Monday, June 9, 2008

Who’s Taking the Risk?

In yesterday's post, Defining Retirement, I pointed out that House Bill 315 was working its way through the Ohio General Assembly. This is a bill that would require Ohio teachers and school districts to increase their contributions to the healthcare fund of the State Teacher's Retirement System (STRS). The problem this bill addresses is that STRS has projected that this fund will run out of money by 2021.
These big retirement systems are really insurance companies. They take in Contributions (premiums) from their members/customers, invest the money in various ways, then pay out benefits at some point in the future. To remain solvent, all they have to do is have more money coming in than going out. In other words, the amount they collect in premiums plus the amount they earn on investments has to be less than they pay out in benefits.
The challenge is that at any point in time, the money they have to pay out in benefits today must come from premiums collected and earnings generated in the past. When they were collecting those premiums and making those investment decisions in the past, how did they know how much they would be paying out today?
They didn't exactly. The art of predicting those future cash demands is called actuarial science, and it's a mixture of economics, accounting, finance and statistics that requires a pretty sharp mind. I have a good friend who is an actuary. He was his high school valedictorian, got a perfect 36 on his ACT, and graduated summa cum laude from Ohio State in four years with two BS degrees in four majors. A true brainiac.
My friend and actuaries like him have to take in account projected future life expectancies, inflation, earnings rates, cost of living to figure out how much to collect from teachers and school districts today so that there's enough money in the fund to pay pension and healthcare benefits to teachers who will retire 30 years from now.
As taxpayers we can, with a little work, see how much the district employees and the district itself is contributing to the STRS. It's a little harder to figure out how the STRS is investing that money – a good chunk of which originated as our property taxes. Here's a website that appears to have a pretty good summary of the STRS stock holdings. It reports that the STRS stock portfolio is nearly $26 billion, but the investment return has been only 0.50%.
However, in recent years it seems to have done pretty well: On February 16, 2007, Buck Consultants the STRS actuary, issued to the STRS Board an actuarial valuation of the STRS health care program. The report noted that the funding status of the health care fund has improved during the last year due in large part to an investment return exceeding 16%."
Here's a glimpse into the world of actuarial science: "If legislation to create a dedicated revenue stream for STRS health care is enacted (ed- HB315), the annual required contribution for health care is 4.18%. However, …one component of GASB 43 may cause some confusion in the coming months. If a retiree health care program is not fully funded, GASB 43 requires that a lower assumed investment return rate for the existing health care funds be used. STRS Ohio has been using an 8% rate (the same rate it assumes for its pension fund). Based on the current funding status of the health care fund, STRS Ohio must now lower that rate to 5.5%. This, in turn, lowers the funded status of the health care fund from 41% to 28% and raises the annual required contribution from 4.18% to 6.55% … If the legislation requiring an increase in the annual contribution passes, and if an annual contribution of 5% of payroll is ultimately contributed to the health care fund, GASB 43 allows the investment return rate to move back to 8%. In short, based on the January 2007 valuation of the health care fund, the proposed 5% contribution increase is still adequate to fund the health care program on a full-reserve basis."
In other words, if HB315 passes, the actuaries can assume that the healthcare fund will earn 8% annually and the contribution (paid half by teachers and half by the school district) can remain at about 5% of salaries. However if HB315 doesn't pass, the actuaries have to assume that investment return will be only 5.5% annually, meaning the contribution will have to increase to 6.55% to keep things solvent – in their estimation.
Hopefully all of this gives some sense as to how complex a retirement system is.
But that's not the point of this post. The question is risk. What happens if the investment return is less than projected and the benefit payout more? Clearly, contributions would have to increase and/or benefits decrease to keep things in balance.
And if HB315 is any indication, the first step would be to burden the taxpayers of Ohio with higher taxes to pay those increased contributions on behalf of the school employees.
Doesn't there also have to be some discussion about whether the benefits need to be adjusted?


  1. HB315 has no chance in this legislative session.

    There is no statuatory requirement for STRS to fund health care. None at all. STRS does it because they can. As soon as they can't, they won't.

    Lack of health care changes retirement behavior. Teachers who would otherwise retire will stay on until Medicare kicks in. Districts desperate for expensive teachers to leave might have to offer additional incentives to counter STRS' inability to pay health care benefits. It really is a nasty cycle of dependency.

  2. This is an issue much greater than Hilliard or the teaching profession overall. The private sector woke up years ago to the fact that it could no longer afford to allow someone to retire in their 50's with 30 years of service and support them with a pension and health care for a 20+ year retirement. Global competition can no longer support such benefits. It was a painful transition, but the traditional pension is all but dead for most private employers now.

    This same issue will eventually face public sector employees, including teachers, in the years to come (as Paul's article describes). I think there will be friction in the future from the general tax-paying public when they see themselves working well into their 60's or later while some of their public sector neighbors have retired years before.

    I think it is very interesting that the debate going on right now with the levy is an issue forced by the fact that schools by law cannot operate in a deficit (which is a good policy). Makes me wonder how the Social Security and Medicare debates in our country would be different if the federal government had to operate under the same rules.

    THanks for the good work Paul.