Successfully Managing $80 Billion Dollars Worth of Risk for a Pension Fund (w/ Jim Keohane)
ED HARRISON: Hi, I'm Ed Harrison here in Toronto for Real Vision. I'm talking to Jim Keohane, he's the president and CEO of the Healthcare of Ontario Pension Plan. Jim, it's great to have you. JIM KEOHANE: Oh, thanks for having me. ED HARRISON: I think, when I spoke to you yesterday about this interview, and what I was telling you is that our co-founder and CEO, Raoul Pal, he has a big issue with regard to retirement. And I think it's driven from a personal perspective. He saw what happened to his father's pensions in 2008, and his savings. And he really thinks that this is a big issue, especially from a demographic perspective, and that, in terms of the democratization of financial information, which he's a big advocate of, he wants to start a series talking about best practices in the industry, Canada being a place where they have them. What we can do to make our retirements better. Before we get into all of that, let me ask you about your own personal career. Because you are about to retire next month as CEO and president. And you've been at the company now for over 20 years. Tell me about the transition from where you were, which was Merrill Lynch and Wall Street banking, to the pension company. JIM KEOHANE: Yeah. So actually, I worked at several Wall Street firms, Merrill Lynch being one of them. But actually, the last one was Deutsche Bank, which you mentioned. You worked there yourself. I had an opportunity to come to the pension plan. And at the time, I could see a few things. I mean, there was a shift in-- I think, in power from the dealers. You could see that pension funds are getting very large pools of capital and that's where you wanted to be. But also, there's a big difference, I mean, in terms of-- I mean, I've found that since I've got there, I mean, when you work at investment banks, I mean, I was doing proprietary trading. Which, today, would be done in the hedge fund world, so when you worked at an investment bank, you're as good as your last trade. If you got a good trade, you continued to work there. If you didn't, I mean, maybe they'd show you the door. So there was no loyalty given to the employees, and the employees showed no loyalties to the employer. And so it's a bit of a toxic environment. And what it was all about was, if I make a certain amount of money, I may get a percentage of it in my pocket. And that was as far as it went. And also, it really didn't, after a while, it doesn't get you out of bed in the morning. It doesn't really motivate you to continue to work. Whereas when I got to Hoop, it was a very different environment in a sense of, what we do really makes a difference in people's lives. And it's very tangible. And you actually meet the pensioners in particular, I mean, they're extremely thankful that they've been in the plan, and they're very grateful for what we do for them. So we allow them to retire in dignity with a stable financial future going forward. So people are extremely appreciative of that. So what we do I think is very important to our members and it's very important to society. So that really is a good motivator to get you to come in and do your job every day as well as you can because it does make a big difference to those people. ED HARRISON: Yeah, and what you're saying reminds me that we should definitely talk about defined benefit versus defined contribution here, because that's a big part of it in terms of giving people a safety net. This is how much income I'm going to get, irrespective of how long I live for the rest of my life. JIM KEOHANE: Yeah. So I mean, most individuals, no question, they're better off in defined benefit plans, because for a whole bunch of reasons. But the challenge has been difficult for employers to stand defined benefit plans, because there is a changing environment. We have low interest rates. We have people living much longer. So it is more difficult to actually manage these plans and keep them going. ED HARRISON: We were talking earlier before the interview about your transition and one of the places where you can make a difference is in terms of fees. And it's interesting in terms of how a pension plan can deal with costs. And we were talking in particular about Nortel Networks. They were 37% of the TSX, the Toronto Stock Exchange index, and huge outsized risk for HOOPP at the time. But you were able to manage that risk in a very positive way. You gave me a big number about of $800 million, $850 million. Talk me through that episode when Nortel had tanked during the tech bust. JIM KEOHANE: Sure. So we're a very big user of derivatives-- one of the largest in the world, actually. And most people are scared of derivatives, but if you use them properly, they're very powerful risk management tools. And I think we're a very sophisticated user of derivatives. So what we did at the time-- Nortel became this disproportionate weight in the index and at that time, we had a bunch of outside managers as well. So when you start drilling down in all these portfolios, they all had Nortel in them. So what we did is we did an overlay on top of the thing using derivatives. So I was charged with trying to keep our exposure below 5% of the fund. And so I used what we call a costless collar to do that transaction, which is effectively buying put options-- to sell a stock at a fixed price for a period of time. And to pay for that, we sold call options about 50% above the market, which would cause you to actually force you to sell a stock if it went up by more than 15%. So it effectively capped our exposure within our range. And we did that in very material size, because of the size of the exposure we had. And so I think it was right around 2000, Nortel warned, and stock went down 30% one day. And so in that one day, that offset gained us about $850 million. ED HARRISON: $850 million, right. And the thing is that what you're talking about is reducing the volatility. You still have exposure, but you capping upside and downside. And that's part of the profile that you're talking about in terms of risk. This is something that you can do that individuals can't do. That's something that we're going to be talking about going forward. JIM KEOHANE: Yeah, so individuals just wouldn't have the credit worthiness to do with strategies like that. Because of our size, we're an extremely credit worthy counterparty. So Wall Street banks are very willing to deal with us knowing that when it comes time to pay, we'll pay. Whereas individuals, they would never do that strategy because you know people could go bankrupt and they can't get their money from them. ED HARRISON: So how have you changed HOOPP and how has the pension industry in Canada in particular changed in the time when you first came in 1999 to now, when you're leaving? JIM KEOHANE: So there's a few big things. We've pretty much insourced all our activities. So we have our own in-house investment management staff that runs virtually all of the money. We still have some partnerships outside, but most of the money is run directly by our own staff. And that has huge advantages in the sense of it's much more cost effective. So paying people to run money for you is significantly more expensive. Just to give you an example. When I first became the chief investment officer, we had about 15% of our money run externally. And so when I insourced that, that 15% cost more to run than the other 85%. And actually, the returns were not as good. And one of the other intangibles is that you sacrifice control of your risk management, because when you give money to other people, they're going to do what they want with it. And your choice us you can take your money back or leave it with them. And so whereas internally, if you're not comfortable with the market, we can dollar risk up and down quite easily. ED HARRISON: And you say 15% was more expensive than 85%. JIM KEOHANE: That's right. ED HARRISON: That's astounding. Because again, one of the key things-- we'll talk about your framework of how you look at the pension industry-- but one of the things that I thought was extraordinary is about the cost versus an individual-- that is a cost savings that you can't make as an individual, if you're investing on your own. JIM KEOHANE: Yeah, so our investment costs are about 20 basis points or 0.2% percent per year. And when we looked into what individuals pay, and it's typically somewhere between 2% and 3% per year. So 10 times as much. ED HARRISON: Right. JIM KEOHANE: And that difference of 180 basis points-- I mean, it doesn't sound that much annually, but you start compounding that over 40 years, and you actually end up with half as much money. ED HARRISON: Right. JIM KEOHANE: So I mean, when I first saw that, I thought, that can't be right. And I did the calculation myself, and in fact, that is true, right. ED HARRISON: The magic of compound interest. JIM KEOHANE: Yeah. It does make a huge difference over time. ED HARRISON: And what other things have you seen? Because I think that the industry has changed a lot. I mean, essentially, you came in from an industry, you brought your expertise. My sense is that in order to have people of that capability, you have to pay them the going rate. What staff do you have in terms of trading and risk management and things of that nature? JIM KEOHANE: We really have top notch staff-- really, some of the best people in the world. And we pay them market rates. And I think that's one of the big challenges that the US funds have-- is the governance structures don't allow them to do that. And so there's some very large pools of capital you ask that could be run the way we run our money. So all in in-house staff. But the structure of most US plans is not independent. I think a lot of the state plans, they have politicians sitting on their boards and stuff. And it's politically unacceptable to pay people in-house-- you have to write a check to an outside manager that's 10 times as much, because it depoliticizes the payment. So even though you're paying more to have the same thing done, it's not politically acceptable to write a check to somebody internally. But no problem writing to somebody outside. ED HARRISON: You mentioned governance. It actually reminds me that we have-- I was looking at your website, and you talk about advocacy at HOOPP. And there were five drivers of that. And I think maybe this is a good framework for thinking about this conversation. The five drivers you talked about were savings, fees and costs, which we already mentioned, investment discipline, fiduciary governance, which is what you were just mentioning. And then risk pooling. I want to go through those one by one and then get a sense of how much that makes a different in terms of how much I as an individual need to save if I were to be with a defined benefit plan like HOOPP versus if I would try to replicate that on my own. JIM KEOHANE: Yeah. ED HARRISON: So let's talk about the savings and how people save. And why that's one of the five. JIM KEOHANE: It's one of the big items, actually-- savings patterns. And what we see-- so if you're in our plan, it's taken out of your paycheck every two weeks. And it's automatically done. So people don't even notice it. So they just live off their take home pay, and it's automatically taken off, and they don't have to think about it. And the other thing is it's locked in. You can't take it out. ED HARRISON: Right. JIM KEOHANE: What we see in individuals trying to do it on their own is it becomes an afterthought. They are dealing with their kids' education, cars, paying for their house. And at the end, do I have any money left to save? If I do, I'll put some aside. And here, we have an instrument called a registered retirement savings plan, which is similar to your IRAs, right? So the deadline is February 28. People rushing in February 27 to the bank and put whatever it is and by the flavor of the day, right? And so it's no real thought given to what should put the money, and they put in wherever they happen to have at the time, which is usually very inadequate to provide you with a decent pension. And the other thing you see is that when they have a crisis, a financial crisis in life, they withdraw that money. So essentially, when you just look at the stats that people have in individual savings accounts, most of them have actually no money at the time of retirement. So it's so not just they don't save enough-- they don't save at all. And so unless people are in workplace pension plans-- and it doesn't necessarily have to be a DV plan, but in a workplace pension savings vehicle, they don't save it all. And so unfortunately, what we've seen in the last few years is this trend away from workplace savings plans. And we need to think about ways to stem that tide and move things back in the other direction. ED HARRISON: Even though I want to go through these step-wise, that when you mentioned the fact that we've seen this move away, the immediate thing that I think about is the what you told me about the accounting issues and why this happens. I want to go straight to the solutions thing here, because basically, the solution is defined benefit is my understanding And what we're already talking about in terms of savings on a regular basis. But the reality is that in a private company, it's not on an accounting basis, a good thing to have that on your balance sheet. Like, you mentioned GM in particular as an example of that. JIM KEOHANE: Yeah. And this goes back to the Sarbanes-Oxley legislation, which happened after the Enron and WorldCom bankruptcies, where they had always off balance sheet entities that masked a bunch of risk that was there. And so that legislation essentially said you have to put all these things back on your balance sheet, which included the defined benefit plan. So in the past, a defined benefit plan was one line-- was off the balance sheet. But just if you get swings in interest rates, you can get very material swings. And you've got 50 year assets there that very small changes in interest rates for example, can change a lot. So once you get that back on the balance sheet in the [indiscernible], it creates a huge amount of noise. And so companies have big pension plans and GM is an example of that. I think the pension plan is about five times the size of the company. The pension plan affects your earnings more than anything. And so the joke in the financial markets was that GM is a pension plan that makes cars and it's true, in a sense. And also, if I put my investor hat on and I want to invest in a car company, I look at GM and think, well, I'm going to get too much exposure to its pension assets, so I'm going to go buy some other car company instead. So it's a huge amount of pressure from shareholders for GM to get out of the pension business. So that's where it comes from. If the accounting was not bad, if you went back to the previous accounting, that probably would alleviate that issue. So employers are looking to have defined contribution account. In other words, all they have to put in their earnings statement is the contribution they make in the employee's account that year. And then any future risk is the employee's, actually. ED HARRISON: Right. JIM KEOHANE: So the risk doesn't go away. It just got shifted off the company's books to the employee's book. ED HARRISON: You used defined contribution accounting, though. JIM KEOHANE: Yes, our employers do. The reason is that HOOPP is a different structure. So we don't just manage the money on behalf of the employers. The obligation for the pension is actually HOOPP's obligation, not the hospital's obligation. So in effectively, we not only take on that management money, that pension is guaranteed by HOOPP-- it's not guaranteed by the hospital. ED HARRISON: Right. JIM KEOHANE: So from the hospital's point of view, they really just make a contribution into the plan. And the only future obligation it could have is we could raise the contribution rates. ED HARRISON: Right. JIM KEOHANE: But they have no obligation in the future to fund it. If we had gotten into a situation where we're underfunded or something, they have no future obligation that way. So their accounting is DC accounting. So our structure, actually, it's an interesting structure that could be brought into the private sector that may encourage employers to get back into something that looks more like a defined benefit. ED HARRISON: Right. And so you're talking about governance right there. So let's unpack that a little bit, because we have on the one hand, the fact that you can have your constituents have defined contribution accounting. And that takes away this whole accounting issue. But at the same time, they have no control over the governance of how the plan works. How do you achieve that? JIM KEOHANE: Well, they do have some control in the sense of our board is constructed of-- so the trust- - so the HOOPP is is a trust. And so it was originally created by and agreement between the Ontario Hospital Association, the employer, and four county unions, which is OPSEU, QP-- OPSEU is Ontario Public Service Employees Union, public employees, SEIU, Service Employees International Union, and Ontario Nurses Association. So that's the five founders of the trust. And so the employer side appoints eight board members in each [indiscernible] point 2. So it's half union, half management, if you will, at the board table. So they do have some level of control over it. Trust law requires, though, that they all check our hats to the door and they do things that are in the interest of the members of the trust. ED HARRISON: And who are these individuals in terms of their competence from a financial perspective? What do they do, what is their knowledge about pensions and things of that nature? JIM KEOHANE: So it's mixed. So we have some people that I would consider financial experts on the board and some people that are senior members of unions, for example. And it's a good mix, because the sense that the union-- people represent the interest of the members. And so you get to understand things from the members' point of view. And plus, we have some financial experts that sit on the board that can provide expertise at the table. And we also have hospital CEOs, for example, on the board that represent the interest of the employers. So it's a good mix there. And it does lead to good decision making. I think most people call our board a lay board. That's a bit of a misnomer, because they're all very intelligent people, well-educated. And their day job-- in all cases, they're not in the financial services sector. But a lot of them have been on the board for a long time. They're familiar with the issues. They're up to speed. And decisions do get made in the best interest of the members of the plan. So it all works. And you think that maybe you'd have all the union line up on one side of the table and management on the other side. That's never happened. So we have a dispute resolution mechanism that's never used-- it's never even been close to being used. So people do actually do act very much in the interest of the members. So I say to people, if you were a fly on the wall of our board meeting, I think you'd have trouble telling who is the union rep and who is the management [indiscernible], which is how it should work. ED HARRISON: Right. And the key for me in terms of that is the ability for these hospitals-- even though they're not necessarily publicly traded companies-- to use defined benefit, defined contribution accounting. Because legitimately, if you take that issue away, then the opportunity for private companies to use defined benefit solutions increases. Instead of what you were saying, that we're actually moving away from that, you could actually have people move towards that because suddenly, they can offer that to their employees, and that's a safety net that people would want. JIM KEOHANE: Yeah. Again, it moves away from the-- we're training much very much more towards the individual managing their own plan when it's much more effective to have collective plans. And you want to try to move the trend back in that direction. ED HARRISON: With regard to the governance, what other factors within the governance-- I'm thinking of it from the Canadian model-- are different than, say, governance in the United States? JIM KEOHANE: Yeah, I think just in fact, we're allowed to run our pension plan like a business. And I think a lot of the cases in the US, they get used as instruments of public policy. And so we are completely independent of the government. the government doesn't appoint any of our trustees. And they're an important stakeholder, obviously. But they're pretty hands-off. I mean, that's pretty true of all the major Canadian plans as well, which has been very effective. And it's allowed us to get into areas that I think other pension funds have had trouble doing. And also, we're early movers on the use of derivatives for example. We're early movers, in our case, of using liabilitydriven investment approach. And some of our peers have been very early adopters of infrastructure. And we also have been early movers in private equity as well, so. So that model of better governance has allowed things to be done and that worked well for the members. And so that's always the talking mind consideration in terms of what you're doing. And so the political interference is not there. And going back to the issue of pay, for example, it's way cheaper for us to pay internal staff. And we can actually run the plan much more effectively with an internal staff rather than outsourcing. And so there's a bunch of activities we can do in an insourced environment you just couldn't do in an outsourced environment. So it allows us to run the plan much more effectively when we don't get this political interference. ED HARRISON: In that response that you just had, you mentioned something about what I would call the third plank of the five that you went down, investment discipline. Because you were talking about liabilitydriven investing. And there were some other things that you talked about. I want to talk about what you are able to do that individuals aren't able to do. And in particular, I'm thinking about your asset allocation mix as well as some of the other things you were talking about. What, as you think about when you got into the business in '99 versus now, what's happened in terms of the asset allocation mix? And how is it different than, say, I, as an individual, would be able to invest? JIM KEOHANE: Well, just an example, we went through this exercise after the 2000 tech meltdown. And we went very quickly from having a surplus to a deficit. And when we unpacked that, we can see that first of all, there was way more risk in a portfolio than we thought. We had the traditional 60-40 equity plan at the time. And most of the risk came from mismatched between the assets and liabilities. So we had a situation there where interest rates went down, so our liabilities went up, and our assets went down. So it was a perfect storm. And that time, it was accepted that that's just a risk of being in the pension business. And we thought, well, surely, we can manage that more effectively. And so we started thinking about ways to better align our assets and liabilities to take away some of those major risks. And in our previous exposure with derivatives, it really allowed us to think about the portfolio in very different ways. And derivatives allow you to break the portfolio down of its component parts. So I think about the capital asset pricing model, which sells risk brief was beta plus alpha. So a risk brief for us is essentially long term bonds. Beta is whatever exposure risky assets you want to get, which you can achieve through the use of derivatives. And alpha is just management strategy. So the two biggest risks probably most pension funds have is actually, equity markets exposure and interest rate risk. And both things those scenes come from moving to having equities in your portfolio. So if you think about the least risk in a position we can have is owning bonds, right? But that doesn't produce enough income to actually-- the plan would be unaffordable if that's what you have. So if you don't use derivatives, the only way you can get exposure to equities is to actually to sell your bonds and to buy equities. So not only do you take on equity exposure, you actually create a big interest rate mismatch. So if you use derivatives, you actually do an overlay. So you can go leave your money in bonds and then just do equity overlay on top of that. So using equity futures swaps or options. So that's essentially what our portfolio structure is. We have a whole bunch of interest rate sensitive and inflation sensitive assets that hedge your liabilities much more effectively. And then we take on other risks in an incremental way using derivatives to gain those exposures. So that combination is actually less risky than if you had a traditional portfolio. So that's an example of things that we can do that you could not on your own. ED HARRISON: Right. And what about the alpha component of that mix? Because I know that that mix that you're talking about gives you less volatility. But I think you also said that there is more upside as well. You have almost the best of both worlds. JIM KEOHANE: In fact, what we've done is-- so there's three big risks which you're trying to hedge, which is inflation risk, interest rate risk, and equity market risk. So we're trying to control those risk more effectively. And we're trying to take other risks that are maybe more quantifiable and that if the worst case scenario plays out, it doesn't actually have a catastrophic impact on a plan. Whereas those other risks actually would. ED HARRISON: Right. JIM KEOHANE: So we entered into a whole bunch of absolute return strategies, which typically we would be used in a hedge fund world. So we'll do equity long shorts, credit long shorts, funding trades. We have a list of about 20 or 30 different things that we'll work on. And we may not have all the macro due at any point in time, but it's a diversified portfolio of absolute return strategies. So those strategies themselves actually produce enough return that then enables us to take our equity market risk down and still achieve the same level of return. So our equity market exposure is about 35% the portfolio while most people, it's more like 60% or 70%. ED HARRISON: Right. JIM KEOHANE: So if we had a big equity down market next year, we wouldn't lose anywhere near what our peers would lose. Now on a big up year, they're going to do better than us, but we're OK with that. ED HARRISON: Right. JIM KEOHANE: So it's intentionally making that trade off. ED HARRISON: And that goes to the conversation that we were having just before the cameras rolled. This is also another aside away from the five structure, because right now, what we're seeing-- we were talking about the coronavirus and we're talking about risk, and the question I had for you as someone who's in the business is, how is it possible that equity markets continue to go up almost more now and the macro risks are greater? And it's not just the coronavirus. It's also the fact that you look at growth global growth in general, you look at the PMIs that came out of Europe as an example-- very negative industrial production numbers, even in December before the coronavirus hit. So how is it that your equities-- the DAX is an example-- all time high. I don't understand how that's how people are doing that and what's going to happen to those two those markets when bad things happen. JIM KEOHANE: Well, I scratched my head a bit on that, too. But I've seen that before. If you go back to 2007-- and we're involved in all these markets, we could see it going on-- the credit crisis is well underway six months before the market peaked. So it was all there for you to see. And the market completely ignored it for a period of time. And so it's interesting-- my observation over time is that markets, even when they've got momentum, can go a lot harder than you think they're going to go. And they tend to ignore facts when it suits them. And we may be one of those peers right now where you look back a couple of years, you think, what were people thinking about? Because if you look back in 2010, what was going on at that point, you thought, why didn't people see that? So I think there's a bit of that now. I don't think people think it's a blip that we're going to look through. And everything is going to be fine. And central banks have the ability to manage all these things, which I think if you look previous periods before the last 10 years, you can see there's lots of things where central banks can't manage that. Again, it's a bit surprising, but that pattern I've seen before. ED HARRISON: And so that's why you're taking the position that you are in terms of giving away a little bit of the upside in order to deal with the downside. The view that I have is that the downside risk, when you look at those factors, could be larger than people might think. That is, when you think about the fact that we haven't really had a 20% pullback, and when you think about the fact that these macro risks are out there, and the markets are still going, you could have a very sharp drop in the market. And if that were to occur, it goes to a concept that I think that you were talking about in terms of wrong way risk. Talk to me about what that means in terms of pension companies-- how they manage those downturns. JIM KEOHANE: So you mentioned the wrong way risk. The wrong way risk-- in other words, if the market goes down, you're going to do worse. So I would describe the risk profile of a pension plan as a nonlinear risk utility. What I mean by that is that a loss is way more damaging than a gain is beneficial. So if I gained 25%, it's not as beneficial as a 25% loss is damaging. And so why that's true-- so if you go back to 2008, some funds did have 25% losses. And so today, if we we're fully funded, we have 100% of the assets we needed, we need during about 6% to keep the thing on an even keel. So if we lose 25%, we now only any of 75% of the assets to produce that same level of income, so we need to earn 8% on those assets. And plus, because we now only have 75% of the assets we had before, we need to earn 33% to get back to where we were. So it's a bit of a slippery slope. And we've done modeling, and you can see that there's a certain tipping point you get to that you can't recover from it. So this is an implicit assumption in the way pension funds are run that if you are this long term time horizon, equity market risk can get absorbed and you're going to be fine. Our modeling choice-- you can go these periods where you get to a position where you can't recover from it. So I think there's a tipping point which is probably somewhere between 60%, 70% funded that returns you need to earn to get back to a fully funded status are impossible to actually achieve. So what you want to do is make sure that you never get on that slippery slope. And so that's why we've constructed our portfolio the way we've constructed it. So we're prepared to give a work give away some of the upside to keep us all from having that downside. And so it just effectively reduces our volatility and never is going to get us in that position where we're not going to be able to recover from a big downturn. And we're very conscious of that all the time. ED HARRISON: Right. And since we're talking about asset allocation in general-- that's where I started on this-- you told me that you actually have a decent amount of real estate in Toronto-- also in DC, where I'm based. Asset allocation-wise, what's the breakdown? You talked about 60-40 when you first came to the business. How would you break that down today in terms of alternative assets like that-- real estate private, investment, and things of that nature? JIM KEOHANE: Yeah so we have about 15% of our assets in real estate. And real estate, because they're a matching asset, because that has very good inflation hedging characteristics. And plus, it produces good income. We have about 15% in private assets, private equity, private credit. And we have about 15% in public equities. And the rest of it is in long term fixed income and real return bonds, which is it'd be equivalent to tips. We do on some tips. And so we have an inflation hedging asset, which is real estate and real return bonds. So most of our-- I should start over. So we've actually broken our portfolio down two components, which is a inflation hedging portfolio and a return seeking portfolio. So inflation hedging portfolio contains real estate, real return bonds, and long term interest rate bonds-- all governments. And we also have a small infrastructure component right now we just started. So again, that portfolio would probably produce in today's world about a 3% to 4% return. We need to earn 6%. So we have another 200 basis points from other activities. So that's why we overlay on top of that, exposure to equities using equity index futures swaps for options. We have exposure to credit using credit default swaps. So we saw credit protection on the investment grade index to get our credit exposure. And then we have a whole suite of absolute return strategies. And so that combination creates our overall estimate. So it's hard to describe or perform in a traditional way. ED HARRISON: Right, yes. JIM KEOHANE: But it's because it adds up to more than 100. But that's the structure of the portfolio. ED HARRISON: Well, as you were talking, you were talking about inflation, and I was thinking about the drop in market. One of the things in terms of the underfunded position of pensions that I found interesting was this concept that in the board managed structure that you have, there is the opportunity to deal with COLA in a way that gives you some catch up. And that's also another, I would call, right way risk type of structure. Can you explain how that works? JIM KEOHANE: Sure. So our board intends to pay inflation protection on pension payments. So our objective is to try and pay people 100% of CPI every year as an adjustment on the pension. And we will do that most of time. But the board-- so it's ad hoc. So in other words, the board will only give you that if we have sufficient funding to do so. If we got into a period where we became underfunded-- our modeling shows that if took that to from 100% of CPI to zero, that would improve our funding position by up to 20%. So that's a big lever that really allows you to go through a lot of different downturns and manage through risk. And again, we model these things-- most of the time, if that's all you would need to deal with in order to keep our finance funded status sufficient to meet the obligations. So it's a very powerful lever. And a lot of the funds here have that. And the trade off I would tell members on that one is that our price is one of the lowest of all the major funds here. So members pay roughly about 8% of their compensation or their salaries for the plan. And we can keep it affordable like that because of features like that. The alternative is we can give you a guaranteed call, where we'd have to charge at 12. So if you give people that trade off, the risk is to you is that when you're retired, there may be periods where we have to lower your inflation protection. But when we get sufficient funding, we'll give it back to you. And we've done that a couple of times. We've never taken it to zero, but we've taken it to 75% CPI a couple of times. And once we had sufficient funding, we brought it back to 100% and actually made people hold back to where they would've been. So it's a very effective tool to enable us to manage through difficult periods and keep the fun going. So again, it surprises people when you find out how effective a tool that actually is. ED HARRISON: When you mentioned that example, by the way, it reminded me of the advocacy part that you have on the website, which breaks down into those five components. It talks about how much money you could save-- how much money you could put in if you were to put it into a HOOPP versus if you did it on your own. And the number that I saw was something like $900,000 extra that you would have to save on your own. Walk me through that math, because I think that's pretty extraordinary. JIM KEOHANE: Yeah, so what we did is we created a theoretical pensioner, and because we're a health care organization, it was a nurse. And so our nurse, Sophia, we assumed that she started her career at age 25 earning about $40,000 a year, and got the usual escalation through a career. And that she retired at, say, 65, and wanted to replace roughly, 7% of our income, which is what our plan does. And so if you go through what you need to do-- so that's the way we looked at the five factor savings patterns-- investment acumen, governance alignment, management of the accumulation phase, reassuring and I'm missing one. ED HARRISON: Savings fees and costs. JIM KEOHANE: Fees and costs, yeah. So when you look at all those things-- and the two biggest ones are actually fees and costs and management of longevity risk-- those things result in, if you were an individual, you'd have to put aside about-- a correct number, I think, is about $1.2 million over your career to actually achieve that outcome for that particular individual, which, by the way, is almost impossible, given the income level. But then if you did it through HOOPP, you'd have to put aside about $320,000, I think, is the right number. So it's about a $900,000 on a difference between what it would cost you to produce exactly the same thing outcome on your own that you could produce with an approved plan like HOOPP. So it's a much more efficient way to actually achieve the same outcome. ED HARRISON: And you guys-- from my perspective, you're totally underselling that differential, because you say $900,000, but you don't show the actual numbers. 320 versus 1.2 is, like, a ridiculous transformation. I mean, you're talking about almost four times as much that you would have to put away in order to replicate that on your own. JIM KEOHANE: Yeah. And the reality is most people just don't have that kind of money to do that. So it's not even a matter of whether you if you wanted to, you probably don't have sufficient funds to actually do that. But that's the equivalent number. ED HARRISON: The thing is-- and we talked about this yesterday, when we were talking about the interview, that I think-- Jim Leach, when I spoke to him, and Ramsey Smith, who you also know-- when I spoke to him, they both mentioned this mortality risk, risk pooling. You said that risk pooling and fees were the two biggest things. And we haven't talked about risk pooling at all, but tell me where does the big savings come in there? JIM KEOHANE: There's a couple of things. The first is-- well, there's three places where you get big risk pooling benefits. The first is if you were an individual and think you're going to retire in 2008, you may have had a 40% drought on your funds. He's off to take a much lower income in your retirement or you have to postpone your retirement activity. If you're in our plan, that risk gets absorbed across generations, so people are retired in 2008 got the same as they were expecting and it worked out fine. Second place is if you're on your own and you retire at 65, you've got this chunk of money, it's got to last the rest of your life. So you can't take a loss or you may find yourself in a very difficult position. So you have to actually dial your risk now. So you have to take a much higher fixed income component in your portfolio than you would otherwise have. So that actually reduces your return over-- which could be very long period of time. It's 20, 30 years, right? Whereas in our plan, again, because that's absorbed across generations, we can maintain the same asset mix all the way through that period, so we can maintain the returns. So again, that makes a big difference. The third place is longevity pooling. And so if you think of it a large plan like ours, we have 380,000 members in the plan. So our mortality becomes pretty predictable. And so in our case, it's about people over 65, the average mortality in our plan is about 87. So we know that we have to pay people for roughly 22 years. And we can charge people based on that. And so we can charge you less through you're working career, because we know that that outcome is pretty predictable. Whereas if you're an individual-- within our plan, some people pass away shortly after retirement, but a lot of people live a very long time, too. So we have members in our plan-- the oldest member is 104. And she actually retired in 1976, by the way, so she got a pretty good deal. ED HARRISON: Yes. JIM KEOHANE: But we actually have 72 members that are over 100. And we have 2,500 between 90 and 100. So people live a long time. So as an individual, you have to assume you're one of those people, because you don't want to run out of money when you're 90, right? ED HARRISON: You don't want to be eating cat food at 90. JIM KEOHANE: Right. So in our plan, you're going to get paid for your entire life, because that risk is shared across the membership. Whereas you as an individual, you'd have to save a lot more money to get the same outcome or you have to take a lot less money in your retirement in order to make sure it lasts through your career. So just that, even if you assume you're going to live five years longer than the average, that's a lot of money. ED HARRISON: That is a lot. And of those two outcomes, the second one is the one that gets me. You say you can either save more money or reduce your expenditure once you actually retire, because that has huge public policy implications. I mean, the whole concept-- when you're going from defined benefit to defined contribution, basically, what happens is all of the risk is loaded onto the individual and that individual changes their behavior. JIM KEOHANE: That's right. ED HARRISON: And that change is one that actually reduces consumption. It reduces your growth in the economy. JIM KEOHANE: And so we had a study done a few years ago-- it was done by Boston Consulting Group for us. And the objective the study was actually to look at how the distributions from defined benefit plans impacted local economies. One of the interesting things that came back out of that study-- I mean, they weren't looking for this, but that's what they found-- is that there is a very different spending pattern between people that were in defined benefit plans and had predictable income versus people that were not. And so people that were not generally hadn't saved enough during their working careers and became savers in retirement. ED HARRISON: Right. JIM KEOHANE: And they're all worried about outliving their money. And there was no predictability as to what the next check is going to be. So they became savers in retirement. Versus people that were in defined benefit plans knew they were going to get a check next month, so spent the money. And so one has a dampening effect on the economy. The other has a stimulating effect on the economy. But even if you go back to what we just talked about, that difference between in the working group, putting aside $1.2 million versus putting aside $300,000-- that puts $900,000 back in a person's pocket or in their working career they can spend on other things. So again, a stimulative impact on the economy. So that seems to get lost a bit. And in fact, that there are a lot of economic benefits to people having predictable income and , again not taking as much away from them during their working career. So efficiency makes a big difference. ED HARRISON: Oh yeah, definitely. And I mean, I guess we've gotten to the solutions. I feel like we've gone through all five of the different parts that you were talking about. So I feel like we should talk about now that you're on the verge of retirement, when you think about your legacy and what you can tell people about what needs to be done for the future, what are the takeaways? I mean, one of the big takeaways for me is that defined benefit is good. JIM KEOHANE: Yeah. So a defined benefit-- I think in today's vernacular, you wouldn't call HOOPP a pure defined benefit plan. It's a target benefit plan. ED HARRISON: And tell me what what's the difference between those two. JIM KEOHANE: So the difference is our objective is to meet that pension obligation to the member. And that's very much ingrained in our DNA in the organization. But if that didn't happen, you'd have to do things like adjust the COLA or if it got worse than that, you may have to actually reduce people's benefits. We don't want to do that, but it's possible that could happen in a really extreme negative scenario. So that's why we try to make sure we never get into that. So effectively, the risk is in HOOPP. So it's not in the employer. So that model actually, I think, is one that could work going forward for employers. It gets around the accounting issue. So it becomes acceptable to employers. So you can create something that looks a lot like a defined benefit plan, which is way better-- most people are way better off in that type of structure than trying to do it on their own. So really, what we want to do is try to move people away you-- the trend is very much moving from traditional defined benefit plans to individual plans. And I think unless something happens, that trend is going to be unstoppable. And so I think we need to try and think about what solutions can we have that will work in today's world that are going to move things back in the other direction. And I think a structure like our plan is one that could work in the private sector if you had the right public policy that allows that to happen. ED HARRISON: Right. Some people, they don't have any access to target or a defined benefit plan. So the question is, what can public policy do for them? JIM KEOHANE: Well, it can create-- again, so we create entities that are run the pension plan. So I think the important thing is to move the management and operation of the pension away from the employer to these third party entities. ED HARRISON: OK, yes. JIM KEOHANE: Which is what would our structure is. And so if you look at Australia, that's effectively what they've done. So in Australian, all Australians have to be in a pension plan. Their structure is defined contribution. But I think you could take it one step further make it look like our plan. And those entities are set up away from the employer. So each state has one. So there's a Victoria state plan, there's a New South Wales plan. So each state has one. Plus, you could choose a private solution if you want to. And so there's a bunch of industry funds set up. So you have to be in a fund. You pick the one you want to be in. So a portion of your paycheck every month goes into that fund. And the employer in some cases, matches, some cases, doesn't. But then it becomes pretty portable-- wherever you work, you can stay on that fund. So portability is another drawback in the current world to the traditional corporate DB plan, because people don't tend to stay in the same job their entire life, which used to be true. And so portability is an important factor as well. So having third party entities that are separate from the corporation alleviates that issue. The other issues that that alleviates is that the life of the pension plan is very long. And so if a Canadian rolls it forward, it sounds infinite. So we have current liabilities that go at 70, 80 years. Very few corporations survive 70, 80 years. So there's a mismatch between the life of the plan and the life of the corporation, too. So the traditional idea that the corporation sponsors the plan doesn't work very well in today's world. So again, there's a bunch of things that I think our model deals with that are challenges in the current environment. ED HARRISON: And can you talk to the generational issue that is what I would call baby boomers, who are retiring now, Gen X, people like myself, and millennials, who are coming? The types of things that you're talking about, who would benefit from them the most, and how do you deal with those different generations in terms of what they can expect to achieve? JIM KEOHANE: Yeah, I think it's probably too late to deal with the baby boomer generation, because the baby boomer generation, those people like me, they're entering retirement. ED HARRISON: Right. JIM KEOHANE: And so if you haven't dealt with it, you should have dealt with it 20 or 30 years ago. But it's too late for that. It's like the expression, when is the best time to plant a tree is 25 years ago. But the next best time is today. ED HARRISON: Right. JIM KEOHANE: So you can take the learnings from today and apply them to the next generations coming up so they don't have the issue. And I think in a lot of the current generation, actually, we're in DP plans, so it's not as acute an issue for the current group of retirees. It will be a problem for your generation, because a lot of-- I'm sure a lot of you and your peers don't have defined benefit plans. But if you start the process today, it's going to be a lot better than it would be otherwise. And so it's not going to fix the current acute problem, but you can take those learnings and make it better for future generations. And if you don't fix it, you're going to have the problem. And [indiscernible] doesn't have a problem. And so I always say they should be the ones paying the most attention to this, not the current generation, because it's going to affect them the most. ED HARRISON: Well, we'll leave it there. Jim, it has been a pleasure to talk to you. And I really wish you well in your retirement. JIM KEOHANE: Well, thanks, guys. It's been great talking to you today. ED HARRISON: Thank you.