Tuesday, December 16, 2008

Time Bomb

The chart above was posted on the blog of retired Ohio teacher Kathy Bracy. It shows that the value of the pension fund administered by the State Teachers Retirement System (STRS) has collapsed in value from a peak of $80 billion just a year ago to $50 billion, a loss of $30 billion, or 37.5%. Lots of investment charts look like these days, unfortunately.

This is a time bomb that threatens us all, not just the Ohio teachers – past, present and future – that are depending on this money to fund their promised retirement benefits. Whether you know it or not, you are one of the investors in this system (but not one of the beneficiaries).

Think of a retirement fund like the man-made lake behind a dam. The volume of water flowing through the dam and into the river downstream represents the benefit payments being made to retired teachers. The more that is allowed to flow through the dam, the lower the lake falls.

Just as a lake is replenished by rain, the STRS fund is replenished by three sources: a) contributions made by working teachers, currently 10% of their salary; b) contributions by the employer, currently another 14% of salaries; and, c) earnings generated by investing the pool of money.

The objective is to allow a planned amount of water to flow through the dam – year in and year out – without the lake going dry. Some years it will rain more than others. When there is a lot of rain, the lake fills up. In years of drought, the lake level falls. If our luck holds, and the demand for water downstream doesn't increase, we can keep water in the lake.

We are losing this battle at Hoover Dam by the way. There has been low rainfall for many years; meanwhile the demand for the water of the Colorado River (and the electrical power produced with it) continues to increase, preventing the dam operators from slowing the rate in which the Lake Mead is being drained. If this trend continues, the water may get so low that no more electricity can be produced by Hoover Dam. It would devastate the economy of the southwest, especially nearby Las Vegas. Some say it could happen in 5-10 years.

This massive $30 billion loss to the STRS fund is like a big hole opened up in the bottom of the lake and 37.5% of the water disappeared. It's just irretrievably gone. No way to get it back.

Meanwhile the volume of water that needs to be released through the dam is ever increasing because more and more teachers are retiring, and they're retiring at ever-increasing benefit levels (ie their retirement benefits are based on the average pay of the highest three years, not their lifetime annual pay – on which their contributions were based). Like Social Security and many other retirement plans, it's a Ponzi scheme of sorts in which the oldest members are being paid benefits funded substantially by the contributions of the newer (and working) members.

So what's the impact of that $30 billion loss?

Remember that one of the three sources of money into the fund is the income produced by investing the money already in the fund. Let's say that the STRS investment managers made conservative investments, like US Treasury Bills at 2% interest. With $80 billion in the fund, this would generate $1.6 billion per year in earnings. With only $50 billion in the fund, the earnings produced at 2% interest drops to $1 billion/yr. How do you make up the $600 million loss of income?

One way is to make more aggressive investments in hope of generating the same amount of income with less capital. To generate $1.6 billion in earnings with $50 billion, you need to be earning 3.2% interest. That doesn't sound like much more, but it is. It's actually pretty hard finding places to invest $50 billion and not take a fair amount of risk. As of last week, the auction for Treasury Bills produced a zero percent interest rate. In other words, folks would rather stash their money in an investment earning nothing than put it in CDs at a commercial bank. That's how scared some folks are right now.

And everything else is more risky, as the STRS investment managers found out in their process of losing $30 billion.

Here's another point that many people miss: While the slide from $80 billion to $50 billion equals 37.5%, to get from $50 billion back to $80 billion requires increasing the fund by 60%. Think of it this way, if you have two dollars and lose half, you've lost one dollar and have one dollar remaining. To get back to $2, you have to double your $1. In today's investment environment, it would take years and years. In fact, at a 2% annual return, it would take 24 years to grow $50 billion back to $80 billion – if no money were being withdrawn for benefits.

Remember that there are two more sources of replenishment for the fund, the contributions of the working teachers and the contributions of the employers – the school districts. Us.

STRS is not strictly a government agency, but it is chartered by state law, which also defines many of its operating parameters. In particular, it defines the maximum contribution of pay a school district may be required to contribute to the STRS fund. Currently that maximum is set to 14%, and that's how much is being collected. In other words, even in the recent 'good years' STRS took the maximum they possibly could from the school districts. They've already used up all their bullets.

However, we must remember that laws can be changed. The education lobby is a powerful presence in our statehouse, making significant campaign contributions to politicians at all levels, up to and including the Governor. It would not surprise me in the least to see ORC 3307.28 changed to raise the 14% limit a few percentage points.

When that happens, our School Board will be required, by law, to allocate funds to pay the increased percentage. The money used to pay for this benefit will have to be taken out of something else.

It should be taken out of the next employee contract, in my opinion. After all, we already paid for these benefits once. It wasn't our decision to hire investment managers who would make risky investments and flush $30 billion down the drain. Most of that $30 billion was money we paid directly (via a paycheck from which they made their 10% contribution), and indirectly (via the 14% employer contribution). I certainly don't feel any responsibility to pay more property tax to restore the $30 billion THEY LOST.

We have to keep eagle eyes on this.


  1. Ugggh.

    I feel for the teachers and administrators (especially the younger of the group) on the potential impact to their retirement based on this.

    Just as I feel for the UAW and any other company-sponsored pension plans that people counted on that look like this.

    Just like my retirement plan shows a similar trend.

    Everyone is in this boat, and everyone is afraid and angry.

    Nothing against public education employees, but everyone is hurting, and there is no way I can see that everyone gets served.

  2. Isn't this the fundamental problem we are seeing in the auto industry, and frankly, ALL industry where pensions are earned and paid? I know my pension (yes, I'm a dinosaur and actually still have a pension) is a "pay forward" type of arrangement. Granted the impact of today's economy on a particular pension fund is dependent upon how the funds were invested (high or low risk). But, just as GM is struggling with the weight of a large retired base, many companies are experiencing the same problem.

    Education, auto, manufacturing, other government agencies, police officers, firemen, etc., are all in the same boat (assuming they have a pension plan). That's one of the issues with the auto-industry bailout.... some say to let them fail (I tend to be one of them, only because I believe it to be inevitable, so why sink good money after bad), but the ramifications of that are not only the loss of current jobs, but also the loss of a pension for MILLIONS of retired autoworkers. So, in that sense, taxpayers will be paying for those retirees one way or another. Either by bailing out the indistry so the pension plan can remain solvent or by federal aid that becomes necessary because of loss of benefits and income.

    I don't have an answer... wish I did. But my point is that this is a wide-spread problem and not at all unique to STRS.

  3. Hey Mark.... Great minds think alike! LOL

  4. Paul, has the board, treasurer, supt
    commented on this situation. Given the power in the statehouse by the
    OEA, NEA< HEA and its teacher support
    this would have a drastic effect on our budget. I see this passing in the statehouse.

    So in effect we would be having to deter funds from our current programming to pay for this. It would require cutting more than
    music, sports, middle school language, summer school.

    I think it would be a good idea to get a projection on the various scenarios of a 1,2, or 3% increase
    in the contribution. Standing on this alone, what would be the increase in local tax contribution
    needed to cover this new need for
    a local tax increase. This would be on top of the next contract,
    which most likely will be the same
    increase as the last 3 contracts,
    7% for at least 70% of the staff
    plus 3% for everyone else and
    a 4% administrative raise.
    KJ brought up the planning time increase
    and additional aides support staff.
    This will also increase our costs

    Based on contract negotiations last time I dont see the HEA and the teachers willing to adjust anything as you suggested
    but will certainly be looking to add cost in the planning area besides the regular raises.

    I know that our responsibilities are to provide top leveleducation for our kids Howeverwont
    this pension fund shortfallgoing to come at the expense of our
    educational offerings.? So wont we need to add even more to our future levies to account for this?

    This is a very scary scenario.
    Hopefully the board, and treasurer
    can comment at the next meeting and get some breakdown costs.

    Last question as it is allways about the kids. If we lose programming because we have to fund
    more pension money, how is that
    benefitting the kids and their education. Would we still keep hearing we dont get it from the employee unions and their members ?

  5. Mark, I think the teachers and administrators will expect us to
    offset the deficit amounts with an increase in the contribution rate from the district. With the clout at the statehouse hopefully the increase would only be perhaps 1 or
    2% As I asked in another post, I wonder what that increase would cost us in additional taxes.

    This concerns me as this money would come out of current programming and we would have to replace it. Why is a pension fund
    more important than our education
    of our kids ?

  6. KJ:

    STRS is a very different beast than most pension funds, mainly because of its quasi-governmental nature.

    For example, my older brother worked for a metals company his whole life, retiring a few years early through a buyout program created to help them downside the company. The trouble was that his employer went bust, taking the pension fund down with them, forcing the retirees to fall back to the benefits available under the federal Pension Benefits Guarantee Corporation (PBGC). His pension was cut to about 25% of what he was getting before. Moreover, he was a number of years short of being old enough for Social Security and Medicare. It was a very tough time for him and his wife.

    In the crazy times we have right now, it will be interesting to see which pension funds the federal government decides to bail out. One approach would be to shore up PBGC and pay out benefits at pennies on the dollar, as was the case with my brother.

    But big politics are in play today, and when you're talking millions of retirees - the most faithful voters - the possibility is high that a failed GM pension system, for example, would get fully funded by the government.

    So in a way, you're right, STRS is apt to get a bailout, just like GM is apt to get a bailout - all because the special interests have more pull in the houses of government than do the ordinary citizen.

    We let it get that way. Doesn't mean we shouldn't put up a fight.


  7. Rick:

    I doubt that this stuff is even on the radar of our school board or administrators. It's not real yet, and they have some immediate stuff to pay attention to - notably the revenue shortfall at the state level. There's a very real chance that state funding to our district could get cut materially - some are guessing up to 25%.

    I write about this stuff because it's one of the key drivers of behavior for folks in the school community.

    We also need to note that our administrators are conflicted on this point - because they are also STRS members. While they may seem to be on the side of the school board when it comes time to negotiate union contracts, they are very much aligned with the interests of the union members when we start talking about pensions.

    They would not likely raise any objection to the law being changed to raise the contribution limits for school districts.


  8. According to OSBA, there is a good chance that a new bill will be inroduced in the Ohio legislature next year that attempts to increase the taxpayer contribtion to STRS by 2.5% (for a total of 16.5% of certified staff salary) in addition to increasing the employee share from 10% to 12.5% over 5 years. HB315 was introduced last year but didn't get very far.


    OSBA thinks it may find a warmer reception in a Democrat-controlled assembly. The original purpose was to pay for retiree health care but it is plausible the money could be repurposed to keep STRS afloat if the investment portfolio continues to tank. Both sides of the STRS issue are covered here:


  9. Thanks for the links Marc.

    I wrote a similar piece about HB315 back in June, but this is a story that needs to be repeated every once in a while to keep it in everyone's head.

    There are just so many ways for the government to pick our pockets...


  10. Paul,

    From what I understand, there is nothing in the Ohio revised code that requires the providing of health insurance to retired teachers.

    Just a note: I say "we (STRS)" because although STRS makes these decisions, the money comes from me and you and all of the other Ohio taxpayers.

    In 1974 we (STRS) began subsidizing health care insurance for retired teachers and in 1978 the coverage was modified to include spouses and dependents. Prior that that, no health insurance was offered and to date, although the system is permitted to subsidize health care coverage, it still is not required. I assume at that time the number of teachers (and corresponding dollar amounts) contributing to the fund outweighed the number of retirees drawing resources from the funds.

    We (STRS) even used to give retirees a 13th month check for the surplus funds.

    As the number of retirees increased and the highest 3 yr. average amount increased and the percentage growth in new teachers entering the system decreased, it was necessary to eliminate the 13th month check. Then it was necessary to increase the amount charged to retirees for continuing to provide medical insurance.

    Right now, of the 14% that the school districts pay, the retirement system uses 1 percent of the employer contribution for retirees' health care with the rest (13%) going to pensions.

    Maybe the solution isn't for us to increase the amount of money set aside for health care coverage, but to quit providing it and allow the teachers to function like the rest of the population who either have to work until they qualify for Medicare, or to privately purchase coverage for themselves and their families.

    Then the entire 14% that we are currently contributing could go entirely toward funding the retirements. That might motivate teachers to work past the age of 50, thus reducing the number of years we are paying their pensions.

    I'm definitely against the whole concept of HB 315 - which only rewards teachers who retire at the earliest ages possible at the expense of those of us who must keep working to age 67 in order to draw our retirement checks.

  11. KK:

    That's my understanding as well - Ohio law does not require STRS to provide any kind of health coverage. The point of HB315 is to create a dedicated revenue stream for that health insurance, in essence making it part of the defined benefits.

    You make excellent points. When pension systems were first created, the contributions made by and on behalf of a worker, along with the earnings from conservative investments, provided enough funding to pay for the lifetime retirement benefits of that worker.

    But in the span of two generations, the life expectancy of retirees went up by 15-20 years. The contributions made by and for a current retiree are nowhere near enough to pay for 2x or 3x the numbers of years those contributiions were originally designed to fund.

    There are only so many solutions to that problem:

    1. Increase the contributions. This has certainly happened, primarily by the steady rise in salaries of working employees. The catch is that this also increases the future liability.

    2. Seek greater investment returns. However, higher returns means more risk. I think the STRS folks forgot that, and so just got burned for $30 billion.

    3. You can cut the benefits to retirees.

    I doubt that any either class of STRS member wants any more of #2.

    Retired STRS members want choice #1 of course, and would put up quite a fight against #3.

    Working STRS members probably like #3 better, even if it means cutting their own future benefits. It's a bird-in-hard kind of thing.

    Of course the best form of #3 is to have the taxpayers contribute more - which is exactly what HB315 is meant to do.

  12. I agree we need to keep an eagle eye on this, AND that any increase of the 14% we already pay MUST come from the actual salary budget. The word "bailout" has become the buzz word of the decade and the way I look at it, every time the district comes to us with a levy or bond request, it is a "bailout". Bailouts need to be justified, and if the district, by state law, has to increase it's contribution, and then asks the taxpayers to cough up the money while continuing the past contract practices, then we need to stand up and say no. As said, this is NOT about the kids. This issue could/should become another reality check for the district and it will be interesting to see how they respond.

  13. Paul:

    Other than a blog posting, what is the basis for the graph. I'm not saying it's wrong, but I looked for something similar on the STRS web site and can't find it. Is there some "official" source that says that STRS lost 37.5% of their portfolio?

  14. Marc:

    I don't recall exactly where I saw it, but it seems to me that there is a table somewhere on the STRS website that shows the same data points.


  15. Kathy Bracy's latest post suggests that this victim mindset she portrays is widespread.

    I'm not defending the bonuses paid to the STRS managers. All I'm saying is that both the leadership and the members of the STRS let it happen.

    They had no problems when their investment managers were producing high level of return, and didn't bother to ask if that was happening because they were also taking high levels of risk.

    Now that their retirement fund has taken a big hit, they want to blame everyone except themselves...


  16. The STRS web site defends the bonuses as being paid for performance in the last fiscal year, which tends to make sense. I think we need to wait to see what they pay out after the market crash. You have to keep in mind that many top corporations pay out those kinds of bonuses even in years when they lose money - it seems to be the corporate philosophy in America. Also, it seems to me that some are lambasting the performance of the fund, while forgetting that almost no fund has been immune. Has anyone bothered to check how much they have paid in fees for their OWN retirement accounts? Or what the fund managers have made in bonuses? Now, if it comes down to the district having to cover those losses, that is something to protest, ideally BEFORE it actually gets paid. And lets make sure we protest at the state level, not the district level where they have no control over it, other than to adjust their budget somehow to account for any increase in that 14%.

  17. Hillirdite:

    My understanding is that the bonus structure is such that the fund managers get paid a bonus based on their performance relative to a benchmark set of investments (e.g. the S&P 500 index). So if the S&P500 index loses 20%, and the STRS managers lose only 10%, they get rewarded.

    The thinking behind such a reward system is that you don't over compensate the managers in a year when the whole market is rising ("all boats rise with the tide"). But obviously the STRS board didn't think through what would happen if the whole market went down - ie that the fund could lose money and the managers still get rewarded, provided they lost less than the benchmark.

    What I'm trying to say the Board (and the STRS membership) made the same mistake as many many people in the past decade - assuming that the historically huge returns they were seeing had no accompanying risk. I had more than a few folks tell me that it was more risky to not be in stocks over the past decade.

    I disagreed and backed up that belief by pulling all of my retirement investments out of the stock market in 1999, and shifted everything to CDs, municipal bonds and other low risk investments. As a consequence, my retirement portfolio is completely intact, while most of my friends have seen upwards of half of theirs evaporate. Hard way to learn about risk.

    The STRS membership has just learned that same lesson. They could have made much safer investments. Compare way STRS invests its money to the way the Treasurer of the State of Ohio invests state funds. The State of Ohio's funds are invested in US Treasuries and high grade commercial bonds with maturities within 2 years. Boring, but low risk. Can you imagine what kind of mess the State would be in if the Treasurer had lost a boatload on screwy investments (that happened in my home state of WV about 20 years ago).

    Anyway, the point of this post is to alert folks to the current of thinking in the education community - especially among retired teachers - that they were somehow innocently victimized, that their huge losses are not their fault, and that it should be the duty of the state (meaning we taxpayers) to replace the lost funds.

    That's wrong. It was the Board they elected managing the funds managers they hired who made risky investments that resulted in this loss of the money we taxpayers contributed in the first place.

    In those years when they had extraordinary investment profits, they didn't tell the taxpayers they could contribute less for a couple of years. They just paid out more to the retirees (e.g. the so-called '13th paycheck').

    So maybe at a minumum, they should get 11/12th of their pension for a few years to help the fund recover.

    Like that's going to happen...


  18. Shouldn't we just make the appropriate planning for an additional tax increase to pay for this increase in contribution from the districts ? This could be a significant amount, on top of certainly a bond levy for infrastructure upkeep, and more dollars to cover anotheremployee contract like the last 3.

    Perhaps the board and the admin can shed some light on at the next meeting about some straight talk on
    potentially needed dollars.

    Dont expect any adjustments tothe compensation model. The question was asked and no answer which means business as usual.

    The community will get a huge new and probably shocking bill, hope everyone has some home equity funds to pay for this big increase.

    In the meantime our union leadership and their members will continue to ask for more and more.
    And if we dont come through we will be hurting the kids. Not quite sure on a slightly less pension hurts the kids, but I guess we have to make it whole. I am sure one of the supporters for all of this will come up with one reason or another

  19. This is NOT about the kids at all,it is ALL about the employees. And the STRS admits that at least a small portion is intended to shore up the pension fund, while the rest is for health benefits which are not
    mandated by the state. Their brochure mentions that "Teachers understand that by requiring the employer to contribute an additional 2.5%, money for salary increases may move off the bargaining table". Am I the only one who doesn't believe for a minute that the HEA will go along with that, especially since the increase will "only" be .5% a year for 5 years until it hits the 2.5% total. Regardless, this is something our group is going to have to stay on top of. We must keep insisting that the Board cough up budget proposals that take these types of things into account, and tell us where they think the money is going to come from. You can guarantee that none of the present members who are considering running for reelection
    are going to want to address the need for getting into our pockets with another levy again - we will need to make sure they do exactly that.

  20. http://www.strsoh.org/pdfs/44-951F_HC_INIT1-2.pdf

    Forgot to include this link and can't figure out how to embed it.
    Thanks to Marc for providing it in his earlier post.

  21. Ms. Bracy has posted a presentation put together by an STRS member. It's in five parts

    Part 1
    Part 2
    Part 3
    Part 4
    Part 5

    Perhaps the most important statement in the presentation is this:

    "The STRS Board has contributed to the problem by setting an 8% growth rate goal. This is obtainable only by utilizing a higher proportion of stocks than is otherwise prudent for a retirement fund. The primary goal of all retirement pension systems is preservation of capital. Insistence on a high percent growth rate simply encourages investments more risk than wise because of the higher returns.

    Exactly. So where was this guy BEFORE the crash? I suspect that he was just as apathetically happy as the rest of the STRS members.

    There's another gem in there that says a great deal about teacher-think:

    The current [investment manager pay] package is just too rich. It begins with very high base salaries (compared to STRS's clientele, who have just as much education as the investment counselors)...

    Someone needs to remind these guys that the richest man in the world (Bill Gates) is a college dropout. If Microsoft had a payscale like unionized teachers, he'd be about the lowest paid person in the building...