, the For example, if the assumption is too high and professional management of the pension funds investments earn less than expected, a funding invests time in educating and communicating shortfall could result, requiring younger and with sponsoring organizations about what the future plan members to contribute more to the plan’s staff is doing, including reinforcing the pension plan, receive lower benefits, or both. If the value of the arm’s-length approach. assumption is too low, current members could pay more than necessary for their pensions or benefits may be reduced more than necessary.120 Figure 5.4: Discount rates of select Canadian pension plans (Rates are One major difference between Canadian public sector in nominal terms, including inflation, plans and plans in the United States is the discount based on most recent annual reports) rates that they use to value their liabilities (figure 5.4). Large Canadian public pension plans tend to use discount rates at least two percentage points lower 4.8% than those used by U.S. public pension plans.121 While lower than those of their U.S. counterparts, the discount rates used by Canadian public pension 5.4% plans are higher than those used in other contexts, such as U.S. corporate pension plans (which tend to use a lower, corporate bond rate to set their discount 6.2% rates) and the Netherlands, which has moved to a system in which the Dutch central bank sets discount rates for all plans. Some commentators have argued 5.45% that Canadian public sector plans should be lower still, mimicking the approach in the U.S. private sector.122 To date, Canadian pension law and regulation have tended to defer to the professional 5.5% standards and judgment of the actuarial profession Largest pension plan in Alberta. Assets managed in setting discount rates rather than prescribing a by AIMCo. rate that plans must use. Some pension regulators in Canada have been using moral suasion to influence 60 | THE EVOLUTION OF THE CANADIAN PENSION MODEL pension plans to reduce their discount rates to more • “Investing” in more cautious assumptions conservative levels. over time. In some cases, Canadian plans have chosen to use pension surplus not to Getting to a realistic, but not overly prescriptive, decrease contributions or increase benefits, but discount rate is easier said than done. Plans often to lower the discount rate and therefore make sustain stakeholder pressure to deal with pension the assumptions underlying the plan more problems simply by raising the discount rate, conservative and to adapt them to current market making unrealistic assumptions about future returns trends and interest rates. OPTrust, for instance, rather than dealing with the issue through increased has done this a number of times, including in contributions, reduced benefits, risk sharing, or 2016.125 In other words, maintaining a realistic other more concrete ways of tackling the challenge. discount rate is an ongoing process that requires Unrealistic assumptions have been used as superficial continuous engagement of plan board members. solutions to pension sustainability challenges by both management and labor, and in both the public and private sectors, as has been well documented Plan design and funding in the U.S. context.123 The arm’s-length governance principle 3: Risk sharing and structure of Canadian pension plans helps here. prudent funding Independent boards, supported by the right Major Canadian public pension funds have, on the management and outside professional advice, are whole, managed to achieve reasonable funding arguably less likely to make unrealistic assumptions levels. Many of Canada’s largest public pension than pension oversight bodies that are more closely plans are fully funded or in surplus on a regulatory tied to the sponsoring organizations, whether labor basis. According to the Office of the Chief Actuary, or management. In addition to the basic governance the Canada Pension Plan is expected to be able structure, Canadian pension organizations have used to meet its obligations, at current contribution some more specific tactics to achieve more realistic rates, for the next 75 years, despite the increases discount rates and assumptions: in benefit obligations projected to result from an aging population.126 Most Canadian pension • A single discount rate set by the board, leaders acknowledge that plan sustainability based on a single actuarial opinion. Part of remains a challenge, especially in light of maturing the independence of the Canadian model of plan demographics and lower expected returns. plan has to do with the discount rate. According Interviewees also acknowledged that mistakes have to OPTrust’s O’Reilly, the lack of political been made along the way. O’Reilly, for example, interference in setting actuarial assumptions is highlighted the contribution holidays and benefit one of the key characteristics of the Canadian improvements that many plans undertook during model.124 The way most Canadian plans ensure the late 1990s as examples of mistakes.127 Overall, independence is to have a single discount rate for however, it can be argued that the Canadian model the plan that is informed by independent actuarial of investment plan has managed the sustainability advice and set by the plan’s board. Where the challenge well, including weathering with global public asset manager is not responsible for plan financial crisis without any fundamental changes to funding, including actuarial assumptions, one the plan design model. option is to set up an independent office of the chief actuary, the model used for the Canada Pension Plan. Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 61 Large Canadian plans use a variety of tools to stay dealing with surpluses and deficits. The purpose on the path toward sustainability: of a funding policy is to provide a framework for funding decisions, taking into account factors • Risk sharing. Although large Canadian public that are relevant to the plan and the sponsor. A pension plans are generally regarded as defined- clear, comprehensive, and well-documented benefit plans, the majority have some element of funding policy can help pension plans make risk sharing. Members bear some of the downside funding decisions on a systematic rather than ad risk if a plan is underfunded and also some of hoc manner, and impose a measure of financial the benefit if a plan is overfunded. This structure discipline on plan decision making. Funding helps lead to a sense of shared responsibility policies often spell out a decision-making for keeping the plan on a sustainable footing. process for when the plan is at certain levels of The risk-sharing structure, said Dan Anderson, over- or underfunding. vice-chair of HOOPP, “has allowed us to avoid getting into disputes about surplus and other traditional pension conflicts.”128 To deal with their Regulatory and Public Policy underfunding in the wake of the financial crisis, Environment the sponsors of many Canadian plans agreed to raise contribution rates (for both employers and Regulatory and public policy employees), reduce benefits (for example, by principle 1: Trust and autonomy making indexation contingent), or both. Canadian pension policy and regulation have evolved alongside Canada’s more sophisticated • Removal of pensions from collective pension organizations. The process can be seen as bargaining. In the jointly sponsored model, part of an ongoing dialogue between governments used by plans such as OTPP, HOOPP, OPTrust, and regulators, on the one hand, and public pension OMERS, and British Columbia’s major public organizations, on the other hand. These public sector pension plans, employer- and employee- policy changes occurred gradually, over a 20- to side sponsors are jointly responsible for the key 30-year period. It could be argued that the changes terms of the plan, including the contribution rates were based, in part, on the successful track record and benefit levels. This means that such plan of the funds, thus allowing them to earn the trust of design decisions are made at a pension-specific policy makers and regulators that would result in table—generally either a sponsors’ committee greater autonomy. (in the case of OTPP) or the board of trustees itself (in the case of HOOPP). “The model Mills, of the Financial Services Commission of work[s] well when sponsors don’t try and use the Ontario, attributes part of the greater autonomy pension plan as a bargaining chip or bring other granted to plans to the nature of their advocacy. bargaining issues to the table,” said Bill Foster, Mills noted: “When the plans would identify former Chief Administrative Officer at OPTrust restrictions in the rules that impeded them from and one of the first employees of OTPP. “It is acting how they wanted or needed to, they would often best if the sponsor representatives dealing propose concrete changes and tended to think in with pension issues are not the same people as terms of regulatory and policy considerations.”130 those who are dealing with bargaining.”129 Some of the key pension-related regulatory and • Funding policies. Another common feature of public-policy developments since the early 1990s Canadian public plans is a well-defined funding that are relevant to large Canadian public pension policy that spells out in advance the process for funds include 62 | THE EVOLUTION OF THE CANADIAN PENSION MODEL • The relaxation of quantitative investment with having joint sponsorship and governance limits, including the Foreign Property Rule, of a pension plan, shared between employer and the 5 percent, 15 percent, and 25 percent and employee representatives. quantitative limits. The Foreign Property Rule, • The growing adoption of pooled investment which was eliminated in 2005, restricted fund’s management, in which a single public asset ownership of foreign property (including manager invests assets on behalf of multiple shares or debt issued by nonresident entities) public pension clients. This model began in to 30 percent of the plan’s assets.131 The 5 the 1970s when CDPQ began managing assets percent, 15 percent, and 25 percent limits, for public pension and insurance funds other eliminated in 2010, applied to resource and than its original depositor, the Québec Pension real property investments. These changes have Plan. The model has since been adopted within tended to allow Canadian pension funds to the federal government (PSPIB, founded invest a broader portion of their assets outside 1999), British Columbia (bcIMC, founded of Canada.132 They have also allowed funds 1999), Alberta (AIMCo, founded 2008), and to play a more active role as asset owners Ontario (Investment Management Corporation (by allowing them to hold greater ownership of Ontario, created by legislation in 2016 to shares in their investments) and to invest more manage assets on behalf of smaller Ontario freely in a diversity of asset classes. In 2015, public pension funds and other public entities). CDPQ began to play a much more active role in infrastructure projects in Québec and • Changes to allow for the growth of existing abroad, through the creation of its CDPQ Infra public pension organizations. This has subsidiary. Another relaxation of investment included rules to facilitate the merger or restrictions that occurred over the years applies consolidation of plans. It has also included rules specifically to CPPIB. In the first few years of that allow certain public pension organizations CPPIB’s existence, legislation precluded the to provide services, such as third-party asset organization from investing actively within management, to others beyond the existing Canada. This restriction was later removed membership of the plan.135 as the board became convinced, and helped persuade the government, that it could add Regulatory and public policy value through active management.133 principle 2: Robust regulatory • The spread and formal recognition of regime the jointly sponsored pension plan model The regulatory and public policy story behind (a model followed by HOOPP, OPTrust, the evolution of the Canadian model is not just OTPP, and OMERS, as well as by British one of increasing regulatory “laissez-faire.” To Columbia’s major public sector pension the contrary, the presence of a robust regulatory plans). Originally restricted to Ontario, the and legislative framework, including the way this model has now expanded to other provinces. framework has evolved, is arguably one of the In a recent round of pension reform, Ontario reasons the Canadian model evolved the way it did. created a separate, less onerous funding regime • Subject public sector pensions to a similar for jointly sponsored plans, on the basis of regulatory regime as private sector pensions. recommendations of an expert commission on Unlike in some other countries, including pensions,134 and in recognition of the additional the United States, public sector pensions in member protection and oversight that can come Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 63 Canada tend to be subject to the same or similar some changes to the plans to bring them into regulatory regime as private sector pensions. compliance with the new regulatory regime. There are some exceptions to this rule: Canadian More recently, a wave of reforms in Canadian federal public service pensions are not subject pension standards legislation that began around to the federal Pension Benefits Standards Act the time of the global financial crisis has been but rather to a separate legislative framework;136 followed by—and arguably led to—a broader the funding regimes that apply to private sector series of reforms to public pension institutions, plans often differ from those that apply to public including the proposed creation of the Ontario sector plans; and public sector plans use different Retirement Pension Plan, enhancements to the accounting standards than private sector plans.137 CPP, and the creation of a new public pooled However, most Canadian public sector pensions asset manager in Ontario, the Investment are subject to the same pension standards Management Corporation of Ontario. legislation and investment rules as private sector pensions. Holding public sector plans to Regulatory and public policy similar standards as private sector plans can help principle 3: Good governance subject public sector plans to a higher degree of Good governance can serve not only to increase scrutiny and transparency. It also brings public the performance of pension arrangements. It can sector plans into the same regulatory community also help supplement the regulatory regime. For as private sector plans, arguably encouraging the kinds of Canadian pension funds profiled as greater dialogue and sharing of best practices part of this study, governance is arguably part between the public and private sectors. The and parcel of the regulatory regime, if looked at United Kingdom is an example of a jurisdiction broadly. The governance models of legislated that has recently subjected public sector pension pension arrangements (including AIMCo, CDPQ, plans to greater regulatory scrutiny. CPPIB, and OTPP) is often codified in the enabling • Harness the momentum from reforms to legislation of these organizations, including rules the regulatory system to make changes to around board appointments and composition, public pension arrangements. Some cite the transparency and accountability, and roles and reforms to the regulatory regime governing responsibilities. pension plans in Ontario in the late 1980s as Like other pension regulatory systems based on one of the catalysts for the reforms that were principles of trust law, Canadian pension regulation made to public sector plans in that province.138 places significant emphasis on fiduciary standards, In 1987, Ontario passed a series of reforms including the “prudent person rule.” Because to the Pension Benefits Act, the key piece of regulators have limited capacity to enforce these legislation governing pension plans in Ontario principles given the number of plans they oversee, and the piece of legislation that often sets the much of the responsibility for discharging the standard for pension legislation across the fiduciary duty falls to pension boards of trustees. country. This pension reform effort directed More effective boards, therefore, can help regulators the government’s attention to pension issues, do their job and lessen the need for prescriptive, which may have facilitated its later focus on rules-based regulation.139 This, in turn, can have reforming its larger public sector plans. It also positive effects on the pension fund’s ability to caused the government, as sponsor of a number innovate, invest in new asset classes, and explore of public pension plans, to have to make new investment strategies. 64 | THE EVOLUTION OF THE CANADIAN PENSION MODEL To help realize these lessons, stakeholders can rules.”142 Paying close attention to governance, consider two key approaches that have been used in here, means a combination of rules, structure, the Canadian context: agreements, and legislation, on the one hand, and getting the people right, on the other hand. • Governments should pay considerable attention to governance during the setup • Regulatory incentives to improve governance phase or early reform phase of pension should be put into place. One of the main organizations. In the case of many leading incentives that has been created in Canada is the Canadian pension funds, government officials funding regime for jointly sponsored pension invested considerable time and energy getting plans, the structure used by both HOOPP and the governance model right. In the case of OPTrust, as well as plans such as OTPP and OTPP, considerable emphasis was placed OMERS. In Ontario, where plans transition on the creation of a sponsorship agreement to joint governance and risk sharing, they are between the teachers’ unions and the Ontario subject to a less onerous funding regime and government.140 In the case of CPPIB, the are required to fund only on a “going concern” government spent significant time crafting basis (assuming the sponsoring organization[s] the Canada Pension Plan Investment Board remain in operation), whereas most plans that do Act.141 Former Bank of Canada governor David not use this structure are required to fund on a Dodge, who helped lead the drafting of the “solvency” basis (ensuring the plan has sufficient CPPIB enabling legislation as deputy minister funds even if the sponsoring entity shuts down). of finance at the time, described the process This differential funding regime provides a as “building a structure that creates trust.” significant financial incentive for plans to make “Where trust is lacking,” Dodge said, “it can the transition to what is considered to be a more lead to prescriptive rules. We [in Canada] have robust governance model. done a good job of avoiding such prescriptive Section 5: PRACTICAL LESSONS LEARNED FROM THE CANADIAN EXPERIENCE | 65 Section 6 The Future of the Canadian Model: Challenges and Opportunities Ahead D uring our interviews with Canadian pension leaders, we covered not only the history of the Canadian model leading up to today, but also the future of the Canadian model. What are the main challenges Canadian pension organizations will face over the coming 5 to 10 years? How are they thinking about addressing these challenges? This forward-looking view is relevant to emerging economy stakeholders for two reasons. First, it can help them anticipate the kinds of challenges they may face in the future as they build their retirement systems. Second, the challenges offer some insight into how Canadian pension organizations are navigating some of the same external macro forces that pension stakeholders face in emerging economies today, regardless of where they are on their own evolutionary journeys. Challenge 1: Lower expected number of active members to the number of retired members) of 1.3:1. At OTPP, the average member is returns and interest rates expected to receive 31 years of pension payments, Pension funding is adversely affected by the compared with 26 years of contributions.143 combination of lower return expectations from traditional asset classes and low interest rates, Plans have used a number of tools to mitigate both of which many expect to last for some time. the funding risks associated with rising maturity, This problem is hardly unique to Canada but including raising contribution rates, reducing rather is central to the conversation among pension early retirement provisions, making indexation stakeholders around the world. Return expectations contingent, and seeking to merge with other plans from a conventional 60 percent equities/40 with more favorable demographics. Second, percent fixed-income portfolio have decreased plans are also grappling with structural workforce substantially, leading institutional investors to look changes for the sectors that they cover. HOOPP, for new ways to deliver risk-adjusted returns. Many for example, while having a higher maturity ratio Canadian plans have shifted assets substantially (2.2:1), is adjusting to a health care system in into less liquid, and in some cases riskier, asset which more and more care is delivered outside the classes such as infrastructure, real estate, and hospital setting, the plan’s traditional membership private equity. Some, including HOOPP, have base. To adjust to this new reality, the plan has looked to their fixed-income portfolios to generate expanded to cover workers outside hospitals and more value. Some organizations have revised their has removed eligibility requirements for part-time assumptions downward, lowering discount rates. workers, although some health care workers remain A number of funds, including CDPQ and OPTrust, outside the plan. Special challenges can arise for are increasingly looking to emerging markets as a public pension plans when public service delivery source of long-term growth. is pushed from traditional bureaucracies to lower- cost channels such as nonprofits or private entities Challenge 2: Demographics and whose workforce is often less stable and in more the changing workforce precarious, lower-wage jobs—and is therefore less Two membership-related realities represent well suited to the plan design of the traditional potential risks to the sustainability of Canadian public sector defined-benefit plan. pension plans. First, plans are becoming more mature, particularly as the baby boom generation Challenge 3: Pension inequality reaches retirement age. For some plans, the ratio A common challenge raised during our interviews of contributing members to retired members has was the growing gap between the pension “haves”— decreased substantially. For instance, OTPP and mainly public sector workers with a solid, well- OPTrust each have a maturity ratio (the ratio of the funded, well-performing defined-benefit pension Section 6: THE FUTURE OF THE CANADIAN MODEL: CHALLENGES AND OPPORTUNITIES AHEAD | 67 plan—and “have-nots”—mainly private sector or Challenge 4: Complexity and self-employed workers who very often have a lower- quality plan or no retirement plan at all. In Canada, other challenges of growth While the increased scale of pension organizations as in other jurisdictions, many private firms have confers many advantages, growth also presents shifted their retirement arrangements from defined- challenges. “We are a high-growth organization,” benefit to defined-contribution in recent years. HOOPP CEO Jim Keohane said. “Our compound Some public pension leaders are concerned that this rate of return [for the past 20 years] has been 9 to 10 growing gap is fueling a simmering “pension envy” percent which is faster than most corporate entities. that could lead to policy action to undermine the Managing the growth is a challenge.”145 Although high-quality pensions that exist, rather than action greater scale can unlock access to some kinds of to boost the retirement security of the pension have- deals and investment strategies, other strategies are nots. Others argue that the gap is fueling a demand not scalable, and finding attractive investments to by the unpensioned for retirement vehicles that have meet allocations in a rapidly growing fund can be a the characteristics of high-quality pension plans. challenge. Moving into new asset classes, sectors, The risk of such envy is arguably linked to a broader and geographies in search for these investments can sense of economic and financial insecurity in western add layers of complexity for pension organizations societies, stemming from growing income and with in-house, direct-investment models that may wealth inequality and the scarcity, both actual and require changes in governance, processes, and perceived, of stable, high-quality jobs that provide a capability. Claude Lamoureux identifies complexity middle-class income and decent benefits. as one of the future challenges facing Canadian To date, the primary response to pension inequality pension funds: “You can’t be good at everything. has been government policy action, including You need other partners, including people with Ontario’s initiative to create an Ontario Retirement operational expertise and people who can sit on Pension Plan (a government-sponsored pension plan the boards of the companies that plans buy. These for all workers without a workplace pension plan aren’t necessarily the same people who made the that was meant to be based on the Canadian pension investments in the first place.”146 Jean Michel from model), and the agreement in 2016 to enhance CPP CDPQ talks about the challenge of growth from benefits—a change that was supported by labor the point of view of emerging markets: “We need leaders and a number of leaders in the pension to be [in those geographies] in private placement, community. Another response by some Canadian which means we need a structure with multiple pension leaders has been to explore ways to offer offices around the world. How do we manage the services of public pension organizations to this organization, that will grow with multiple more people, including by expanding membership offices, while keeping it efficient with proper eligibility (such as to part-time workers), governance?”147 encouraging consolidation of smaller plans into larger public sector plans, offering third-party asset Challenge 5: Value-for-money management services, and developing alternative scrutiny plan designs that would allow different kinds of Like the financial services industry generally, workers to join the plan. Further, policy makers particularly since the global financial crisis, and regulators have, over the past several years, Canadian funds are likely to face an increased need taken steps intended to preserve defined-benefit to demonstrate value for money to their stakeholders. plans in the private sector, including easing funding The rise to prominence of passive investment requirements and encouraging risk sharing.144 68 | THE EVOLUTION OF THE CANADIAN PENSION MODEL management, and increased flows of both retail and of the overall retirement system. The Canadian institutional assets into market-tracking vehicles, is Association of Pension Supervisory Authorities, likely to lead to an ongoing onus on investors who composed of federal, provincial, and territorial employ active management to show an incremental representation, recognizes these challenges and payoff from the additional costs associated with an recently issued a new strategic plan with a focus active approach. While the scale, in-house teams, on harmonization of rules. Ontario, which regulates and patient capital of Canadian pension funds enable more pension plans than any other Canadian them to deliver active management much more jurisdiction, is in the midst of updating its financial cost-effectively than plans serving the retail market, services and pension regulator, the Financial Canadian pension funds are not immune to the Services Commission of Ontario. The government ongoing active-versus-passive debate, as pension is creating a new regulator, the Financial Services fund CEOs such as AIMCo’s Kevin Uebelein have Regulatory Authority, that will be independent of pointed out. A number of other broader societal the government and have rule-making powers. It is forces increase the likelihood that Canadian hoped this new regulator will be empowered to be pension funds will face ongoing value-for-money more proactive, flexible, and innovative.148 scrutiny: the rising expectations of transparency of The second regulatory challenge relates to changes major institutions among members of the public; to the global financial regulatory environment in ongoing fiscal challenges facing provincial and the wake of the global financial crisis. The broader federal governments in light of slower growth financial system, both domestically and globally, has and cost pressures in areas such as health care; been subject to an intensive round of re-regulation and the increased prominence and success, both and regulatory restructuring since the crisis. This domestically and globally, of Canadian pension has included the creation of new regulatory bodies institutions. (such as the Financial Stability Board), new bodies of complex rules (such as Basel III and Dodd- Challenge 6: Regulatory Frank), and ongoing work both domestically (such environment as by the Bank of Canada149 and through the federal Canada’s regulatory environment has played Capital Markets Stability Act) and internationally an important role in enabling the success of the (as by the Financial Stability Board) to examine the Canadian pension model, as previously described. role and appropriate regulation of pension funds and Looking ahead, two distinct but related regulatory asset managers from the point of view of financial challenges could influence the future of the stability and macroprudential regulation. The Canadian pension model. combination of these changes has created a variety The first challenge that pension leaders identify of implications for public pension organizations, is the need for greater regulatory capacity and from increased compliance costs to investment coordination in the pension space. Canada’s opportunities and ongoing regulatory risks. pension regulation remains somewhat fragmented, divided between the federal and provincial levels, Challenge 7: Preparation for the and some experts and industry leaders have argued next crisis that existing regulators are not equipped to keep up Canadian pension funds were, on the whole, able with changes in financial markets, in the increasing to weather the global financial crisis. Preparing for sophistication of pension organizations, and in the next major market downturn or financial crisis opportunities for innovation and improvement figures prominently on the lists of top challenges Section 6: THE FUTURE OF THE CANADIAN MODEL: CHALLENGES AND OPPORTUNITIES AHEAD | 69 for Canadian pension fund leaders. An important economies, it is not practical for the funds to have part of this preparation has to do with portfolio a physical presence in every emerging economy in construction and testing. “We have designed our which they wish to deploy capital. Hence finding portfolio so that we should do better than average [in trusted local partners is critical. the next recession],” CDPQ chair Robert Tessier said, Stakeholders working on pension, retirement “but the true test of this will be when that recession security, and institutional investing issues in happens.”150 Commenting on CDPQ’s performance emerging economies are looking to models like in the last years, Michael Sabia said, “While not the Canadian one as a path toward improving immunizing our portfolio against market movements, pension plan performance. These stakeholders— our strategy makes it more resilient in turbulent times.” including governments, regulators, Social Security Another important element of crisis preparation administrators, pension plans, and the private firms is ongoing communication with governments, that serve pension organizations—have significant plan sponsors, and other key stakeholders. Such desire to learn from the Canadian experience and to proactive communication, relationship building, incorporate those lessons, in a practical way, into and expectations management can help avoid knee- their work on both a short- and long-term basis. jerk political reactions and other moves that could undermine the independence and governance of Deeper collaboration between Canadian pension Canadian pension organizations. Reflecting on the funds and pension stakeholders in emerging impact of past crises on CDPQ, Senior Vice President economies could be of mutual benefit. It could Maxime Aucoin highlighted the importance of allow Canadian funds to build local knowledge and maintaining an open line of communication with partnerships to assist them in investing in emerging stakeholders before a crisis hits: “In the past, we have economies. And it could enable emerging economy had periods of instability during down markets. We stakeholders to incorporate the most relevant, are doing our best to avoid this kind of a problem in practical lessons from the Canadian experience into the future, managing expectations and proactively a program for reform and continuous improvement. working to preserve trust.”151 Collaboration could be structured in a number of ways: Opportunities for • Exchanges or secondments of pension Partnerships with Emerging professionals between Canadian pension Economies to Enhance organizations and those in emerging economies. Retirement Security Such exchanges could provide valuable international experience to Canadian pension In addition to helping outline the challenges facing professionals, while offering meaningful Canadian pension plans, the interviews and other knowledge exchange and transfer for emerging research involved in the preparation of this report economy pension organizations. have also revealed an important opportunity for collaboration. Many Canadian pension funds are • Participation in capacity-building projects, actively working to increase their allocations to including those sponsored by the World Bank, emerging markets, and their leaders believe that in which Canadian pension professionals could local knowledge and partnerships are critical to their contribute to modules on certain subjects, from investment success in those markets. Although some investments to administration, governance, of the funds are establishing offices in emerging plan design, and funding. 70 | THE EVOLUTION OF THE CANADIAN PENSION MODEL • Longer-term, more formal partnerships • Investments in emerging market assets in between Canadian pension organizations, conjunction with local partners or with government bodies, or both and pension assistance from the World Bank or other organizations, government bodies, or both international financial institutions. For in emerging economies. CPPIB recently example, CDPQ has already made direct signed a Memorandum of Understanding investments with local partners in a number of with the National Development and Reform emerging markets, with a particular focus on Commission of China, in which CPPIB infrastructure opportunities. will “share its experiences and leverage its advantages to offer intellectual support to the NDRC in formulating policies related to China’s aging population, including providing joint training, workshops and research on pension reform and attracting international capital for the senior care industry.”152 Section 6: THE FUTURE OF THE CANADIAN MODEL: CHALLENGES AND OPPORTUNITIES AHEAD | 71 Appendix A List of Interviewees Keith Ambachtsheer, president, KPA Advisory Services; director emeritus, International Centre for Pension Management, Rotman School of Management, University of Toronto Dan Anderson, trustee and vice-chair, HOOPP Maxime Aucoin, senior vice president, total portfolio, CDPQ Kathy Bouey, former deputy minister, Ontario government; served as civil service lead during reforms to Ontario Teachers’ Pension Plan and the Ontario Public Service Pension Plan Chris Brown, president and CEO, Alberta Local Authorities Pension Plan Corporation Jennifer Brown, former chief pension officer, OMERS; former trustee, OPTrust Gail Cook-Bennett, founding chair, CPPIB; former board member, Ontario Teachers’ Pension Plan David Dodge, former governor of the Bank of Canada; former deputy minister, Department of Finance Canada Lowell Epp, assistant deputy minister, Alberta Treasury Board and Finance Bill Foster, former chief administrative officer, OPTrust; former senior staff member, Ontario Teachers’ Pension Plan Malcolm Hamilton, retired senior actuary, Mercer Jim Keohane, president and CEO, HOOPP Claude Lamoureux, former CEO, Ontario Teachers’ Pension Plan Dale MacMaster, chief investment officer, AIMCo Jean Michel, executive vice president, depositors and total portfolio, CDPQ Brian Mills, CEO and superintendent, Financial Services Commission of Ontario Michael Nobrega, former CEO, OMERS Hugh O’Reilly, president and CEO, OPTrust Marlene Puffer, trustee and chair of asset-liability management committee, HOOPP Malcolm Rowan, author, In Whose Interest?, report of the Task Force on the Investment of Public Sector Pension Fund. Kevin Smith, former trustee, HOOPP Macky Tall, executive vice president, infrastructure, CDPQ; CEO, CDPQ Infra Robert Tessier, chairman of the board, CDPQ Kevin Uebelein, CEO, AIMCo Lester Wong, deputy superintendent of pensions, Financial Services Commission of Ontario Appendix A: LIST OF INTERVIEWEES | 73 Endnotes 1. For a complete list of interviewees, please see appendix A. 2. See Keith Ambachtsheer, “The ‘Canada Model’ for Pension Fund Management: Past, Present, and Future,” The Ambachtsheer Letter, August 1, 2017. Ambachtsheer benchmarks the performance of eight large Canadian public pension funds against that of 132 other pension funds and other long- horizon investment funds. 3. See the Economist, “Maple Revolutionaries: Canada’s Public Pension Funds Are Changing the Deal- Making Landscape,” March 3, 2012. 4. See Chris Taylor, “These Canadians Own Your Town,” Fortune, December 2, 2015. 5. See Mary Childs and John Authers, “Canada Quietly Treads Radical Path on Pensions,” Financial Times, August 24, 2016. 6. See Boston Consulting Group, “Measuring the Impact of Canadian Pension Funds,” October 2015. 7. Unless otherwise noted, all currency figures in this report are in Canadian-dollar terms. 8. See Boston Consulting Group, “Measuring the Impact of Canadian Pension Funds,” October 2015. 9. See Keith Ambachtsheer, “The ‘Canada Model’ for Pension Fund Management: Past, Present, and Future,” The Ambachtsheer Letter, August 1, 2017. Ambachtsheer benchmarks the performance of eight large Canadian public pension funds against that of 132 other pension funds and other long- horizon investment funds. 10. See, for example, William Price, John Ashcroft, and Michael Hafeman, “Outcome Based Assessments for Private Pensions: A Handbook” (working paper, World Bank, Washington, D.C., June 2016); Aleksandar Andonov, Rob Bauer, and Martijn Cremers, “Pension Fund Asset Allocation and Liability Discount Rates” (ICPM sponsored research paper, International Centre for Pension Management, Toronto, March 2016); Gordon L. Clark and Roger Urwin, “Making Pension Boards Work: The Critical Role of Leadership,” Rotman International Journal of Pension Management 1, no. 1 (Fall 2008); Wilson Sy, “Superannuation Fund Governance: An Interpretation” (working paper, Australian Prudential Regulatory Authority, Sydney, July 15, 2008); Keith Ambachtsheer, Ronald Capelle, and Hubert Lum, “Pension Fund Governance Today: Strength, Weaknesses, and Opportunities for Improvement” (ICPM working paper, International Centre for Pension Management, Toronto, 2006.  11. See Terrie Miller and Chris Flynn, “Internal Management Does Better after Costs,” CEM Insights, CEM Benchmarking, Toronto, October 2010. 12. See, for example, Fiona Stewart, Romain Despalins, and Inna Remizova, “Pension Funds, Capital Markets, and the Power of Diversification” (World Bank, Washington, D.C. July 2017). 13. See I. J. Alexander Dyck and Lukasz Pomorski, “Is Bigger Better? Size and Performance in Pension Plan Management” (Rotman School of Management Working Paper 1690724, University of Toronto, 2011). 14. In particular, readers are encouraged to study the work of Toronto-based academic and consultant Keith Ambachtsheer, as well as the literature produced by the International Centre on Pension Management at the University of Toronto (including the Rotman International Journal of Pension Management), of which Ambachtsheer was the founding director. Ambachtsheer’s books include Pension Funds and ENDNOTES | 75 the Bottom Line: Managing the Corporate Pension Fund as a Financial Business (1986); Pension Fund Excellence: Creating Value for Stakeholders (1998) (with D. Don Ezra); Pension Revolution: A Solution to the Pensions Crisis (2007); and The Future of Pension Management: Integrating Design, Governance, and Investing (2016). 15. See PricewaterhouseCoopers, Société coopérative, “Global Pension Funds: Best Practices in Pension Funds Investment Process” (report, PwC Luxembourg, 2016). 16. See, for example, Jack Mintz, “Summary Report on Retirement Income Adequacy Research” (Summary report of the Research Working Group on Retirement Income Adequacy, Department of Finance, Canada, 2009); Bob Baldwin, “Research Study on the Canadian Retirement Income System” (prepared for the Ontario Ministry of Finance, 2009); Michael Wolfson, “Projecting the Adequacy of Canadians’ Retirement Incomes: Current Prospects and Possible Reform Options” (IRPP Study 17, Institute for Research on Public Policy, Montreal, 2011). For a helpful overview of relevant recent studies, see Bob Baldwin, “Assessing the Retirement Income Prospects of Canada’s Future Elderly: A Review of Five Studies” (C. D. Howe Institute Commentary 456, C. D. Howe Institute, Toronto, 2016). 17. See In Whose Interest? (report from the Task Force on the Investment of Public Sector Pension Funds, Ontario, 1987). 18. See interview with Kathy Bouey. 19. See David Slater, A Fresh Start: Report to the Treasurer of Ontario, the Chairman of Management Board of Cabinet, and the Minister of Education on Teachers’ and Public Servants’ Pensions (Toronto, Queen’s Printer for Ontario, 1988). 20. See interview with Claude Lamoureux. 21. Ibid. 22. Significant documentation exists on the OTPP story. For more detailed accounts, see for example, Claude Lamoureux, “Effective Pension Governance: The Ontario Teachers’ Story,” Rotman International Journal of Pension Management 1, no. 1 (Fall 2008); John Lorinc, “Pension Envy,” Walrus, September 26, 2013; INSEAD case study, “Going Direct: The Case of Teacher’ Private Capital” (2013); Keith Ambachtsheer and D. Don Ezra, Pension Fund Excellence: Creating Value for Stakeholders (New York: John Wiley & Sons, 1998), chapter 13; Andrew Rozanov, “Public Sector Investment Funds: How the Best-in-Breed Evolved,” (Program on Public Pension and Sovereign Funds Working Paper 1, Columbia University, New York, February 2017). 23. Bruce Little, Fixing the Future: How Canada’s Usually Fractious Governments Worked Together to Rescue the Canada Pension Plan (Toronto: Rotman-UTP Publishing, 2008). 24. Under the Canadian parliamentary system, the governor in council is the governor general of Canada acting on the advice of the cabinet of the government of Canada. 25. Since the inception of CPPIB, such a nominating committee has made recommendations to the minister in every instance in which directors are appointed to the board of CPPIB. Before making any 76 | THE EVOLUTION OF THE CANADIAN PENSION MODEL recommendation to the federal Cabinet, the federal minister of finance receives advice regarding the appointment of directors from other appropriate provincial ministers from the participating provinces and an external nominating committee comprising a representative designated by the federal minister of finance and a representative of each participating province designated by the appropriate provincial minister for that province. The federal minister of finance consults with the appropriate provincial ministers of the participating provinces before making any recommendation to the governor in council. In addition, before making any recommendation, the federal minister of finance must have regard to the desirability of having directors who are representative of the various regions of Canada and of having a sufficient number of directors with proven financial ability or relevant work experience such that CPPIB will be able to achieve its objects. 26. Interview with Gail Cook-Bennett. 27. Ibid. 28. See, “Our History,” CPPIB website, http://www.cppib.com/en/who-we-are/our-history/. 29. See CPP Investment Board, “Canada Pension Plan Investment Board Signs Memorandum of Understanding with National Development and Reform Commission of the People’s Republic of China,” news release, September 22, 2016. 30. For more detailed accounts, see Little, Fixing the Future, chapter 17; Harvard Business Review case study, “The Canada Pension Plan Investment Board: October 2012” (Harvard Business School, Cambridge, MA, 2014); Richard Ivey School of Business case study, “The Canada Pension Plan Investment Board: Governance” (2010); Rozanov, “Public Sector Investment Funds: How the Best- in-Breed Evolved.” 31. CDPQ accounts for the vast majority of these 6 million members because it serves as the asset manager for the Québec Pension Plan, Québec’s social security system. 32. See “Investment Philosophy,” AIMCo website, http://www.aimco.alberta.ca/How-We-Think/ Investment-Philosophy. 33. See Act Respecting the Caisse de dépôt et placement du Québec, R.S.Q. 1977, c. C-2, s. 4.1. 34. Boston Consulting Group, “Measuring the Impact.” 35. Interview with Kevin Uebelein; presentation by Kevin Uebelein to the C.D. Howe Institute, Toronto, shared with the authors. 36. Interviews with Chris Brown and Kevin Uebelein. [[AQ: OK?]] 37. Interview with Kevin Uebelein. 38. Interview with Dale MacMaster. 39. Ibid. 40. Interview with Lowell Epp. 41. Interview with Kevin Uebelein. ENDNOTES | 77 42. Interview with Lowell Epp. 43. Interview with Kevin Uebelein. 44. Interview with Robert Tessier. 45. Correspondence with CDPQ management team. 46. Interview with Macky Tall. 47. Interview with Jean Michel. 48. Ibid. 49. Correspondence with CDPQ management. 50. Interview with Dan Anderson. 51. Ibid. 52. See interviews with Dan Anderson, Jim Keohane, and Kevin Smith. 53. Interview with Jim Keohane. 54. Interview with Dan Anderson. 55. Interview with Kevin Smith. 56. Ibid. 57. Interview with Jim Keohane. 58. Ibid. 59. Interview with Marlene Puffer. 60. See HOOPP 2016 annual report. 61. Interview with Hugh O’Reilly. 62. Ibid. 63. Interview with Hugh O’Reilly. 64. See OPTrust 2016 Funded Status Report. 65. OPTrust, “How OPTrust Thinks about Investing” (2017, internal OPTrust document). 66. On the importance of integrating key elements of pension management, see Keith Ambachtsheer, The Future of Pension Management: Integrating Design, Governance, and Investing (New York: John Wiley & Sons, 2016). 67. Interview with Keith Ambachtsheer. 78 | THE EVOLUTION OF THE CANADIAN PENSION MODEL 68. See “Plan Governance,” Ontario Teachers’ Pension Plan website (accessed April 2017), https://www.otpp.com/ corporate/plan-governance. According to the site, “At the heart of our model is a strong, independent Board that ensures Ontario Teachers’ is run like a business.” 69. Interview with Keith Ambachtsheer. 70. Interview with David Dodge. 71. See, for example, Canada Pension Plan Investment Board Act (SC 1997, c. 40); Teachers’ Pension Act (RSO 1990, c. T.1); Alberta Investment Management Corporation (AIMCo) Act (SA 2007, c. A-26.5); Act respecting the Caisse de dépôt et placement du Québec (CQLR, c. C-2). 72. Changes to the Canada Pension Plan actually require a greater degree of consent than do changes to the Canadian constitution, which requires the consent of the federal government plus two-thirds of the provinces representing 50 percent of the Canadian population. 73. Interview with David Dodge. 74. Interview with Claude Lamoureux. 75. Ibid. 76. Ibid. 77. Interview with Keith Ambachtsheer. 78. Interview with Kathy Bouey. 79. Interview with Gail Cook-Bennett. 80. Ibid. 81. Interview with Claude Lamoureux. 82. Interview with Jean Michel and Maxime Aucoin. 83. Interview with Dale MacMaster. 84. See, for example, Miller and Flynn, “Internal Management Does Better after Costs.”  85. In recent testimony before a Canadian parliamentary committee, CPPIB CEO Mark Machin stated that, since 2006, CPPIB has created $17.1 billion of additional value relative to a passively invested alternative portfolio (Standing Committee on Finance, November 1, 2016). According to pension expert Keith Ambactsheer, OTPP has outperformed its benchmark by an average of a net 2.2 percent per year over the course of the past 25 years, amounting to $36 billion in value added. See Keith Ambachtsheer, “An Open Letter to Andrew Coyne” (May 25, 2016), available at www.kpa-advisory. com. 86. See Ambachtsheer, “The ‘Canada Model.’” 87. For an overview of significant transactions and assets owned by the largest 10 Canadian pension funds, see Boston Consulting Group, “Measuring the Impact.” ENDNOTES | 79 88. Interview with Kevin Uebelein. 89. Interview with Jim Keohane. 90. See “Comparative Advantages,” CPPIB website, http://www.cppib.com/en/how-we-invest/compare- overview/. 91. Interview with Jean Michel and Maxime Aucoin. 92. See Boston Consulting Group, “Measuring the Impact.” 93. Interview with Claude Lamoureux. 94. Interview with Hugh O’Reilly. 95. Interview with Jim Keohane. 96. Interview with Michael Nobrega. 97. Boston Consulting Group, “Measuring the Impact.” 98. Ibid. 99. Interview with Jean Michel and Maxime Aucoin. 100. Interviews with Malcolm Hamilton, Gail Cook-Bennett, and Michael Nobrega. 101. Interview with Jim Keohane. 102. Interview with Marlene Puffer. 103. Interview with Jean Michel. 104. Interview with Claude Lamoureux. 105. Interview with Kathy Bouey. 106. Interview with Kevin Uebelein. 107. Interview with Claude Lamoureux. 108. Ibid. 109. Interview with Brian Mills. Mills was seconded from the government to work on the set-up of the Ontario Pension Board, where he later became vice president of administration. 110. Ibid. 111. Ibid. 112. Discussions with HOOPP’s Strategy and Stakeholder Relations team. 113. See the People for Pensions website, http://www.peopleforpensions.com/. 114. Interview with Malcolm Hamilton. 80 | THE EVOLUTION OF THE CANADIAN PENSION MODEL 115. For example, in the interview with David Dodge, Dodge said, “The defined nature of the benefit is an important part of the model because it gives you contribution certainty and pooling.” 116. Interview with Jennifer Brown. 117. Interviews with Kathy Bouey and Claude Lamoureux. 118. See Slater, A Fresh Start. 119. Interview with Claude Lamoureux. 120. “Discount Rate,” Ontario Teachers’ Pension Plan website (accessed April 2017), https://www.otpp. com/corporate/plan-funding/funding-valuations/discount-rate. 121. A Society of Actuaries report found that the median discount rate for a U.S. state or city public pension plan in 2014 was 7.6 percent. See Lisa Schilling, “U.S. Pension Plan Discount Rate Comparison 2009–2014” (article by the Society of Actuaries, Schaumburg, IL, September 2016). 122. Interview with Malcolm Hamilton. Also, see William B. P. Robson and Alexandre Laurin, “Ottawa’s Hidden Deficit: The Widening Gap between Federal Government Pension Liabilities and Assets,” (C. D. Howe Institute Commentarie 406, C. D. Howe Institute, Toronto, 2014). 123. See, for example, Warren Buffett, “Chairman’s Letter,” 2007 Berkshire Hathaway Annual Report, 18, which calculates that, of the S&P companies that have pension plans, the average investment return assumption is 8 percent. 124. Interview with Hugh O’Reilly. 125. Interview with Bill Foster; OPTrust 2016 annual report. 126. Office of the Chief Actuary, 27th Actuarial Report on the Canada Pension Plan (Ottawa: Office of the Superintendent of the of Financial Instituteions Canada, September 2016). 127. Interview with Hugh O’Reilly. 128. Interview with Dan Anderson. 129. Interview with Bill Foster. 130. Interview with Brian Mills. 131. Department of Finance Canada, “Pension Plan Investment in Canada: The 30 Per Cent Rule,” 2016. 132. Ontario also recently announced its intention to eliminate the restriction on a pension plan’s ability to own more than 30 percent of a publicly traded company. 133. Interview with Gail Cook-Bennett. 134. See Ontario Expert Commission on Pensions, A Fine Balance: Safe Pensions, Affordable Plans, Fair Rules (Toronto: Queen’s Printer for Ontario, 2008). 135. Ontario granted this ability to OTPP and OMERS in 2009. Some other plans are able to provide these services without any change in law because they are not creatures of legislation. ENDNOTES | 81 136. See Public Service Superannuation Act, R.S.C., 1985, c. P-36. 137. Some Canadian commentators have argued that the standards governing public sector plans are materially—and unjustifiably—different from those governing private sector plans. Malcolm Hamilton, for example, a respected actuary and the former actuary for OTPP, has argued that public sector plans should be required to use the same accounting standards as plans in the private sector, effectively the corporate bond rate. Interview with Malcolm Hamilton. Also, Malcolm Hamilton, “Evaluating Public- Sector Pensions: How Much Do They Really Cost?” (C. D. Howe Institute Commentary 403, C. D. Howe Institute, Toronto, March 2014). 138. Interviews with Kathy Bouey and Bill Foster. It should be noted, however, as is mentioned in the earlier section of the report on the origins of the Canadian model, that the main motivation for reforming Ontario’s public sector plans appears to have been fiscally driven—a desire to eliminate the large funding shortfall. Interview with Brian Mills. 139. For a helpful discussion of the symbiosis between governance and regulation, see the report of the Ontario Expert Commission on Pensions, A Fine Balance, chapter 8. 140. Interview with Kathy Bouey. 141. Interviews with David Dodge and Gail Cook-Bennett. 142. Interview with David Dodge. 143. “Funding Considerations,” Ontario Teachers’ Pension Plan website, https://www.otpp.com/corporate/ plan-funding/funding-considerations. 144. For example, Ontario recently announced a new funding framework for single-employer defined- benefit pension plans. This framework reduces requirements for plans to fund on a solvency basis. 145. Interview with Jim Keohane. 146. Interview with Claude Lamoureux. 147. Interview with Jean Michel and Maxime Aucoin. 148. See George Cooke, James Daw, and Lawrence Ritchie, “Review of the Mandates of the Financial Services Commission of Ontario, Financial Services Tribunal, and the Deposit Insurance Corporation of Ontario” (Final report, Ontario Ministry of Finance, Toronto, March 2016), http://www.fin.gov. on.ca/en/consultations/fsco-dico/mandate-review-final-report.html. 149. See, for example, Guillaume Bédard-Page et al., “Large Canadian Public Pension Funds: A Financial System Perspective,” Financial System Review, Bank of Canada, June 2016. 150. Interview with Robert Tessier. 151. Interview with Jean Michel and Maxime Aucoin. 152. CPP Investment Board, “Investment Board Signs Memorandum of Understanding.” 82 | THE EVOLUTION OF THE CANADIAN PENSION MODEL