OE News Special Edition July 2013

The interest rate impact
The following is an example of interest rate impacts. If I want to pay you a certain amount of
money now, in return for your promise to pay me $1 per year indefinitely, the amount I’ll have
to pay depends on current interest rates. If rates are high, I’ll be able to pay you less, because
you’ll have the opportunity to invest the money I pay you at a high rate of return.
In other words, I need fewer assets now to secure certain future payments when interest
rates are high. And I need more assets when interest rates are low.
A pension plan works the same way. The plan has assets now and needs to make certain
payments in the future. The current value of a pension plan’s future liabilities (and therefore
the assets it needs now to meet those liabilities) goes down as interest rates rise, and goes up as
interest rates drop.
In other words, a pension plan needs fewer assets to make the same future payments
when interest rates are high than when interest rates are low.
This has been a growing problem in recent years as interest rates have steadily declined,
resulting in an increasing level of liability for the OEPP and other pension plans. By shifting to
a different mix of assets, the Trustees believe we can protect our plan against the impact of low
interest rates, and of interest rate changes generally.
The Plan’s asset mix
The large majority of our assets continue to be made up of bonds. A bond is simply a promise
to re-pay a certain amount of money at a specified date, with interest payments in the interim
based on a fixed rate. It is a “fixed-income asset”, meaning that there is no doubt as to the rate
of return it will deliver. The only risk relates to the survival of the bond issuer. Although this
can be an issue with corporate bonds, it is much less of an issue with government bonds. The
pie charts below show all of the Operating Engineers’ Pension Plan assets by class and what
each manager holds
By asset class
0.4 % Real Estate –
Mortgages (internal)
2.5 % UBS Global
Asset Management
0.8 % Fengate
Capital Management
4.6 %
Mortgage Fund Two
0.3% Realcor Mortgage
Fund (external)
Real Estate
– Revenue
Producing
20.6%
PHN – Bonds
60.4%
0.2 % Real Estate –
Non-Revenue Producing
5.6% Prepaid Leases
3.3% Concert Properties
1.3% Short-term
Interest Rates and
Promises to Pay
Cost of a promise of a
$1/year indefinitely, at
different rates
Cost Interest Rate
$10.00 10%
$16.67 6%
$20.00 5%
$25.00 4%
$33.33 3%
$50.00 2%
Interest Rates
and Pension
Plan Liabilities
As
interest
rates
drop....
... the
value of
pension
plan
liabilities
rises.
Special Edition Summer 2013 News 7